Partners Capital: Evaluating Fund Performance Custom Case Solution & Analysis

Evidence Brief: Partners Capital Performance Evaluation

1. Financial Metrics

Assets Under Management: Approximately 48 billion dollars as of the case period.
Internal Rate of Return (IRR): The primary metric used by General Partners (GPs), often cited in the 15% to 25% range for top-quartile funds.
Total Value to Paid-In (TVPI): A multiple-based metric used to show total value created per dollar invested, typically targeting 2.0x or higher for mature funds.
Public Market Equivalent (PME): The Kaplan-Schoar PME is the focal benchmark. A score above 1.0 indicates outperformance relative to a public index; a score below 1.0 indicates underperformance.
Fee Structures: Standard private equity fees follow the 2 and 20 model (2% management fee, 20% carried interest), creating a high hurdle for net-of-fee alpha.

2. Operational Facts

Investment Model: Partners Capital operates as an Outsourced Chief Investment Officer (OCIO), selecting third-party managers rather than investing directly in companies.
Manager Selection Process: Involves deep due diligence on General Partners, focusing on historical performance, strategy consistency, and team stability.
Data Aggregation: The firm must normalize disparate data formats from hundreds of different fund managers to create a consolidated view for clients.
Reporting Cycle: Quarterly reporting is standard, though private equity data typically lags public market data by 45 to 90 days.

3. Stakeholder Positions

Stan Miranda (CEO/Founder): Pushes for analytical rigor and the adoption of PME to ensure the firm is not just buying beta at private equity prices.
General Partners (GPs): Generally prefer IRR and TVPI because these metrics often look more impressive than PME during bull markets. They resist benchmarks that adjust for market timing.
Institutional Clients: Require clear justification for the illiquidity and high fees associated with private equity compared to low-cost index funds.
Investment Analysts: Tasked with the technical challenge of calculating PME and explaining variances to clients.

4. Information Gaps

Benchmark Specificity: The case does not specify which exact public indices are used for niche strategies like distressed debt or sector-specific buyouts.
Risk Adjustment: Precise methodology for adjusting PME for the inherent leverage differences between public companies and private equity-backed companies is not fully detailed.
Survivor Bias: The data provided does not account for funds that failed and stopped reporting, potentially inflating category averages.

Strategic Analysis: Solving the Alpha Measurement Dilemma

1. Core Strategic Question

How can Partners Capital implement a performance measurement framework that accurately isolates manager skill (alpha) from market returns (beta) while maintaining access to top-tier fund managers?
How should the firm communicate potential underperformance to clients when traditional metrics like IRR remain positive but PME lags?

2. Structural Analysis

The private equity industry relies on IRR, which is easily manipulated by the timing of cash flows and the use of subscription credit lines. The Kaplan-Schoar PME addresses this by discounting all private equity cash flows using the returns of a public index. This reveals that much of what is sold as private equity outperformance is actually the result of a rising tide in public equities. The bargaining power of top-tier GPs is high, meaning Partners Capital cannot unilaterally demand new reporting standards without risking losing allocations in oversubscribed funds.

3. Strategic Options

Option	Rationale	Trade-offs
Full PME Integration	Adopts Kaplan-Schoar as the primary metric for all manager evaluations and client reporting.	Provides maximum transparency but may alienate GPs and confuse clients during periods of public market volatility.
Custom Hurdle Framework	Creates a bespoke benchmark that adds a 300-500 basis point illiquidity premium to the PME.	More accurately reflects the cost of capital but introduces complexity and subjective assumptions.
Dual-Reporting Status Quo	Continues using IRR/TVPI as primary metrics while keeping PME as a secondary internal tool.	Maintains industry alignment but fails to address the fundamental risk of paying high fees for market-matching returns.

4. Preliminary Recommendation

Partners Capital should adopt the Custom Hurdle Framework. Simply beating the S&P 500 (a PME of 1.0) is insufficient for private equity. The firm must justify illiquidity by targeting a PME of 1.2 or higher. This approach formalizes the expectation of an illiquidity premium and provides a clear basis for terminating managers who consistently deliver only market beta.

Implementation Roadmap: Transitioning to Alpha-Centric Evaluation

1. Critical Path

Month 1: Data Standardization. Recalculate historical performance for the top 50 managers using Kaplan-Schoar PME against relevant sector indices.
Month 2: Manager Feedback Loop. Present PME data to GPs to solicit their perspective on discrepancies and performance drivers.
Month 3: Client Education. Conduct webinars for the top 20% of clients to explain why IRR is a flawed metric and how PME protects their long-term interests.
Month 4: Reporting Rollout. Issue the first quarterly reports featuring the new Alpha-Beta decomposition.

2. Key Constraints

Data Quality: GPs provide quarterly valuations that are often subjective; PME calculations are only as good as the underlying cash flow data.
GP Resistance: Top-performing managers may view PME as an unnecessary hurdle and prioritize investors who ask fewer questions.
Public Index Selection: Selecting the wrong index (e.g., using S&P 500 for a European mid-market fund) can lead to false conclusions about manager skill.

3. Risk-Adjusted Implementation Strategy

To mitigate the risk of manager alienation, the firm will position the PME transition as a tool for better portfolio construction rather than a punitive measure. If a manager shows a PME below 1.0, the first step is an operational audit to determine if the underperformance is structural or a result of temporary market dislocation. Contingency: if public markets crash, PME will look artificially high for private equity; the implementation must include a smoothing mechanism to account for the valuation lag in private markets.

Executive Review and BLUF

1. BLUF

Partners Capital must immediately transition to a PME-plus-premium reporting standard. The current reliance on IRR masks the reality that many managers are failing to earn their fees on a risk-adjusted basis. By institutionalizing a PME hurdle of 1.15 to 1.20, the firm protects client capital from expensive beta and reinforces its position as a sophisticated OCIO. This change is not optional; as public markets become more efficient, the window for unmeasured private equity alpha is closing. Speed in adoption will differentiate the firm from less analytical competitors.

2. Dangerous Assumption

The single most dangerous assumption is that public market indices are a suitable proxy for private equity risk. Private companies often carry significantly higher leverage and lack the governance requirements of public entities. A PME of 1.0 does not mean the manager matched the market; it means the manager matched the market while taking on significantly higher structural risk.

3. Unaddressed Risks

Adverse Selection: By being the most demanding investor regarding performance metrics, Partners Capital may be excluded from the hottest deals where GPs have a line of less-demanding investors out the door.
Benchmark Mismatch: Using broad indices like the MSCI World for specialized venture capital funds will produce meaningless PME data that could lead to poor divestment decisions.

4. Unconsidered Alternative

The team failed to consider a Synthetic Index approach. Instead of using a standard public index, the firm could construct a basket of public stocks that mimic the sector and leverage characteristics of each specific private fund. This would provide a much more accurate measure of true alpha than a generic S&P 500 comparison.