Internal Rate of Return (IRR)

Formula

How IRR is calculated in private funds

There is no closed-form solution; IRR is found iteratively (spreadsheet IRR/XIRR functions use numerical solvers). Inputs come from the LP's capital account: each capital call, each distribution, and the latest net asset value. Fee-paying LP flows produce net IRR; deal-level flows before fees, expenses and carried interest produce gross IRR. Because calls and distributions arrive on specific dates, managers compute the date-exact version, XIRR.

Money-weighted, not time-weighted

IRR is a money-weighted return: periods with more capital invested count for more. A time-weighted return removes the effect of external cash flows and measures the manager's return per unit of time regardless of how much money was in the fund. Private-markets managers control when capital is called and returned, which is why money-weighted returns are the convention for closed-end funds. The same property makes a fund IRR unsuitable for direct comparison with an index's time-weighted return; public market equivalent methods exist to make that comparison on the fund's own cash flows.

Reading an interim IRR

Before a fund is fully realised, its IRR treats NAV as if it had been paid out on the valuation date. In the first years, fees and expenses on small amounts of called capital usually produce negative or erratic IRRs (the J-curve), and early figures can move sharply between quarters. A since-inception IRR also becomes less responsive over time: once a fund has returned capital, later quarters move it little even if the remaining portfolio changes value. Analysts therefore read IRR together with TVPI, DPI and RVPI, the fund's age, and how much of the value is realised.

Subscription lines and IRR

A subscription line of credit lets a fund invest before calling LP capital. Delaying calls shortens the period the LP's money is at work and usually raises IRR, while interest on the facility slightly reduces multiples. Guidance on subscription lines published in 2020 by the Institutional Limited Partners Association (ILPA) recommends that managers report net IRR both with and without the use of the facility, so LPs can see the difference.

How LPs use IRR

LPs compare net IRR with peers of the same strategy, geography and vintage year (see quartile ranking), use it as one input in manager selection, and aggregate it across funds as a pooled IRR rather than a simple average of fund IRRs. How gross and net IRR may be presented in a manager's marketing materials is covered under gross IRR and net IRR.

Worked examples

Examples are illustrative; figures are not market data.

Not the same as

• Time-Weighted Return (TWR): A time-weighted return (TWR) neutralises the size and timing of external cash flows; IRR is driven by them.
• Multiple on Invested Capital (MOIC): Multiple on invested capital (MOIC) and TVPI measure how much value was created per unit of capital, with no time dimension; IRR measures the annualised rate and is sensitive to timing.
• Public Market Equivalent (PME): A public market equivalent (PME) compares the fund's cash flows with an index; IRR is an absolute return with no benchmark.
• Modified Internal Rate of Return: Modified IRR (MIRR) replaces the implicit reinvestment and financing rates with stated ones and always yields one answer; IRR can have several solutions, or none.

Common mistakes

• Describing IRR as time-weighted. It is money-weighted.
• Comparing a fund's IRR directly with a public index's time-weighted return over the same years.
• Averaging the IRRs of several funds instead of computing a pooled IRR on their combined cash flows.
• Treating a since-inception IRR from the first two or three years of a fund as evidence of manager skill.
• Ignoring whether the IRR is gross or net, and whether it includes the effect of a subscription line.
• Annualising a return measured over less than one year. The Global Investment Performance Standards (GIPS) prohibit annualising returns for periods shorter than a year.

Edge cases

• Cash flows that change sign more than once can produce several IRRs or none.
• A fund that has not yet returned capital and reports a NAV below paid-in capital can show a very large negative IRR in its early quarters.
• Recallable distributions and recycled proceeds change the sign pattern of LP flows; follow the actual capital account entries.

Questions

External standards

Sources

1. Global Investment Performance Standards (GIPS) for Firms 2020. CFA Institute, 2020 edition; effective 1 January 2020; required for GIPS Reports with periods ending on or after 31 December 2020. Status: Current (checked 2026-10-01). 1.A.35 (money-weighted returns); 2.A.12 (no annualisation under one year); 2.A.29.a (annualised since-inception money-weighted returns) — supports: IRR is a money-weighted return; returns for periods under one year are not annualised
2. Enhancing Transparency Around Subscription Lines of Credit. Institutional Limited Partners Association, ILPA, June 2020 (follows the June 2017 guidance Subscription Lines of Credit and Alignment of Interests). Status: Current (checked 2026-10-01). p. 4 (effect on IRR and TVPI); p. 5, recommendation 1 (net IRR with and without the use of the facility) — supports: Subscription lines raise IRR and lower multiples; managers should report net IRR with and without the facility
3. The Hazards of Using IRR to Measure Performance: The Case of Private Equity. Ludovic Phalippou, SSRN (working paper), SSRN 1111796, 2008. Status: Working paper (checked 2026-10-01). Abstract (SSRN 1111796) — supports: IRR creates incentives on the timing of cash flows and the grouping of funds and biases simple averages upward; modified IRR or NPV proposed as alternatives

• Total Value to Paid-In (TVPI)
• Distributions to Paid-In (DPI)
• Multiple on Invested Capital (MOIC)
• Time-Weighted Return (TWR)
• Public Market Equivalent (PME)
• Direct Alpha
• Vintage Year
• Benchmark
• Gross IRR
• Net IRR
• XIRR (Date-Exact IRR)

• Alternative Investments (Alternative Assets)
• Cap Rate (Capitalization Rate)
• Capital Call
• Discounted Cash Flow (DCF)
• Dividend Recapitalization
• Equity Multiple
• Fair Value
• Illiquidity Premium
• Independent Sponsor Economics
• J-Curve
• Net Asset Value (NAV)
• Opportunistic Real Estate
• Preferred Return (Pref)
• Private Capital (Private Markets)
• Search Fund Economics
• Subscription Line of Credit