The private equity return gap

Abstract

Investors in private equity funds do not control the timing of their cash flows to and from the fund. The internal rate of return (IRR), the most popular measure of returns for private equity investors, is affected by cash flow timing, while the cash-on-cash multiple is not. Any gap between a fund's reported IRR and the return implied by the cash-on-cash multiple arises from exogenous shocks to cash flows and/or the timing choices of the fund's general partner (GP). In a sample of 3,915 private equity funds, we find that return gaps average over half of the magnitude of reported IRRs, are larger than expected, and persist across a GP's funds. High return gaps are negatively related to the GP's future performance, but facilitate future fundraising, especially among certain investor types (funds of funds, insurance companies, and private pension funds) and among relatively unsuccessful investors.