Investment Management
FEBRUARY 2004
AIMR Issues New Provisions to Professional Standards
Relating to Private Equity
by Michael S. Caccese*
The Association for Investment Management and
Research (“AIMR”) recently issued new provisions
and related guidance (“Provisions”) to investment
firms that claim compliance with AIMR Performance
Presentation Standards (“AIMR-PPS” or
“Standards”) 1 relating to the calculation and
presentation of Private Equity2 investments other
than open-end or “evergreen funds” (which must
follow the main AIMR-PPS provisions). The Private
Equity provisions supplement all of the required and
recommended elements of AIMR-PPS, except where
the Private Equity provisions override the existing
AIMR-PPS provisions for valuation, calculation
methodology, fees, and presentation and reporting of
returns.
INTRODUCTION
Private Equity refers to investments in non-public
companies that are in various stages of development
and encompasses venture investing, buyout
investing, and mezzanine investing. Fund-of-fund
investing as well as secondary investing are also
included in Private Equity. Because of the unique
characteristics of this asset class, additional
performance reporting requirements are needed.
INPUT DATA
The Standards require that portfolios be valued
monthly beginning January 1, 2001 and it is expected
that portfolios will be required to be valued at the
time of any external cash flow beginning January 1,
2010. However, because the Standards require a
“Since Inception—Internal Rate of Return (SI-IRR)”
for Private Equity assets, increased frequency in
valuations will not result in increased accuracy of the
return calculation. The Standards only require that
annual returns be presented and therefore the only
valuation that is needed is at the year end. The
Standards recommend quarterly valuations because
this will allow firms to report performance on a more
frequent basis. Firms that do not value on at least a
quarterly basis can only present performance
through the prior year end.
CALCULATION METHODOLOGY
An Internal Rate of Return (IRR) reflects the effects
of the timing of cash flows in a portfolio. The IRR is
required for Private Equity assets because the firm
controls the cash flows into and out of the portfolio.
A time-weighted rate of return (TWR) will not offer
the best measure for an investor to compare returns
1
While the Guidance Statement refers to the Global Investment Performance Standards (GIPS), all interpretations issued by
AIMR related to GIPS are applicable to AIMR-PPS.
2
All capitalized terms used herein are defined terms in the Provisions.
*
Michael Caccese is a partner in the Boston office of Kirkpatrick & Lockhart LLP. He works extensively with investment
firms on compliance issues, including all of the AIMR standards. He was previously the General Counsel to AIMR and was
responsible for overseeing the development of the AIMR-PPS, GIPS and other standards governing the investment
management profession and investment firms. He can be reached at 617.261.3133 and mcaccese@kl.com.
Kirkpatrick & Lockhart LLP
between Private Equity funds because the TWR will
not capture the critical effects of cash flow
management within the control of the Private Equity
manager.
While the Standards advocate that the IRR is the
most accurate measure of performance for an
individual Private Equity manager, it may not be so at
higher levels of aggregation. In the case where an
investor, e.g., a Limited Partner, is trying to calculate
the return at a wider portfolio level, including a
number of Private Equity funds, that investor has no
control over the timing of any cash flows. In this
situation of a wider portfolio, a TWR is more
applicable and will provide a comparability measure
at a portfolio level with other Private Equity
portfolios as well as other asset classes. It is
inappropriate to directly compare IRR and TWR
figures to each other. This clarification is provided in
recognition that the main purpose for the Standards
is to provide comparability between Private Equity
firms and not necessarily to standardize the
performance presentation of the investors.Firms are
required to deduct Carried Interest, the investment
management fee and any transaction expenses when
calculating net-of-fees returns. Carried Interest can
often have a greater impact than the actual
investment management fees. In the case of
Investment Advisers that have discretion over the
selection of Venture Capital or Private Equity funds
or partnerships for their clients, the Investment
Adviser must also calculate all returns net of all the
fund or partnership investment management fees and
Carried Interest and be net of all of the Investment
Adviser’s fees, expenses, and Carried Interest.
COMPOSITE CONSTRUCTION
All closed-end Private Equity investments, including,
but not limited to fund-of-funds, partnerships, or
Direct Investments must be included in a composite
defined by strategy and Vintage Year. Partnership/
fund investments, Direct Investments, and open-end
Private Equity investments (e.g., evergreen funds)
each must be in separate composites.
DISCLOSURES
Firms are required to disclose the Vintage Year of
each composite. The Vintage Year is the year in which
the Private Equity fund or partnership first draws
3
down or calls capital from its investors. The
disclosure of the Vintage Year increases
comparability by allowing prospective clients to
understand the time frame when the fund was
initiated. In addition, firms are required to disclose
the Final Realization Date of a composite for all
closed (discontinued) Private Equity composites.
Similar to the Vintage Year statistic, the Final
Realization Date also aids in determining the time
frame that the partnership was in existence in order to
determine the appropriate comparability of one
investment to another.
Firms are also required to disclose the investment
strategy of the composite and the composite’s
unrealized appreciation or depreciation. This
disclosure helps prospective clients determine the
potential for returns to change in the future based on
the potential changes in the valuation of the
investments within the composite. Firms must also
disclose the total Committed Capital (or
capitalization). Total Committed Capital is the Total
Value of capital that investors have agreed to invest.
In addition to requiring the use of the AIMR-PPS
Private Equity Valuation Principles3 , the Standards
require the firm to disclose if it complies with any
other valuation guidelines (e.g., British Venture
Capital Association, European Venture Capital
Association). The valuation methodology disclosure
is important to determine the comparability of
different returns and other important statistical
information. In situations where a firm uses a nonFair Value basis to value investments within a fund,
an additional disclosure is required. The Fund
Manager must disclose why the Fund Manager
believes a non-Fair Value basis is better and why a
Fair Value basis is not applicable. Firms are required
to document their procedures for reviewing
valuations and must disclose that those procedures
are available upon request.
PRESENTATION AND REPORTING
Firms are required to present the annualized SI-IRR
for Private Equity composites. Firms are required to
present an annualized SI-IRR for each year since the
Vintage Year. Unless disclosed, calendar year period
ends are assumed. Periods less than one year must
not be annualized. When presenting Private Equity
performance, firms are required to present both
AIMR-PPS Private Equity Valuation Principles may be found as Appendix A to the Provisions.
Kirkpatrick & Lockhart LLP
2
gross-of-fees and net-of-fees returns. Net-of-fees
returns must be net of the Investment Management
Fees, Carried Interest (the management firm’s portion
of any realized gains as well as the implied Carried
Interest component of any unrealized gains in the
portfolio), Transaction Expenses, and any other Fees.
In addition, if any fees are paid outside of the fund
vehicle, they still must be incorporated in the net-offees return. Firms must disclose when fees are paid
outside of the fund vehicle.
For each year presented, firms are required to report
Paid-In Capital to date, total current Invested Capital,
and cumulative Distributions to date. The Paid-In
Capital to date is the amount of the total Committed
Capital that the firm has drawn down (called) from
investors. The total current Invested Capital is the
amount of the Paid-In Capital that is actually
invested in Private Equity assets. The total
Distributions are the total amount of capital or
income that has been returned to investors. This
measure gives prospective clients an understanding
of the amount of initial Invested Capital returned to
investors relative to other composites with similar
Vintage Years and strategies.
For performance calculation there is (i) one non-cash
flow item, Residual Value (net of Investment
Management Fees and Carried Interest) and (ii) two
cash flow items, 1) Drawdowns from Limited Partners
(also referred to as capital calls or Paid-In Capital),
and 2) Distributions (cash and/or stock) to Limited
Partners. These three components can be used to
calculate the internal rate of return assuming the
Residual Value is taken as a terminal cash flow value.
The Standards require firms to report the Investment
Multiple (TVPI) and the Realization Multiple (DPI) for
each year presented. The Investment Multiple is
calculated by dividing the Residual Value plus
distributed capital by the Paid-In Capital. The
Investment Multiple gives prospective clients
information regarding the value of the composite
relative to its cost basis. The Realization Multiple is
calculated by dividing the cumulative Distributions
by the Paid-In-Capital. In addition, firms must
present the ratio of Paid-In Capital to Committed
Capital (PIC). The Standards also require the
presentation of the Residual Value to Paid-In Capital
(RVPI). The RVPI is calculated as the Residual Value
divided by Paid-In Capital.
If a benchmark is used, the Standards require the
presentation of a cumulative annualized SI-IRR for
that benchmark which reflects the same strategy and
Vintage Year as the composite. Firms must disclose
the calculation methodology of the benchmark
(e.g., monthly cash flows) and if a custom benchmark
is used, how that benchmark is constructed and the
benchmark creation and rebalancing process. If no
benchmark is presented, then the firm must disclose
why no benchmark is appropriate.
EFFECTIVE DATE
The effective date of the Provisions is January 1,
2005. While firms are encouraged to adopt them
earlier than 2005, these Provisions are not required to
be retroactively applied.
The Provisions can be found on AIMR’s website at
www.aimr.org/standards.
Kirkpatrick & Lockhart LLP
3
Kirkpatrick & Lockhart LLP maintains one of the leading investment management practices in the United States,
with more than 60 lawyers devoting all or a substantial portion of their practice to this area and its related
specialties. The American Lawyer Corporate Scorecard, published in April 2003, lists K&L as a primary legal
counsel to the investment companies, board members or advisory firms for 15 of the 25 largest mutual fund
complexes. No law firm was mentioned more frequently in the Scorecard.
We represent mutual funds, closed-end funds, insurance companies, broker-dealers, investment advisers, retirement
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visit our website at www.kl.com for more information, or send general inquiries via email to
investmentmanagement@kl.com.
BOSTON
Michael S. Caccese
Philip J. Fina
Mark P. Goshko
Thomas Hickey III
Nicholas S. Hodge
617.261.3133
617.261.3156
617.261.3163
617.261.3208
617.261.3210
mcaccese@kl.com
pfina@kl.com
mgoshko@kl.com
thickey@kl.com
nhodge@kl.com
LOS ANGELES
William P. Wade
310.552.5071
wwade@kl.com
NEW YORK
Philip L. Kirstein
Beth R. Kramer
Richard D. Marshall
Robert M. McLaughlin
Loren Schechter
212.536.483
212.536.4024
212.536.3941
212.536.3924
212.536.4008
pkirstein@kl.com
bkramer@kl.com
rmarshall@kl.com
rmclaughlin@kl.com
lschechter@kl.com
SAN FRANCISCO
Eilleen M. Clavere
Jonathan D. Joseph
David Mishel
Mark D. Perlow
Richard M. Phillips
415.249.1047
415.249.1012
415.249.1015
415.249.1070
415.249.1010
eclavere@kl.com
jjoseph@kl.com
dmishel@kl.com
mperlow@kl.com
rphillips@kl.com
WASHINGTON
Clifford J. Alexander
Diane E. Ambler
Catherine S. Bardsley
Arthur J. Brown
Arthur C. Delibert
Robert C. Hacker
Benjamin J. Haskin
Kathy Kresch Ingber
Rebecca H. Laird
Thomas M. Leahey
Cary J. Meer
R. Charles Miller
Dean E. Miller
R. Darrell Mounts
C. Dirk Peterson
David Pickle
Alan C. Porter
Theodore L. Press
Robert H. Rosenblum
William A. Schmidt
Lynn A. Schweinfurth
Donald W. Smith
Martin D. Teckler
Robert A. Wittie
Robert J. Zutz
202.778.9068
202.778.9886
202.778.9289
202.778.9046
202.778.9042
202.778.9016
202.778.9369
202.778.9015
202.778.9038
202.778.9082
202.778.9107
202.778.9372
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202.778.9298
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202.778.9025
202.778.9464
202.778.9373
202.778.9876
202.778.9079
202.778.9890
202.778.9066
202.778.9059
calexander@kl.com
dambler@kl.com
cbardsley@kl.com
abrown@kl.com
adelibert@kl.com
rhacker@kl.com
bhaskin@kl.com
kingber@kl.com
rlaird@kl.com
tleahey@kl.com
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cmiller@kl.com
dmiller@kl.com
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dpeterson@kl.com
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william.schmidt@kl.com
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rwittie@kl.com
rzutz@kl.com
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should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
© 2004 KIRKPATRICK & LOCKHART LLP. ALL RIGHTS RESERVED.