What Does Public Market Equivalent (“PME”) Analysis Tell Me?

by Michael Roth

Now that you have chosen the methodology and index, it’s time to interpret the results. Whether it’s a peer benchmark or PME analysis, the important story to tell is not the snapshot (a single quarterly datapoint) but the trend. One year provides more context but we think a three year view offers a clearer picture of how a fund or fund family is performing against the public markets.

In the above example, I plotted the North American All PE IRR against the Bison PME IRR for the Russell 3000 index. If I were a GP presenting this as my fund’s PME analysis, there are several key points that I would emphasize with LPs.

• My fund is outperforming the public markets by 3.2% through Q3 2015.
• My fund has averaged 3.1% PME alpha over the last three years.
• The markets have had a strong run over the last few years but our fund’s PME alpha never dipped below 2%.

Wrapping Up

PME analysis is here to stay as an LP analysis tool. Whether a GP is fundraising or performing their quarterly investor relations responsibilities (quarterly reports and quarterly update calls with LPs), it is important for GP’s to be knowledgeable about PME. A good IR team should have the answers to the questions discussed above. More importantly, they will have a well-crafted message that emphasizes the fund’s strengths.

Which Index Do I Choose for Public Market Equivalent (“PME”) Analysis?

by Michael Roth

In part 1, I addressed the question of which PME method to use. In this piece, I will discuss “best practices” for choosing an index.  This is undoubtedly a question that will be asked by sophisticated LPs. A GP’s answer will reveal how knowledgeable and in tune they are when it comes to LP concerns. When an LP is running a PME analysis against a GP’s net performance they are evaluating the opportunity cost of allocating money to private equity versus public equity.

To learn more about LP preferences, we surveyed 150 of the largest public pension funds in the United States to find out what they use as their private equity benchmark. Eighty-six disclosed their benchmark and we plotted the responses that show up more than once below.

More than two-thirds (59) use a public market index as their private equity benchmark and 70% of those LPs (43) use a broad public market index. The most popular index is the Russell 3000, which tracks the performance of the 3000 largest publicly listed companies in the United States.

In the last piece, I will address how to think about PME in the context of fund performance and how LPs are using it.

Which Public Market Equivalent (“PME”) Method Should I Choose?

by Michael Roth

Outperforming the public markets and the ability to speak intelligently about public market equivalent (“PME”) analysis is becoming a necessity in a GP’s investor relations conversations with LPs. Being unfamiliar with PME or saying “We don’t do PME” reveals a lack of sophistication and/or an indifference towards LP considerations. A GP needs to know the answers to questions like:

• Which PME method do you use?
• Why did you choose that index?
• What does PME analysis tell me?

I will dig in to each question in their own blog post, starting with which PME should I use.

Choosing a PME Method

We know of eight different PME methodologies. We understand the nuances and can walk through the specifics of each one. Frankly, the index IRRs of each methodology are often within 1% – 2% of each other. Despite this close proximity, we are partial to our own methodology, Bison PME. Why?

• Bison PME can be calculated in any situation
• It is the least prone to the shortcomings associated with the IRR calculation
• It is the most stable methodology

What do these points mean? In the image below, I have plotted the Russell 3000’s IRR using four different PME methods. For this analysis, I randomly selected 100 funds from our Bison funds dataset and sorted them by the Bison PME IRR. The Bison PME IRR for each fund is as of Q3 2015. 

The illustration shows that  GEM IPP and Direct Alpha are frequently in line with Bison PME. Meanwhile, Long Nickels shows that it is not a reliable PME methodology since it is frequently the outlier.

In the next piece, I will discuss how to choose a PME index.