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Here’s the right method to assess AIF performance
Alternative investment funds (AIFs ) invest mostly in unlisted investments such as start-ups, early-stage ventures, real estate, infrastructure, and distressed assets
Alternative investment funds (AIFs ) invest mostly in unlisted investments such as start-ups, early-stage ventures, real estate, infrastructure, and distressed assets. Given the varied investments, correct benchmarking is crucial to assess their performance accurately. For AIFs, creation of a benchmark using available broader market indices is a challenge. Further, systematic risks of AIFs vary substantially through time, making it difficult to measure their performance. Peer group benchmarking can serve as a performance barometer, wherein a group of funds with similar investment mandates or strategies are identified for performance comparison. Here are some performance metrics:
AIFs, especially category I and II, are closed-end investment vehicles with cash flows (drawdowns and distributions) that are controlled and staggered based on available entry and exit opportunities, as identified by investment managers. Hence, money-weighted returns measured using pooled internal rate of return, or IRR, are more appropriate for performance comparison. Pooled IRR is calculated at an aggregate level by pooling the cash flows within all the schemes belonging to the category and the vintage year. Since performance comparison across funds should be done for the same period, a common practice is to compare with a group with similar starting year or ‘vintage’.
Money multiples may be calculated at the peer group level for comparison of investment and distribution patterns. Distributions to paid-in capital (DPI) is a key metric to evaluate the money returned versus money managed quotient, while the residual value to paid-in capital (RVPI) helps gauge unrealized gains. Total value to paid-in capital (TVPI) reflects the sum of realized and unrealized gains for similar types of funds. DPI is the ratio of total distributions made to investors to the paid-in capital.
RVPI is the ratio of the residual value of all investments remaining in the fund after distributions to paid-in capital. TVPI is the ratio of the sum of total distributions and residual value to the total paid-in capital.
Public market equivalent methods can be used to understand the alpha from an AIF over broader market indices. These methods replicate cash flows of an AIF to a public index to measure how an investment in the AIF would have performed in the public market index.
Selecting the right peer set is important too. Investors must refer to benchmarks that consider actual portfolio allocation for categorization. As of March 2022, venture capital fund benchmarks across vintages 2016-2021, barring 2019, delivered higher returns than other sub-categories under category I and II. For vintage 2019, benchmark for equity funds investing in a mix of listed and unlisted securities delivered the highest returns among other sub-categories within Category I and II AIFs. Venture capital funds belonging to the vintage years of 2016 to 2021 have also outperformed the S&P BSE Sensex and S&P BSE 500.
With increasing fund launches and changing industry dynamics, there is scope for further evolution of categories and addition of new sub-category level benchmarks. While benchmarking is the first step in fund evaluation, qualitative assessment covering investment management, decision-making processes and controls is equally vital.
Piyush Gupta is director–funds research, Crisil Market Intelligence and Analytics.
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First Published:27 Feb 2023, 11:59 PM IST
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