Articles

What is a fund's multiple without its largest investment?

A concentration test any investor can run from the schedule of investments in ten minutes, and what it says about the NAV the fund reports.

Julian R. Sterling · from How to Read a Private Fund's Financial Statements

Remove the largest position from the schedule of investments and recompute cost and fair value for what is left. In an illustrative seven-company portfolio carried at 1.37x, the largest holding is 39.2 per cent of fair value, and without it the other six are at 0.96x: below cost. One investment carries 110.1 per cent of the fund's unrealised gain.

Worked in full in How to Read a Private Fund's Financial Statements by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

The headline multiple in a quarterly report is an average, and in private equity averages are dominated by their largest term. The schedule of investments, the position-by-position list of cost and fair value in the audited statements, holds everything needed to test that. It takes ten minutes, needs no access to the manager's valuation files, and tells you how much of the NAV you are relying on one valuation for.

The assumptions

An illustrative schedule of investments, unrealised portfolio, in thousands. Company names are fictional.

Company	Cost	Fair value	Multiple
Brightline Software	15,000	60,600	4.04x
Calder Foods	20,000	24,000	1.20x
Norvale Logistics	18,000	19,800	1.10x
Pellham Engineering	22,000	17,600	0.80x
Quayside Clinics	12,000	13,200	1.10x
Redmere Packaging	16,000	15,200	0.95x
Thornfield Retail	10,000	4,000	0.40x
Total	113,000	154,400	1.37x

The calculation, step by step

The largest position by fair value is Brightline Software at 60,600. Take it out: the other six cost 98,000 and are carried at 93,800. Their multiple is 93,800 ÷ 98,000 = 0.96x, against 1.37x for the whole portfolio.

Three ways to see the same concentration

The largest holding against the portfolio.

Measure	Largest holding	Portfolio	Share
Cost	15,000	113,000	13.3%
Fair value	60,600	154,400	39.2%
Unrealised gain	45,600	41,400	110.1%

By cost the fund looks diversified: no position above a fifth. By fair value one company is two fifths of the portfolio, and with the second largest, 54.8 per cent. By gain, the measure that matters for the multiple, one company accounts for more than all of it. The other six positions are 4,200 below cost in aggregate, with three of them, Pellham, Redmere and Thornfield, carried 11,200 below what was paid. That shortfall is the numerator of a loss ratio, the companion test for the downside of the same schedule.

Why above 100 per cent is possible. A share of gain above 100 per cent simply means the rest of the portfolio is losing money on paper. It is the most compact way to say that the fund's reported performance is a single-asset story.

What if: the largest mark moves

Only the largest holding is remarked; everything else unchanged.

Markdown of the largest	Its fair value	Portfolio fair value	Portfolio multiple	Change in portfolio value
0%	60,600	154,400	1.37x	0.0%
10%	54,540	148,340	1.31x	−3.9%
20%	48,480	142,280	1.26x	−7.8%
30%	42,420	136,220	1.21x	−11.8%

Each 10 per cent on the one mark moves the whole portfolio value by about 3.9 per cent. The break-even is more reassuring than the headline suggests, though: the portfolio stays above cost as long as Brightline is worth at least 19,200, which is still 1.28x its own cost and a 68.3 per cent fall from the current mark. The concentration is real, but the cushion is wide. Both facts belong in the same sentence of an investor's notes.

What to do with the answer

• Read the valuation note for that one position. Method, multiple, the key unobservable input and its sensitivity. A 4.04x mark on a company that has never had a third-party transaction deserves more attention than the six around it combined.
• Ask how the mark compares with the last round or offer. If there is no external evidence, the 39.2 per cent of NAV is a model output.
• Track the figure over time. A fund whose ex-largest multiple drifts down from one year to the next while the headline holds is a fund increasingly carried by one asset.

The common mistakes

• Ranking by cost. The largest cheque, Pellham at 22,000, is a 0.80x position. Removing it would make the fund look better, not worse.
• Mixing realised and unrealised. Run the test on the unrealised schedule. Realised proceeds are not at risk to a remark; including them dilutes the concentration you are trying to see.
• Reading the result as a forecast. 0.96x is not what the fund will return. It is how much of the reported 1.37x depends on one valuation.

Takeaway

Recompute the multiple without the largest position by fair value: 1.37x becomes 0.96x here, and one holding carries 110.1 per cent of the gain. Then find the break-even, 19,200, so the concentration is stated with its cushion. The free reporting pack and working documents for this book include the schedule of investments with the multiple excluding the largest, and the NAV calculation shows where that schedule sits in the statements.

Questions readers ask

How do you measure concentration in a private equity fund?

From the schedule of investments, by fair value rather than cost, and by share of the unrealised gain. In the illustrative fund the largest holding is 13.3 per cent of cost but 39.2 per cent of fair value and 110.1 per cent of the gain. Recomputing the multiple without it, 0.96x against 1.37x, is the single most informative concentration figure.

Can one investment account for more than 100 per cent of a fund's gain?

Yes, whenever the other positions are in aggregate below cost. In the illustrative portfolio the largest holding shows a gain of 45,600 while the fund's total unrealised gain is 41,400, because the other six positions together are 4,200 below cost. That is 110.1 per cent.

How much can the largest position fall before the fund is below cost?

Solve for the value that makes total fair value equal total cost. In the illustrative fund the other six holdings are worth 93,800 against a total cost of 113,000, so the largest must be worth at least 19,200, which is 1.28x its own cost. That is a 68.3 per cent fall from its 60,600 mark.

Also on this site

• How do you calculate the NAV of a private equity fund?Fair value plus cash, less what the fund owes. A $430m portfolio gives a $417.0m fund NAV, and $389.6m to the LPs after $27.4m of accrued carry.
• How do you calculate a loss ratio for a private equity track record?Losses on deals below cost over total invested. $59.5m lost on $465.0m is a 12.8 per cent loss ratio, though a third of the deals lost money.
• How do you backtest private equity valuations against exits?Compare proceeds with the mark before the sale process, not the last mark. Ten exits show a 21.6 per cent uplift that the last marks reduce to 2.1.
• How do you calculate a private fund's expense ratio?Total fund costs over average net assets. Here fees and expenses are 1.72 per cent, 2.00 with facility interest and 4.08 with the carried interest accrual.
• How do you reconcile a private fund capital account statement?Roll your opening balance forward with your share of each fund line, then add your own terms. Here that rebuilds 15,820,000 and leaves 22,500 to explain.
• How do you recompute a private fund's management fee after offsets?Gross fee of 4,312.50 on a quarterly cost base, less offsets of 2,175, gives a net management fee of 2,137.50. The recomputation, quarter by quarter.

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