IRR (Internal Rate of Return)
IRR is the annualized rate of return that equates the present value of cash flows (calls and distributions) to zero.
Allocator relevance: A standard metric for private markets performance, but highly sensitive to timing and should be paired with TVPI/DPI for truth.
Expanded Definition
IRR is time-weighted by cash flow timing: early distributions can increase IRR even if total value is modest, and delayed exits can depress IRR despite strong multiples. Because of this sensitivity, IRR can be “gamed” through financial engineering or selective early realizations. In private funds, IRR should be interpreted alongside TVPI (total value) and DPI (realized distributions).
Allocators use IRR for benchmarking, but sophisticated decisions rely on a metric set.
How It Works in Practice
IRR is calculated from capital calls, distributions, and residual value marks. Managers report gross and net IRR; allocators compare against peers by vintage and strategy.
Decision Authority and Governance
Governance ensures consistency in reporting methodology and valuation policy, because IRR depends on marks. LPAC oversight and audits can reduce reporting ambiguity.
Common Misconceptions
- Higher IRR always means better outcome.
- IRR compares cleanly across strategies and vintages.
- IRR is robust to valuation assumptions.
Key Takeaways
- IRR is timing-sensitive and can mislead alone.
- Pair with TVPI and DPI.
- Evaluate net vs gross and the underlying cash flow pattern.