Measuring the Performance of Private Equity

Our Approach to Public Market Equivalent (PME) Benchmarking

What’s the best way to benchmark Private Equity investments? It’s a question that’s been debated for years by performance practitioners, academics, fund managers, and capital allocators alike.

At Backstop, we feel that recent years have proven that a reliable performance assessment of a Private Equity investment can’t be based on a single method. Instead, that assessment must be developed by using multiple tools.

To take that stance a bit further, it’s Backstop’s firm belief that any analysis that doesn’t utilize “Public Market Equivalent” (PME) benchmarking techniques is incomplete.

Why are PME benchmarking techniques so important?

To put it simply, they give us an answer to one crucial question:

“How much better (or worse) off am I as a result of my decision to invest capital into Private Equity, instead of directing those funds to a passively managed, broad market index?”

There are a variety of PME methodologies available. But, generally speaking, they all work by mimicking the cash flows of a Private Equity investment in a hypothetical portfolio that invests the same amount in a broad market total return benchmark. Common examples include the S&P 500, Russell 2000, and Russell 3000 Total Return indices.

A Bit of History

While all PME approaches are thematically similar, they’re not all created equally. To understand why, let’s take a brief look at the evolution of the field.

There is a long history of attempts to develop a PME metric. The earliest of these involved the application of heuristics to try to smooth over the inherent differences in the natural cash flow patterns of public and private equity investments. But these “rules of thumb” were pure artifice, and an Achilles’ heel for legacy PME approaches.

The heuristics aren’t based in economic theory, and aren’t considered mathematically rigorous[1]. Even more troubling, these legacy PME methods introduce unnecessary systematic bias into the benchmarking process.

A Better Way

For these reasons, we prefer PME methodologies rooted in Steve Kaplan and Antoinette Schoar’s framework[2]. (These include the “Direct Alpha” approach, developed by Gredil, Stucke and Griffiths[3].) Broadly speaking, these methods use the Public Market Benchmark’s returns to either compound or discount the value of each cash flow to a common point in time, either past or future.

This method effectively removes the value impacts of the “hypothetical” portfolio, leaving just the value impacts of the Private Equity investment relative to the “hypothetical” portfolio. That way, when we run an IRR calculation on our array of cash flows, or compute a “Total Value to Paid In (TVPI)” multiple, the results reflect the over- or under- performance of the investment, without use of any smoothing heuristics.

Putting it to Work

We believe that calculations built on the “Direct Alpha” approach and the Kaplan-Schoar framework will give our users the most defensible and mathematically rigorous PME tools available today. Moreover, the addition of PME benchmarking capabilities to our already robust platform will provide Backstop clients with the tools they need to increase their agility, productivity, and performance.

If you’d like to learn more about the Backstop point of view on PME benchmarking, download our new white paper now.

[1] Ramani, Prasad, CFA. Evaluating Private Equity Performance: PME vs. Direct Alpha.

[2]Referenced paper can be found here:

[3] Referenced paper can be found here:




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