Fees, carry, closing date and currency are set investor by investor, so the fund's reported net IRR is nobody's return in particular.
An LP's own net IRR differs from the fund's reported net IRR because the fund figure is a blend of every investor's cash flows, while each investor pays its own fees, its own carry and measures in its own currency. In an illustrative fund reporting a 16.39 per cent net IRR, a standard-terms LP earns 15.95 per cent, a fee-discounted anchor 17.28 per cent and a euro investor 13.68 per cent in euros, on exactly the same portfolio. None of the four numbers is wrong.
Worked in full in The Private Equity Fund Controller Playbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The question reaches the fund controller every quarter, usually forwarded from investor relations: the investor has rebuilt its IRR from its capital account and it does not match the quarterly report. The answer is almost never an error. It is a reconciliation, and the controller should be able to produce it line by line.
A $300m fund invests 80 per cent of commitments over three years and returns 2.25 times its invested capital over years four to six, a gross IRR of 21.4 per cent before fees and carry. Fees are charged on commitments for five years. Carry is held back and paid from the final distribution; the preferred return clears and the catch-up is full, so carry equals the carry rate times each investor's own profit. All figures illustrative, per $100 of commitment unless stated.
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
|---|---|---|---|---|---|---|---|
| Invested capital called | 30.0 | 30.0 | 20.0 | 0 | 0 | 0 | 0 |
| Gross proceeds | 0 | 0 | 0 | 0 | 50.0 | 70.0 | 60.0 |
| Investor | Commitment, $m | Fee | Carry | Reports in |
|---|---|---|---|---|
| LP A, standard terms | 150 | 2.0% | 20% | USD |
| LP B, anchor with a side letter | 100 | 1.5% | 15% | USD |
| LP E, euro-based | 50 | 2.0% | 20% | EUR |
Step 1: each investor's own dollar flows. Contributions are invested capital plus that investor's fee. Distributions are gross proceeds less that investor's carry. For LP A: paid in 80.0 + 10.0 = 90.0, profit 180.0 − 90.0 = 90.0, carry 20 per cent of that, 18.000, so the final distribution is 60.0 − 18.000 = 42.000. For the anchor: paid in 87.5, profit 92.5, carry at 15 per cent 13.875, final distribution 46.125.
Net flowt = gross proceedst − carryt − invested capital calledt − feet
LP net IRR = IRR(that investor's net flows); fund net IRR = IRR(sum of all LPs' net flows in $)
In Excel, with dates in column A and each investor's net flows in its own column: =XIRR(C2:C8,$A$2:$A$8) per investor, and =XIRR(F2:F8,$A$2:$A$8) on a total column that adds each investor's flows times its commitment. For a foreign-currency investor, divide each dollar flow by the rate on its own value date before the XIRR.
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
|---|---|---|---|---|---|---|---|
| LP A, $ | -32.0 | -32.0 | -22.0 | -2.0 | 48.0 | 70.0 | 42.0 |
| LP B, $ | -31.5 | -31.5 | -21.5 | -1.5 | 48.5 | 70.0 | 46.125 |
| USD per EUR | 1.10 | 1.12 | 1.08 | 1.05 | 1.15 | 1.20 | 1.25 |
| LP E, € | -29.091 | -28.571 | -20.370 | -1.905 | 41.739 | 58.333 | 33.600 |
Step 2: the fund's reported figure. Weight each investor's dollar flows by its commitment and add them up. The fund pays in $267.50m in total, pays $49.875m of carry and returns a net multiple of 1.832x. The IRR of the summed flows is 16.39 per cent. That is the number in the quarterly report.
| Measure | Net multiple | Net IRR | Gap to fund |
|---|---|---|---|
| Fund, all LPs in $ | 1.832x | 16.39% | |
| LP A, standard terms, $ | 1.800x | 15.95% | -0.44 |
| LP B, anchor, $ | 1.899x | 17.28% | 0.88 |
| LP E, euro investor, € | 1.672x | 13.68% | -2.71 |
LP A sits 0.44 points below the fund because the fund figure includes the anchor's better terms. LP B sits 0.88 points above for the same reason. Their dollar flows differ only by fees and carry. LP E has exactly LP A's dollar flows and LP A's 15.95 per cent in dollars, but the euro strengthened 13.6 per cent over the fund's life, so each dollar it receives in years four to six converts into fewer euros than each dollar it paid in had cost. In its own currency it earns 13.68 per cent on a 1.672x multiple. If it hedged the currency, the hedge result belongs in its own books, not in the fund's.
| Fee and carry | Net IRR, $ |
|---|---|
| 2.00% and 20% | 15.95% |
| 1.75% and 20% | 16.26% |
| 1.50% and 20% | 16.58% |
| 1.50% and 15% | 17.28% |
| 1.00% and 10% | 18.63% |
Each quarter point of fee is worth about 0.3 points of IRR here, and five points of carry another 0.7. For the euro investor, the final exchange rate alone moves its return between 15.17 per cent (at 1.00 dollars per euro in year six) and 13.22 per cent (at 1.35), with every other rate unchanged.
Two other common sources of difference are not modelled here. A late closer pays equalisation interest on its catch-up contribution, which is a cost to it and income to the first-close investors, worked in how equalisation interest is calculated. And an investor computing on its own payment dates, rather than the call due dates, can move its IRR by several tenths of a point; rebuilding your own figure from settlement dates and a closing balance net of accrued carry is worked in how to calculate IRR from a capital account statement.
The mistake is to answer the investor with the fund figure, or to treat the gap as an error in its spreadsheet. The fund net IRR is an aggregate: it is nobody's return unless every investor has the same terms, currency and closing date. The right response is a short reconciliation from the fund's 16.39 per cent to the investor's figure, attributing the gap to fees, carry, closing date and currency, each computed by changing one input at a time. Dating the flows correctly matters as much as the terms, as shown in IRR vs XIRR for fund cash flows.
Report the fund's net IRR, and keep each investor's IRR computed from its own capital account in the investor subledger. When the two disagree, the difference should be explainable in three or four lines. A register that allocates calls, fees and distributions investor by investor, and ties back to the fund, is in the free workbook for this case.
Start from the fund figure and change one input at a time: your fee rate, your carry rate, your closing date and your reporting currency. In the illustrative fund, moving from the blended 16.39 per cent to a standard 2 per cent and 20 per cent investor removes 0.44 points; converting that investor's dollar flows into euros at the actual rates removes a further 2.27 points.
Not the fund's, but it changes the investor's. A euro-based investor with the same dollar flows as a 15.95 per cent dollar investor earns 13.68 per cent in euros if the euro strengthens from 1.10 to 1.25 dollars over the fund's life, because the distributions convert into fewer euros than the contributions cost.
After: it uses the actual flows of all limited partners, so investors with fee or carry discounts pull it up. In the illustrative fund, an anchor paying 1.5 per cent and 15 per cent earns 17.28 per cent and lifts the fund to 16.39 per cent, above the 15.95 per cent that an investor on standard terms actually receives.
This article is one calculation from The Private Equity Fund Controller Playbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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