Public Market Equivalent (PME)

PME asks a benchmark question that IRR and TVPI do not

IRR can show how quickly private-fund cash flows compounded. TVPI can show total value relative to contributed capital.

Neither one directly answers:

What would comparable cash flows have produced in a public market?

PME methods address that question by linking private-fund contribution and distribution dates to a chosen public index.

ILPA benchmarking materials describe PME as a market-adjusted approach that compares private-fund cash flows with a public-market investment made on corresponding dates.^[1]

The basic intuition

Suppose an LP contributes:

• $1 million in Year 1
• $500,000 in Year 2

and receives distributions in Years 4 and 6.

A PME analysis uses the selected public index to model what would have happened if those contribution amounts had instead been invested in the public benchmark on the same dates, with value reduced or otherwise adjusted when the private fund distributed cash.

The exact mechanics depend on the PME variant.

PME is not one single formula

Several methodologies exist, including:

• Kaplan–Schoar PME
• Long–Nickels PME
• modified PME approaches
• direct alpha and related variants

They are not interchangeable.

ILPA materials discussing benchmarking specifically identify KS PME and modified PME approaches.^[1]

A report should state which version is being used.

The public benchmark choice matters

A private growth-equity fund compared with the S&P 500 can produce a different relative result from the same cash flows compared with a small-cap, technology or global index.

Benchmark selection should therefore be economically defensible rather than chosen merely because it produces the most favorable spread.

Questions to ask include:

• Does the index match the geographic exposure?
• Is company size reasonably comparable?
• Is the private strategy sector-concentrated?
• Does the benchmark include dividends?
• Is the comparison net or gross of relevant costs?

PME can reduce one major private-market comparison problem

Public and private investments rarely receive cash at the same times.

Comparing a private fund’s since-inception IRR with a public index’s simple annualized return can mismatch the investment periods and capital exposure.

PME improves the comparison by incorporating the private investment’s actual contribution and distribution schedule.

That does not eliminate every problem. Private investments differ from public equities in leverage, liquidity, governance, valuation frequency and risk.

CFA Institute research notes that private-equity performance data contain important measurement and comparability challenges.^[2]

Interpreting a PME ratio

Under Kaplan–Schoar PME, a ratio above 1.0 generally indicates the private investment outperformed the public benchmark on the modeled cash-flow basis; below 1.0 indicates underperformance.

Other PME variants can report an IRR-like return or spread instead of a simple ratio.

The output format should therefore be identified before interpreting the number.

Common mistakes

“PME is just private-fund IRR minus S&P 500 return.”

No. PME methodologies incorporate the timing of private cash flows.

“There is only one PME calculation.”

No. Multiple variants exist.

“A PME above 1 means the private fund was lower risk.”

No. PME is primarily a performance comparison, not a complete risk adjustment.

“Any public index is an acceptable benchmark.”

No. Benchmark choice can materially affect the conclusion.

PME is most useful when the methodology, benchmark index, cash-flow dates and treatment of ending NAV are disclosed. Without those inputs, a PME number can appear more precise than the underlying comparison actually is.