boltKey takeaways
- PME answers whether a private fund beat the public market by investing the fund's actual cash flows in an index on the same dates.
- Kaplan-Schoar PME is a ratio: above 1.0 means the fund outperformed the index over its life.
- Long-Nickels and PME+ produce an index-equivalent IRR; Direct Alpha produces an annualized excess return.
- The choice of index matters as much as the method; pick one that reflects the fund's risk, size and sector exposure.
- Because PME uses NAV for unrealized holdings, it inherits all the judgment embedded in the fund's valuations.
A public market equivalent (PME) compares a private fund's returns with the returns an investor would have earned by putting the same cash flows, on the same dates, into a public market index. It solves a problem that IRR and multiples cannot: telling you whether a fund's results reflect skill or simply a rising market. The most common version, Kaplan-Schoar PME, produces a ratio where anything above 1.0 means the fund beat the index.
Why a simple comparison doesn't work#
It is tempting to compare a fund's IRR with the index's annualized return over the same period. That comparison is flawed. A fund's IRR is money-weighted: it depends on when capital was called and returned. An index return is time-weighted: it assumes a single investment held throughout. If a fund called most of its capital just before a market rally, its IRR and the index's annual return describe different exposures.
PME methods fix this by applying the fund's actual cash flow timing to the index. Each contribution is treated as if it had bought the index; each distribution as if it had sold index units. The question becomes: given the same timing, would the index have done better or worse?
The main PME methods#
| Method | Output | How it works | Notes |
|---|---|---|---|
| Long-Nickels (LN-PME, or ICM) | IRR of a hypothetical index investment | Buys the index with each contribution, sells with each distribution, computes the IRR including the ending index value | Ending value can go negative if the fund distributes a lot more than the index would have grown |
| PME+ | IRR of a hypothetical index investment | Scales distributions by a constant factor so the index position ends at the fund's NAV | Avoids negative ending values |
| Kaplan-Schoar (KS-PME) | Ratio | Compounds every cash flow to a common date at index returns; divides value of distributions plus NAV by value of contributions | Widely used in academic and LP analysis; easy to interpret |
| Direct Alpha | Annualized excess return | Compounds cash flows by the index, then computes the IRR of the adjusted flows | Expresses outperformance as an annual rate |
All four use the same inputs: dated contributions, dated distributions, the most recent NAV, and index levels on each of those dates.
Kaplan-Schoar PME: the formula#
KS-PME = [Σ Distributions_t × (I_T / I_t) + NAV_T] / [Σ Contributions_t × (I_T / I_t)]
where I_t is the index level on the date of each cash flow and I_T is the index level on the valuation date. Each cash flow is grown (or shrunk) by the index return between its date and the valuation date. Equivalently, you can divide each cash flow by the index level on its date; the ratio comes out the same.
A KS-PME of 1.20 means the fund produced 20% more value than an equivalent investment in the index over the fund's life. It is not an annual figure.
Worked example (hypothetical)#
Assume an LP's cash flows in a fund, with a total-return index level at each date:
| Year | Cash flow | Amount | Index level | Amount ÷ index |
|---|---|---|---|---|
| 0 | Contribution | $100M | 100 | 1.000 |
| 2 | Contribution | $50M | 120 | 0.417 |
| 4 | Distribution | $80M | 150 | 0.533 |
| 5 | NAV (valuation date) | $160M | 140 | 1.143 |
- Index-adjusted contributions: 1.000 + 0.417 = 1.417
- Index-adjusted distributions plus NAV: 0.533 + 1.143 = 1.676
- KS-PME = 1.676 / 1.417 ≈ 1.18
For comparison, the fund's TVPI is (80 + 160) / 150 = 1.60x. The index rose 40% over the five years, so part of that 1.60x reflects market movement. The PME of 1.18 indicates the fund still beat the index by a clear margin on a timing-matched basis.
Notice the effect of the second contribution: it was made at an index level of 120 and the index finished at 140, so the index would have grown it only modestly. A simple point-to-point comparison would have missed that.
Choosing the right index#
The method is less contentious than the benchmark. A fund can look strong against one index and average against another.
- Match the risk. Small-cap buyout funds are often compared with small-cap indices; venture funds with growth or technology-heavy indices. A large-cap index can flatter or penalize depending on the period.
- Use total return. Price-only indices omit dividends and understate the public alternative.
- Match currency and geography. A European fund reporting in euros should use a euro-denominated or local index.
- Be consistent. Choose the index in advance and keep it. Switching indices to find the most favorable result undermines the analysis.
- Consider leverage. Buyout funds use portfolio-company leverage, so some analysts adjust the index or use a levered benchmark. If you do, describe the adjustment.
Disclose the index and method next to every PME figure.
Interpreting PME results#
- Above 1.0 (KS-PME) or positive Direct Alpha: the fund outperformed the index on a timing-matched basis.
- Below 1.0 or negative alpha: the LP would have done better in the index, ignoring differences in risk and liquidity.
- Context matters. LPs often expect private funds to beat public markets by a margin to compensate for illiquidity, fees and concentration. A PME of exactly 1.0 means the fund matched the index, which many LPs would view as insufficient.
- Market cycles shift the picture. In a strong public market, private funds with lagged valuations can show weak interim PMEs; after a public drawdown, the same lag can make interim PMEs look strong. See bull vs. bear markets for how cycles flow through private fund metrics.
Limitations#
- NAV dependence. For an unrealized fund, the final term is NAV, which is an estimate. PME is only as good as the portfolio valuation behind it.
- Beta assumption. Standard PMEs implicitly assume the fund has the same market sensitivity as the index. If the fund is riskier, outperformance may partly be compensation for that risk.
- Not a ranking among peers. PME tells you about the fund against the market, not against other private funds of the same vintage. Use it alongside quartile benchmarking, as covered in fund performance metrics.
Producing PME in practice#
- Export dated LP-level contributions and distributions (net of fees and carry) and the latest NAV.
- Obtain daily total-return index levels for the chosen benchmark.
- Match each cash flow to the index level on its date (or the nearest prior trading day).
- Compute KS-PME, and optionally Direct Alpha for an annualized view.
- Present the result with the index, method, as-of date and NAV basis.
Direct Alpha in brief#
Kaplan-Schoar PME tells you by how much a fund beat the index over its whole life, but not at what annual rate. Direct Alpha fills that gap. Each cash flow is compounded forward to the valuation date at the index's return, exactly as in the KS-PME calculation. An IRR is then computed on those adjusted cash flows. Because the index's return has already been stripped out, the resulting rate is an annualized excess return.
A positive Direct Alpha of, say, 4% means the fund outperformed the index by roughly four percentage points a year on a timing-matched basis. It is often easier to explain to an investment committee than a ratio, and it can be compared with a target excess return set in an LP's private markets policy.
How Privatis helps#
Privatis keeps every capital call, distribution and quarterly NAV in a double-entry fund ledger with exact dates, which is the data any PME calculation depends on. Clean, dated LP-level cash flows and a consistent NAV history make index comparisons straightforward to produce and to defend, and the audit trail records any change to the cash flows or valuations behind a reported figure.