Public Market Equivalent (PME)
Definition
Public market equivalent, or PME, is a family of methods for comparing a private fund's performance with a public index using the fund's own cash flows: each capital call is treated as a purchase of the index on the call date, each distribution as a sale on the distribution date, and the result is compared with what the fund actually delivered. The Kaplan-Schoar PME, the most used, is a ratio: the present value of distributions divided by the present value of contributions, both discounted at the index's returns, so a value above 1.0 means the fund beat the index on a dollar-weighted basis and below 1.0 means it did not. Direct alpha converts the same comparison into an annual rate, the amount by which the fund's IRR exceeded the index over the same timing. PME exists because a private fund's IRR cannot be compared with an index's time-weighted return, since the fund controlled when money went in and came out, and because the multiples a fund reports say nothing about what the same money would have earned elsewhere.
Why it matters
A private fund's IRR and multiple describe the fund. PME describes the decision to be in it. Every pitch for a private markets product rests on the claim that illiquidity, fees and complexity are paid for by returns above what public markets offer; PME is the only common measure that tests the claim with the fund's own cash flows rather than with a time-weighted index return that ignores when the money moved. It is also the measure that most private fund marketing omits, because a fund with a 15 percent IRR and a 2.0x multiple in a decade when the S&P 500 compounded at 14 percent has a PME near 1.0, and that number is harder to sell.
Common misconceptions
- •PME is not the fund's return minus the index's return. Subtracting a 12 percent index return from a 15 percent IRR ignores timing; the fund's calls and distributions fell on specific dates, and PME prices them on those dates.
- •A PME above 1.0 does not prove skill. It shows the fund beat the chosen index on its own cash-flow timing; a different index, or the same index measured against a different benchmark of risk, can move the answer across 1.0.
- •PME is not the same for every investor in the fund. It uses the fund's aggregate cash flows; an investor who entered at a later closing or through a feeder with different timing has a different personal PME.
- •An interim PME is a mark, not a result. Until the fund has distributed everything, the residual NAV is treated as a final distribution at the manager's valuation, so the PME of a young fund depends on marks that have not been tested by a sale.
Technical details
Worked example: the $100 million fund against an index
The fund used across this cluster calls $100 million over years one to three and distributes $180 million over years four to eight: a 1.8x multiple and roughly a 13 percent net IRR.
Suppose the index returned 10 percent a year throughout. Discounting each call and each distribution back to the fund's start at 10 percent: contributions have a present value of about $83 million, distributions about $105 million. Kaplan-Schoar PME = 105 / 83 = 1.27. The fund beat the index: the same money in the index on the same dates would have been worth 27 percent less by the time it came back.
Now suppose the index returned 14 percent a year. Contributions discount to about $77 million, distributions to about $78 million. PME = 1.01. Same fund, same 1.8x, same 13 percent IRR: it matched the market and the investor bore ten years of illiquidity for nothing.
Direct alpha in the first case is about 3 percent a year; in the second, about zero.
The three main methods
Long-Nickels (1996): builds the index portfolio from the fund's cash flows and reports the IRR the index portfolio would have earned, for comparison with the fund's IRR. It fails when large distributions drive the index portfolio negative.
Kaplan-Schoar (2005): the ratio of index-discounted distributions to index-discounted contributions; robust to the Long-Nickels failure and the standard in academic and consultant reporting.
Direct alpha (Gredil, Griffiths and Stucke, 2014): the IRR of the fund's cash flows after discounting them at the index, giving an annual excess return; the version most comparable with IRR.
PME+ and mPME: variants from Cambridge Associates and others that scale distributions so the index portfolio's ending value matches the fund's NAV, used in consultant benchmarks.
What goes into the calculation
Cash flows: every capital call and distribution by date, net of fees and carry, from the fund's capital account statements; in-kind distributions valued at the distribution date.
Residual NAV: treated as a final distribution on the measurement date at the reported mark, which is why interim PMEs of young funds are provisional.
Index: a total-return series (dividends reinvested) chosen to match the fund's risk and geography; the choice should be disclosed.
Subscription lines: they delay calls and raise IRR, but PME is largely immune because a later call is discounted for fewer periods on both sides; this is one reason consultants prefer PME to IRR.
Where PME appears, and where it does not
Institutional reporting: pension and endowment performance reports commonly show program-level PME against the S&P 500 or a custom index, and consultants report fund-level PMEs in quartile benchmarks.
Public pension disclosures: New York City's monthly review reports a PME and spread per fund; most other plans in AltStreet's LP holdings report net IRR and multiples only.
Fund marketing: rare; a manager quoting a PME has usually chosen the index, and the same fund's PME against an alternative index is worth computing.
Access funds and platforms: not reported; the feeder's IRR reflects its own timing and fee layer, and its PME against the same index would be lower than the master fund's.
Evergreen vehicles: not applicable in the strict sense, because there are no fund-controlled cash flows; a time-weighted comparison with an index is the right tool.
Reading a PME
Find the index and confirm it is total return; a price-only index flatters the fund by a few points a year.
Find the date and whether the fund is fully realized; discount an interim PME for the share of value still in residual NAV.
Find whether cash flows are net of all fees and carry, and at which level (fund, feeder or investor).
Compare with the fund's IRR and multiple: a high IRR with a PME near 1.0 usually means a strong market or a subscription line; a modest IRR with a PME well above 1.0 means the fund outperformed in a weak market.
Frequently asked questions
- What is PME in private equity?
- A way of asking whether a private fund beat the stock market with the same money on the same dates. You take every capital call the fund made and pretend you invested that cash in an index instead, take every distribution and pretend you sold that much index on that date, and compare the two outcomes. If the fund returned more than the index portfolio would have, its PME is above 1.0.
- How is Kaplan-Schoar PME calculated?
- Discount every distribution back to the fund's start using the index's return between the distribution date and the start, add them up; do the same for every capital call; divide the first sum by the second. A fund that returned $200 million on $100 million of calls has a 2.0x multiple, but if the index doubled over the same dates, the discounted distributions and calls are roughly equal and the PME is about 1.0: the fund matched the market and added nothing.
- What is direct alpha?
- The annualized version of the same comparison. Instead of a ratio, direct alpha discounts the fund's cash flows at the index's returns and then computes the IRR of those discounted flows; the result is the annual rate by which the fund beat or trailed the index. A direct alpha of 3 percent means the fund earned about 3 percentage points a year more than the index on the fund's own cash-flow timing.
- What is a good PME?
- Above 1.0 net of fees over a full fund life, since that is the point of paying private fund fees and locking up capital. Research on US buyout funds has found average Kaplan-Schoar PMEs against the S&P 500 of about 1.1 to 1.2 for funds raised before 2010 and closer to 1.0 for later vintages; venture funds vary far more by vintage. A PME of 1.3 over ten years is strong; a PME of 0.9 means investors would have done better in an index fund with daily liquidity.
- Which index should be used?
- The one the investor would actually have held instead. The S&P 500 or Russell 2000 for US buyout, a small-cap or growth index for venture, a leveraged loan or high-yield index for private credit, a REIT index for real estate. The choice moves the answer by tenths of a point, which is why a fund that reports its own PME should state the index and why investors compute several.
- Do the public pension plans in AltStreet's LP data report PME?
- Some do. New York City's monthly performance review publishes a PME and a spread for each private fund position alongside net IRR and multiple, which is why the NYCERS rows in AltStreet's LP holdings carry those columns. CalPERS, CalSTRS, Oregon, Washington and Pennsylvania report net IRR and multiples fund by fund but not a fund-level PME; where they publish a program-level PME it is in a separate performance report.