Which metrics matter?

Understanding which performance metrics matter is crucial for making informed decisions. Sophisticated investors—like family offices, sovereign wealth funds, and ultra-high-net-worth individuals—are increasingly diversifying their portfolios with alternative asset classes that bring challenges in performance reporting. 

The Challenge

Alternative investments span a wide range of classes, each with unique characteristics and performance drivers. Unlike traditional investments, these assets often lack standardized metrics, making it difficult to compare performance across classes or even within the same class. Choosing the right metrics is not just a matter of preference; it's essential for accurate reporting, effective risk management, and strategic decision-making.

Classes and Their Metrics

Real Estate

Net Operating Income (NOI): This metric calculates the income generated from a property after operating expenses but before taxes and financing costs. It's a fundamental indicator of a property's ability to generate profit.

Capitalization Rate (Cap Rate): The cap rate is used to estimate the potential return on investment of a real estate property. It's calculated by dividing NOI by the property's current market value.

Cash-on-Cash Return: This measures the annual return made on the property in relation to the amount of mortgage paid during the same year. It's essential for investors looking at the immediate cash flow from their investments.

Internal Rate of Return (IRR): IRR considers the time value of money and provides the annualized rate of return of an investment, making it useful for comparing the profitability of projects with different durations.

Real Estate Funds

IRR: Similar to direct real estate investments, IRR is crucial for assessing the performance of real estate funds over time.

Equity Multiple: This metric shows how much an investor's capital has grown over the investment period. An equity multiple of 2.0x means the investor has doubled their money.

Preferred Return (Pref): This is the minimum return that must be distributed to preferred investors before any profit sharing. It ensures that investors receive returns before the fund managers.

Distribution Waterfall: This outlines the order in which distributions are made to investors and fund managers, impacting the overall returns received by investors.

Venture Capital

Multiple on Invested Capital (MOIC): MOIC measures the total value generated by a venture capital investment relative to the amount of capital invested.

IRR: Given the long-term horizon and cash flow irregularities in VC investments, IRR provides a time-adjusted rate of return.

Distributions to Paid-In Capital (DPI): DPI measures the cash returned to investors relative to the amount they've contributed, focusing on realized returns.

Total Value to Paid-In Capital (TVPI): TVPI combines DPI and the residual value of investments, providing a comprehensive view of both realized and unrealized returns.

Private Equity Funds

IRR: A standard metric for assessing the performance of private equity investments over time.

MOIC: Similar to venture capital, MOIC in private equity measures the multiple of capital returned to investors.

DPI, TVPI, RVPI: These metrics provide insights into the fund's performance, considering both realized and unrealized gains.

EBITDA Multiple: This valuation metric helps in comparing the value of a company, taking into account its earnings before interest, taxes, depreciation, and amortization.

Private Credit

Current Yield: The annual income (interest or dividends) divided by the current price of the security, reflecting the income return on investment.

Yield to Maturity (YTM): YTM estimates the total return anticipated on a bond if held until it matures, considering all payments.

Default Rates: The percentage of issuers who fail to make scheduled payments, crucial for assessing credit risk.

Recovery Rates: The amount recovered by creditors in the event of default, impacting the overall loss given default.

Angel Investing

MOIC: Measures the return multiple on the invested capital in early-stage companies.

IRR: Important for time-adjusted returns, given the high-risk, long-term nature of angel investments.

Portfolio Diversification Metrics: Tracking the diversification across sectors and stages to manage risk.

Art & Collectibles

Appraised Value: The estimated monetary value of an item, determined by experts.

Auction Results: Actual sale prices from auctions provide market-based valuations.

Holding Period Returns: The total return received from holding an asset over a period, including appreciation and any income generated.

Equities

Total Return: Includes capital appreciation and dividends, providing a complete picture of investment performance.

Price-to-Earnings Ratio (P/E): A valuation metric comparing a company's share price to its earnings per share.

Dividend Yield: Measures the dividend income relative to the share price.

Sharpe Ratio: Assesses the risk-adjusted return, indicating how much excess return is received for the extra volatility endured.

The Importance of Selecting the Right Metrics

Using appropriate metrics for each asset class is vital for several reasons:

Accuracy: Different assets have unique cash flow patterns and risk profiles. Using incorrect metrics can lead to inaccurate assessments of performance.

Comparability: Appropriate metrics allow investors to compare investments within the same asset class or across different classes effectively.

Decision-Making: Metrics tailored to the asset class provide insights that inform strategic investment decisions, risk management, and portfolio optimization.

Time-Weighted Return (TWR): The Great Equalizer

Time-Weighted Return (TWR) is a method of calculating investment returns that eliminates the impact of cash flows. It measures the compound rate of growth in a portfolio and is unaffected by the timing of contributions and withdrawals.

Why TWR Matters

Fair Comparison: TWR allows investors to compare the performance of different investments or managers on an equal footing, regardless of cash flow differences.

Performance Evaluation: It provides a clear picture of the investment's performance solely due to market movements and management decisions, not investor actions.

Standardization: TWR is widely accepted as a standard measure for reporting investment performance, promoting transparency and consistency.

How TWR Works

TWR calculates the return for each sub-period between cash flows and then compounds them to arrive at the overall return. This method ensures that the return is not skewed by the size and timing of external cash flows.

Conclusion

Understanding which metrics matter is indispensable for sophisticated investors aiming to optimize their portfolios. Each asset class comes with its unique set of metrics that best capture its performance nuances. 

Our "Performance & Metrics" Lens is designed to help you navigate these complexities by providing custom reporting tools specific to each asset class. Ready to out your Assets Under Intelligence™? Book a demo or create an account and get started.