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Calculating Outperformance in Dollars: Introducing the Excess Value Method

Avi Turetsky, Matthew Pyrz, Barry Griffiths, Joaquin Lujan and Isaac Beckel
The Journal of Portfolio Management May 2021, jpm.2021.1.234; DOI: https://doi.org/10.3905/jpm.2021.1.234
Avi Turetsky
is a partner at Landmark Partners in New York, NY, and a research fellow at Case Western Reserve University in Cleveland, OH
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Matthew Pyrz
is a senior associate at Landmark Partners in Simsbury, CT
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Barry Griffiths
is a partner at Landmark Partners in Dallas, TX
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Joaquin Lujan
is the co-head of the alpha team and director of rates and credit at the Public Employees Retirement Association of New Mexico (NM PERA) in Santa Fe, NM
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Isaac Beckel
is an investment associate at the Public Employees Retirement Association of New Mexico (NM PERA) in Santa Fe, NM
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Abstract

This article introduces the excess value method for calculating the dollar value that a private market investment generates relative to a benchmark. To the authors’ knowledge, this is the first published method of doing so. It is based on the commonly used direct alpha and Kaplan–Schoar public market equivalent (KS-PME) measures of private market relative performance as a rate and multiple. The article demonstrates that direct alpha and KS-PME cannot be directly translated into dollar terms for all but the simplest cash flow streams. It thus introduces adaptations that enable this translation to take place algorithmically. The authors believe that excess value can give investors and fund managers useful insights into the value creation of private market investments over time and can facilitate an alternative to traditional carried interest compensation. Unlike carried interest, which compensates managers for absolute performance regardless of public market behavior, excess value–based performance fees enable performance compensation to be paid only for outperformance versus a public market benchmark.

TOPICS: Real assets/alternative investments/private equity, performance measurement

Key Findings

  • ▪ This article introduces the excess value method for calculating the dollar value a private market investment generates above or below a benchmark. It is based on the commonly used direct alpha and Kaplan–Schoar public market equivalent performance measures.

  • ▪ The excess value method introduces adaptations that enable dollar outperformance to be calculated algorithmically even for complicated cash flow streams.

  • ▪ Excess value can enable parties to measure dollar outperformance over time and to develop performance fee agreements that create better alignment by being based on a split of value in excess of an agreed benchmark rather than absolute returns.

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The Journal of Portfolio Management: 47 (5)
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Investment Models 2021
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Calculating Outperformance in Dollars: Introducing the Excess Value Method
Avi Turetsky, Matthew Pyrz, Barry Griffiths, Joaquin Lujan, Isaac Beckel
The Journal of Portfolio Management Mar 2021, jpm.2021.1.234; DOI: 10.3905/jpm.2021.1.234

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Calculating Outperformance in Dollars: Introducing the Excess Value Method
Avi Turetsky, Matthew Pyrz, Barry Griffiths, Joaquin Lujan, Isaac Beckel
The Journal of Portfolio Management Mar 2021, jpm.2021.1.234; DOI: 10.3905/jpm.2021.1.234
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  • Article
    • Abstract
    • ON ALIGNING COMPENSATION WITH OBJECTIVES
    • A HISTORICAL PERSPECTIVE ON PRIVATE MARKET PERFORMANCE MEASUREMENT
    • REJECTING A STRONG INTUITION—KS-PME NUMERATOR MINUS KS-PME DENOMINATOR
    • ANOTHER INTUITION—THE CARRIED INTEREST WITH A MARKET-BASED PREFERRED RETURN
    • DEFINING A SOLUTION
    • THE EXCESS VALUE METHOD
    • ILLUSTRATED CALCULATION OF EXCESS VALUE IN MORE COMPLICATED CASES
    • CONSIDERATIONS FOR IMPLEMENTING THE EVM
    • CONCLUSIONS
    • ACKNOWLEDGMENT
    • ENDNOTES
    • REFERENCES
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