The Real Performance of this GEM

Amar Pandit , CFA , CFP

One day I received a SMS from a Private Equity Sales Guy.

The message read “Another Gem got listed from ******Private Equity Portfolio.”

I congratulated him for this Gem and messaged him “What is the overall performance (XIRR) of this fund and the other 2 funds from their dates of inception?”

He messaged “Will share the fourth fund deck which has previous fund details also. Best if we could connect over Zoom.”

I wrote “Just send the deck for now.” He acknowledged and then I waited.

After 2 days, I reminded him that I had still not received the deck with the data.”

He wrote back “The deck is getting updated with the latest exit.”

It’s now 9 days and I am yet to receive it.

It’s shocking that someone who is selling simply 1 product could not quickly share this 1 basic number. Overall Performance since inception.

However, this is not at all surprising. This is the concept of picking a few winners and highlighting them. There is never a mention of the ones that have lost money. What about the overall performance? If this was so good, wouldn’t this be the first one to be highlighted? Well, it surely would but that is another story.

Welcome to the world of performance marketing.

Investors love to see returns. The higher the better. First, very rarely do we look under the hood to see how this performance was delivered. Imagine someone utilizing steroids to boost performance. Most of us will not be able to spot the difference but a real professional can.

In the investment world, was this performance delivered by taking on too much risk such as concentrating in a few stocks or utilizing leverage (magnifying returns but magnifying risk too). Real performance evaluation of an investment is beyond the skill set of most investors. The late Bernie Madoff ran a Ponzi scheme of $70 billion+ that even global banks, financial institutions, family offices and high net worth families fell for. When something is too good to be true, it almost never is.

I will have to write an entire book on performance reporting of institutions because the subject itself is so wide and deep. A simple post or two cannot really do justice to this. By now you might have guessed, evaluating performance is not just an art and science but it’s also a real skill. Thus, it pays to have a real professional on your side to protect you from falling for such traps. The value of just this part is invaluable.

Second, anyone would be happy to know that an investment in their portfolio has gone up several times. But the performance marketers know another powerful human motivator. FOMO (Fear of Missing Out). When we hear someone claiming a gem from our portfolio has gone up 10 times, some are likely to think “We should have done this. We missed this opportunity. Let me not miss the next one.” We then hop on to this fund’s next installment hoping for a repeat of performance.

I see many family offices and high net worth individuals falling for this tactic used by many.

This tactic of getting investors to buy into your next fund by highlighting selective performance is called cherry picking the winners. Performance misrepresentation is a big issue in the financial services industry worldwide.

The CFA Institute has even developed a set of voluntary ethical standards called as GIPS (Global Investment Performance Standards) for use by investment management firms around the world.

Does the above messaging pass the GIPS standard? Not by a mile.

So, beware of such messages (protect yourself against this nonsense) and ask these simple questions.

  1. What is the XIRR of the fund since inception?
  2. Is the financial institution following GIPS to report performance? Or is this reporting GIPS compliant? This will give you a sense of the seriousness of the firm towards ethical performance reporting.
  3. What are the gems that have not done well in the portfolio?

Look at the number of winners as well as the losers. Every portfolio will have losers and that’s simply fine. It’s natural to have some losers but look at the weightings of these losers. Similarly, if the investment has gone up 10 times in the portfolio, but it has a 0.25% weight in the portfolio then it does not mean much for the overall portfolio return.

My intent here was not to pick on someone but to highlight a key tactic that is used to gather assets from high net worth and affluent families.

By the way, I am still waiting to get the answer to the one question I had asked. I don’t think I will get the answer anytime soon (not at least till the fund closes its round).