DPI vs. IRR: How to Actually Judge a Private Fund

Ask a private fund how it's done and you'll get an internal rate of return. One confident percentage that sounds like a verdict. It's the number the industry leads with, prints on the first page of every deck, and hopes you'll take at face value. It's also the number a manager can shape more easily than any other, which is exactly why a careful investor should distrust it first.

Judging a fund well means reading past that headline to the measures that are harder to dress up and closer to the truth. Cash actually returned, paper value, and an honest comparison against what the same money would've earned somewhere else. Those tell a more reliable story than IRR on its own. A manager knows precisely which figures flatter the record and which expose it, so an investor who wants the truth has to ask for the ones the manager would rather not lead with.

Why IRR Misleads

The internal rate of return measures the annualized return on your money, and it accounts for exactly when each dollar goes in and comes back out. Sounds precise. It hides two problems. First, it's exquisitely sensitive to timing. An early win can throw off a dazzling IRR on a small slug of capital, and that number tells you almost nothing about whether the fund can compound real money at scale. Second, and this is the one that should bother you, a manager can lift the IRR without earning a dollar more of actual return.

The usual technique is a subscription line, which is just a loan the fund uses to make its early investments so it can put off calling your capital. The IRR clock starts when your money is actually called. So borrowing to postpone that call shortens the measured time your capital was at work, and the reported IRR climbs on financing alone. The fund looks faster without doing anything better. When a manager leads with IRR and goes quiet about how much of it came from a subscription line, that quiet is worth noticing.