Cheating with your IRRs is like cheating at golf.

golf cheat


Chris Flood of the Financial Times is again at odds with the Private Equity industry who he holds are fiddling their investment returns, confusing what they are saying investors get with what they actually get. This goes to the very heart of the transparency debate and the problem is summed up by Ludovic Phalippou.

Mr Phalippou warns that IRRs are not rates of return that investors will earn, adding that it is easy for private equity managers to manipulate IRRs on buyouts deals in western countries.

Taking what actually happens to an investor’s money as the true measure of his or her internal return is a simple business. You take the contribution history and measure it against the outcome, the amount that the investment can be realised at – the net asset value.

This is not what private equity funds always do. The particular issue that Flood is engaged in is the borrowing of money by private equity  (PE) houses received. The trick is to borrow money cheaply (with the borrowing costs charged to the fund) so that the PE house can be credited for performance before the investor’s money arrives. This allows the fund to pay the PE house higher performance fees and perpetuates the myth that the investor is getting more for his/her money than they actually are.

By the time the borrowing costs are charged back to the fund, the performance fees have already been paid and what the investor gets back is considerably less than what the fund is claiming as performance.

According to Flood, financing the buying of investments and the paying of fund distributions through cheap credit is now a long term business. Investors can continue to be duped into thinking that the inflated IRRs are what they’re getting long after their money has been depleted by subscription line loan costs and the performance fees raked off by PE. US Research from ILPA suggests that this practice has been reported by investors in at least 12% of funds it analyses, the implication that actual practice is higher.

This percentage may not sound a lot, but this practice is additive to a long list of egregious offences against cost transparency already commented on in the FT, by Ludovic Phalippou and on this blog

This tricky stuff is quite beyond the capacity of ordinary savers to get to grips with, indeed it’s more than likely the platform managers that provide UK’s professional investors aren’t looking through to this kind of thing when making their value for money assessments.

Right now there is an attempt by the private equity houses to get various forms of PE money into US DC pensions (401Ks)  and the arguments for funds doing so are performance  based.

“This is a positive step towards helping more Americans gain access to private equity investment, which regularly is the best performing asset class for pensioners,”

Drew Maloney, chief executive of the American Investment Council, the PE industry lobby group, tells the FT.


Will the UK DC industry succumb in the same way

To answer that question , we need to understand the difference between retail (SIPP) and institutional (workplace) pensions.

If you are managing a self-invested personal pension, you are simply re-selling funds on your platform, taking fees for doing so from the fund manager as its distributor. This could be called a mark-up model and it’s in your interest to sell the sizzle to the people buying the funds you are selling on.

But workplace pensions work differently, that’s because the vast majority of the money invested is through a default fund where the price at which the fund is sold on to savers is capped and subject to competition. Most UK DC defaults are cleanly priced with only a small part of the total cost being hidden from the displayed charge (the AMC). What is more , the hidden costs are now being published by IGCs and trustees in their value for money assessments. Here the onus is on the platform manager to only offer defaults which are transparent and low-cost.

So while the PE Houses may be able to get away with nonsense like “subscription line financing” to SIPP platforms, workplace pensions should be able to pick up what is going on. I say “should” but “should” depends on being made aware of the issue which is exactly why Ludovic Phalippou is so unpopular and why Chris Flood will be fast catching him up in the Private Equity Rogue’s Gallery.

Studies by Richard Ennis and Rob Bauer suggest the Rogue’s Gallery will need to be expanded to accommodate those lined up against PE performance cheating,

The key is consistent and full disclosure

I have been “outing” lazy disclosures at some IGCs for years. I have also called into question the practice of publishing high hidden charges without commenting on them.

While there have been pockets of bad practice, the IGCs (and GAAs) have improved disclosures and disclosures have improved the value for money investors get from workplace pensions. Similarly, some of the more egregious practices of fund managers have (especially since Woodford) been stamped on by the best SIPP managers.

However, despite MIFID II, the kind of practices outline by Chris Flood are not being picked up by most SIPPs and the advisers who use them.

I suspect that many of the large occupational schemes that have high amounts of private equity in their portfolio will find Flood’s article fresh news. In short, the amount of money under your control is not an indicator of how carefully you monitor what is going on.  Presence of high quantities of private equity in an investment portfolio of any kind needs to be explained and monitoring of what is going on within the fund (especially the declared and undeclared IRRs) is critical.

This is why I support the work of Chris Sier and others on cost disclosure.

How to keep our eye on the ball with our pensions

There is only one way for us to really find out what is going on with out pensions, that is to know our own internal rates of return based on when money goes in and when it comes out. We call this outcomes based or “experienced” performance.

Sometimes poor experienced performance is reasonable. Sometimes you are asked to pay costs up front rather than at the back of a contract. Performance measurement of a pot with front end charges is going to be disadvantaged compared to one who charges at the back end (compare NOW and Smart).

But getting to grips with you have a low or high IRR is your bet way of understanding whether you are getting value for your money. Fiddling IRRs as some PE houses have been found doing is like cheating at golf, it’s easy to do, but if you do it, you should get thrown out of the competition.

The feeling in the UK, where we have people watching over the funds we use, is that Until private equity can be properly measured for value for money, it should not be allowed into the competition in the first place





About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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