Representative investments explained: how to read a private equity portfolio list

A page of logos tells you what a fund has bought. It does not tell you what each investment cost, what has been sold, what is still an estimate, or which deals were left off the page. Those four gaps decide whether a portfolio list is evidence or advertising. The rules that govern how managers present a track record are specific about each one.

What a portfolio company list shows

A portfolio company is a business owned by a fund³. During the investment period the firm works with its management to drive performance improvements³. The list of them is the fund’s inventory, and on its own it is the weakest document in an investor’s pack: names, perhaps sectors and dates, with no cost, no outcome and no valuation. Limited partners get far more than that. Investor reporting is built around regular fund valuation reports and transaction reporting, which give details of new investments and divestments, a breakdown of expenses, income and profit or loss, and a review of the performance of individual portfolio assets⁵.

The ILPA Principles show what the fuller picture looks like. An advisory committee agenda can carry a dashboard of performance per company relative to the original plan, a snapshot of each unrealised investment and the valuation methodology used over the last four quarters⁶. Annual reports arrive within 90 days of year-end⁶, and portfolio company information in them follows the ILPA standardised reporting for portfolio companies⁶. The table lists what the reporting adds to a list of names.

That standard has a history. ILPA released its Portfolio Company Metrics Template on 21 March 2019⁷ as a standardised way for buyout and growth funds to report individual company information to a limited partner⁷. The aim was to cut the work of building and reading data reports that mostly arrived in bespoke formats⁷. The template covers portfolio risk exposure, value creation and compliance with the partnership agreement and side letters, and includes a voluntary returns template, a separate ESG template, an M&A activity section and a valuation section that allows for multiple methodologies⁷. A working group of 30 organisations built it during 2018⁷.

Read a bare list of names as a starting point. Everything that makes it informative has to come from somewhere else: the fund’s reports, its audited accounts and the figures that standards bodies ask managers to disclose.

Selected and representative investments: what the rules say

A page of representative investments shows a subset. Regulators have a name for that and a rule about it. In the United States, the SEC’s marketing rule makes it unlawful for an investment adviser that is registered, or required to be registered, to disseminate an advertisement that breaks its paragraphs on content and performance². The definition of extracted performance is the performance results of a subset of investments extracted from a portfolio², and a portfolio can be an account or a private fund². A handful of deals picked from one fund is therefore extracted performance.

The last row matters for readers of private equity materials. The one-, five- and ten-year requirement applies to portfolios other than a private fund², so a private fund is not held to that grid. The protections that remain are the gross and net pairing, the all-related-portfolios test and the total-portfolio test for extracts.

Gross and net are defined in the rule. Gross performance is the result before the deduction of all fees and expenses that an investor has paid or would have paid². Net performance is the result after that deduction². Any statement, express or implied, that the SEC approved or reviewed the calculation or presentation of performance is itself prohibited².

Targets, rankings and endorsements

Targets and projected returns are hypothetical performance², which means results that were not actually achieved by any portfolio of the adviser². Showing them takes three conditions: policies designed to keep the figures relevant to the audience², enough information to understand the criteria and assumptions behind them², and enough information to understand their risks and limitations². Two general rules sit beside this. An advertisement may not discuss potential benefits without fair and balanced treatment of material risks², and it may not include a material statement of fact the adviser cannot substantiate on demand².

Ranking tables of firms often sit next to portfolio lists. Where an advertisement carries a third-party rating, the adviser needs a reasonable basis for believing the underlying survey makes it equally easy to give favourable and unfavourable responses and is not designed to produce a predetermined result². The advertisement must disclose the date of the rating and the period it covers², the identity of the third party that created and tabulated it², and, if applicable, that the adviser paid compensation in connection with obtaining or using it².

Endorsements carry their own disclosures. The advertisement discloses whether the person speaking is a current client or investor², whether cash or non-cash compensation was provided² and any material conflict of interest². The adviser needs a written agreement that sets the scope of the activities and the terms of compensation². Compensation counts as de minimis at $1,000 or less in the preceding 12 months².

When the team has moved

Results from a previous employer have their own rule. Predecessor performance means results achieved by an account or private fund that was not advised at all times during the period shown by the adviser advertising the performance². It may be shown only when the people primarily responsible for the prior results now manage accounts at the advertising adviser², the accounts are sufficiently similar to those managed at the advertiser, and all similarly managed accounts are advertised unless leaving one out would not raise the results materially². The advertisement must say clearly and prominently that the results came from accounts managed at another entity². A reader who sees deals attributed to a team should ask whether those deals were made by the firm or by its people elsewhere.

Marketing rules in Hong Kong

The SFC’s Fund Manager Code of Conduct covers the same ground in principles. A fund manager should ensure that any representations it makes to a fund or investor are accurate and not misleading⁴. Marketing materials are authorised as required by the SFC before issue⁴, and are not false, biased, misleading or deceptive⁴, and are clear, fair and present a balanced picture of the fund with adequate risk disclosures⁴. They contain information that is timely and consistent with the fund’s offering document⁴, and only contain performance claims that can be verified⁴. IOSCO’s standard for private equity firms asks the same of disclosure to investors: clear, complete, fair and not misleading⁵.

What GIPS asks of a track record

A firm that adopts the CFA Institute’s Global Investment Performance Standards takes on specific duties. The central duty is inclusion. Firms must include all actual, fee-paying, discretionary segregated accounts in at least one composite defined by investment mandate, objective or strategy¹. Pooled funds must also be included in any composite for which they meet the definition¹. The effect is to prevent firms from cherry-picking their best performance¹. A composite includes all portfolios that meet its definition, and a firm may not leave one out solely because of a legal structure difference¹. A change to a composite definition is never applied retroactively¹.

Valuation sits underneath all of it. Portfolios must be valued in accordance with the definition of fair value¹. The underlying valuations of portfolio holdings drive performance, and the standards rely on the integrity of input data¹. For a private equity fund that matters more than anywhere else, because the holdings have no market price.

A GIPS pooled fund report for a fund with committed capital carries a fixed set of figures. The table shows what each tells a reader.

The fund’s inception date marks where its track record begins¹. Money-weighted returns require valuation at least annually and daily external cash flows¹, and new portfolios enter composites on a timely and consistent basis¹. A firm must also disclose if preliminary, estimated values are used to determine fair value¹ and should disclose the key assumptions used to value investments¹. For the arithmetic behind the multiples, see IRR, MOIC, DPI and TVPI.

Compliance is not the same as verification

A claim of compliance and an independent check are different things. Firms may choose to have an independent third-party verification¹. Verification gives assurance that the firm’s policies and procedures for composites, pooled funds and performance calculation have been designed in compliance with the standards and implemented firm-wide¹. A firm that wants to claim compliance in an advertisement must follow the GIPS Advertising Guidelines or include a GIPS report¹. Firms submit a compliance notification form to CFA Institute when they first claim compliance and each year afterwards¹.

How to read a portfolio list: seven questions

Each question below points at something the rules above require a manager to handle.

• Is it every deal or a selection? A subset is extracted performance, and the total portfolio’s results must be provided or offered promptly². GIPS composites exist so that a firm cannot show only its best performance¹.
• What did each deal cost and what has come back? Cash returned and value still held are separate figures: DPI is distributions to paid-in capital and RVPI is residual value to paid-in capital¹.
• Who set the unrealised values? Private equity assets are hard to value⁸. Investors rely on net asset value estimates in quarterly reports because most assets have no liquid market⁸, and the process is subjective and based on data produced by the portfolio companies themselves⁸.
• Is the return gross or net? Gross figures need a net figure of at least equal prominence², and GIPS requires the label¹.
• Did a credit line lift the numbers? GIPS asks for returns with and without a subscription line unless the line was repaid within 120 days¹. ILPA asks for disclosure of line usage and for fund performance excluding the line⁶.
• Whose deals are they? Results achieved before the current adviser took over are predecessor performance and carry disclosure conditions².
• Does the record repeat? Fund-by-fund consistency is the thing a track record is meant to show, and the evidence on it is in a later section⁹.

Worked example (our arithmetic): the same fund read three ways

The numbers are invented to show the effect of selection and valuation. The fund does not exist and nothing here forecasts a return. The measure is total value divided by cost, the logic of the TVPI definition in the GIPS standards¹. Each deal has a cost, and a value that is either cash already received or an estimate of what is still held.

Reading one: three best deals. A page showing only A, B and E has a cost of 32 and a value of 90, a multiple of 2.81 times (our arithmetic¹). Every statement on that page is true. Under the SEC rule it is extracted performance, so the whole portfolio’s results must be provided or offered².

Reading two: all eight. Cost is 90 and value is 133, a multiple of 1.48 times (our arithmetic¹). Cash received from the four sold deals is 84, which is 0.93 times the 90 invested, and 49 is still held at an estimate, or 36.8 percent of all value (our arithmetic¹). In GIPS terms the first is the DPI idea and the second the RVPI idea¹. More than a third of the value on the page is not yet cash.

Reading three: question the estimates. Mark E down from 25 to 20 and G down from 15 to 12, a cut of 20 percent on each, and total value falls from 133 to 125, a multiple of 1.39 times (our arithmetic¹). A modest change in two estimates moves the whole fund by 0.09 times (our arithmetic¹). That is why the share of assets valued with subjective unobservable inputs is a required line in a GIPS pooled fund report¹.

The example is gross: it ignores fees, expenses and carried interest, which come off before a limited partner’s net figure. The net side is in private equity fees and carry.

Why a track record counts, and why valuations need questions

A track record deserves weight, and the evidence is academic. In a study of Venture Economics data, general partners whose funds outperform the industry in one fund are likely to outperform in the next, and those who underperform are likely to repeat it⁹. The persistence does not appear to be caused by risk differences⁹. Better performing funds are more likely to raise follow-on funds and larger funds⁹, and fund flows are positively related to past performance⁹. Funds raised in boom times are less likely to raise a follow-on fund, which indicates they probably perform poorly⁹, so the year a fund was raised belongs next to its deals. The same study finds that average fund returns net of fees approximately equal the S&P 500, with a large degree of heterogeneity⁹. That spread is why selection matters, and why a list that shows only the best deals tells a reader nothing about where the manager sits in it. The paper is from June 2003⁹, so treat its numbers as history and its logic as the point.

The valuation problem cuts the other way. Managers may have an incentive to distort reported valuations if investors use them to decide on commitments to later funds managed by the same firm⁸. A study using a large dataset of buyout and venture funds finds evidence that some under-performing managers boost reported returns while fundraising takes place⁸. Those managers are unlikely to raise a next fund, which suggests investors see through much of the manipulation⁸. Top-performing funds likely understate their valuations⁸. IOSCO flags the same conflict: a manager can be incentivised to overstate valuations with a view to a larger management fee or to presenting past performance to potential investors⁵.

The fee basis already limits the incentive. Fees based on the current market value of a fund or its investments are uncommon in developed markets⁵. Accepted market practice is to base fees during the investment period on committed capital at the final close⁵, and afterwards on still-invested drawn-down capital held at cost, or written-down value where appropriate⁵. The standards bodies respond with process as well. Fund investors need timely, relevant and standardised valuations and information about the assumptions behind them⁵. IOSCO adds that it may be advisable to establish and disclose valuation policies and procedures, and that using external fund auditors is established industry practice⁵. The IPEV Board exists to provide uniform, globally acceptable, best practice guidance for private capital valuation¹⁰. It was created as an independent body in 2005¹⁰ and published its updated guidelines on 14 December 2022¹⁰. ILPA’s view on deal-by-deal waterfalls is conservative: all unrealised investments should be valued at the lower of cost or market⁶.

When one company appears in two funds

A manager that runs several funds may list the same company under more than one. That raises a conflict a reader should know about. The timing of an exit can favour one fund over another where an investment is jointly owned by two or more funds operated by the same manager⁵. The generally preferred approach is to divest all funds simultaneously⁵, with timing normally set by the fund that made the original investment or reached the end of its life first⁵. Even then, a younger fund may gain from a longer hold while an older fund needs cash⁵.

Some deals move a company from one fund to another. A manager may sell the majority of a fund’s investment to a third party and keep a minority stake for one of its other funds⁵. The manager is in effect on both sides of the transaction, representing two sets of fund investors, which creates a conflict over pricing⁵. A similar conflict exists where a manager seeks the sale of an asset between the funds it manages⁵.

The mitigants are disclosure and approval. Fund agreements can require disclosure of exit criteria, including advisory committee approval of non pro-rata divestitures⁵. Actual divestments are disclosed to investors through ongoing performance reporting⁵. It is common practice to refer the proposed handling to the relevant investor advisory committees before the deal proceeds⁵, and an advisory committee can validate the approach used to set the price in a transaction between funds under the same management⁵. When a list shows one company in two funds, the useful question is who set the price when it moved.

How Hong Kong regulation handles valuation

The SFC’s code puts valuation on the fund manager. A manager should ensure that policies and procedures exist so that a proper and independent valuation of fund assets can be performed and that valuation methodologies are consistently applied to similar assets⁴. Price overrides are handled on the record: the manager documents the reason for any override or deviation⁴, and a functionally independent party reviews it⁴. The manager reviews the valuation policies and procedures periodically⁴. If a third party performs valuation services, the manager remains responsible for the valuation of the fund’s assets⁴. A manager responsible for the overall operation of a fund also discloses the frequency and basis of valuation to fund investors⁴.

For a reader in Hong Kong, those clauses turn the questions above into things to ask for. Ask who values the unrealised holdings and whether a functionally independent party reviews overrides. Ask how often valuation happens and on what basis. Then compare the answers with the marketing page, which under the same code may contain only performance claims that can be verified⁴. For the licensing side of a Hong Kong manager, see the SFC Type 9 licence, and for the market, the Hong Kong private equity market.

Read next

Due diligence in private equity shows how a buyer tests a company, and the private equity investment approach shows how firms choose deals before they appear on a list. How a private equity fund works and GP and LP explained cover the structure behind the figures, and the strategies hub lists the rest. The primary texts for this page are the SEC’s marketing rule, the SFC’s Fund Manager Code of Conduct, the GIPS standards for firms, the ILPA Principles and IOSCO’s report on conflicts of interest. No fund, manager or investment is recommended on this page, which is education only about disclosure.