Lesson 2 of 10 · All lessons in this module
- Why appraisal is harder: the life cycle and the J-curveVideo lesson
- Measuring returns: IRR versus MOICVideo lesson
- Leverage: magnifying gains and losses
- Valuation: fair value levels and smoothed returns
- Fees, custom terms and redemption provisions
- Hurdle rates, catch-up, waterfalls and clawbackVideo lesson
- High-water marks, investor timing and either/or feesVideo lesson
- Integrated case: hurdle rate and high-water mark in one fee
- Integrated case: three investors, one fund, four years
- Funds of funds, benchmarks and index biases
Lesson 2 of 10 · 13 min
Measuring returns: IRR versus MOIC
IRR captures both the size and the timing of a fund's cash flows, so it is the preferred measure; MOIC is a quick multiple that ignores how long the money was tied up.
In short
- The internal rate of return (IRR) is the discount rate that sets the NPV of all cash flows to zero. It rewards or penalises the manager for the timing of calls and distributions.
- IRR relies on assumptions about the financing rate for outflows and the reinvestment rate for inflows, and it is harder to compute.
- The multiple of invested capital (MOIC) = (realised value + unrealised value) / total invested capital.
- Invested capital = paid-in capital less management fees and fund expenses.
- MOIC is simple and intuitive but ignores timing: 2.0× over 3 years is far better than 2.0× over 12 years.
- In the middle years of a fund, accounting values often sit near cost and say little about the eventual outcome.
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