Private Equity Returns Are Being ‘Distorted’ by Loans, Research Finds

A pair of Carnegie Mellon business school professors have waded into the subscription credit line debate.

Illustration by II

Illustration by II

Taking out a loan instead of taking money from investors increases a private equity fund’s internal rate of return by 6.1 percentage points — but that performance boost is just a “distortion,” according to a new paper from professors at Carnegie Mellon’s Tepper School of Business.

In their paper — “Distorting Private Equity Performance: The Rise of Fund Debt” — the professors, James Albertus and Matthew Denes, attempt to quantify the effects of subscription credit lines, a form of debt financing that is increasingly being used by private equity managers seeking to put off calling capital from their investors.

Using data from Burgiss, an analytics provider for private capital investors, the two assistant finance professors calculated how a private equity fund’s IRR would change if it had called capital from investors rather taking out a subscription line of credit. They found that the use of these loans resulted in a “substantial” increase in IRR, with the effect amplified for younger funds.

[II Deep Dive: Private Equity Managers Are Increasingly Turning to Loans Instead of Investors]

However, when they evaluated the same funds using a multiples-based measure of performance — as opposed to IRR, which is based on cash flows — Albertus and Denes found that subscription credit lines did not improve private equity returns. In fact, the total value to paid-in multiple, or TVPI, was slightly lower due to managers paying interest on the loans.

“These results suggest that a potential motivation for a fund’s use of [subscription credit lines] is to distort measures of performance,” the authors wrote.


The findings echo concerns expressed by the Institutional Limited Partners Association (ILPA), which in 2017 issued guidance to investors and their private equity managers to encourage greater transparency surrounding the use of subscription credit lines. Private equity manager Howard Marks, the co-chairman of Oaktree Capital Management, also weighed in on the trend in a 2017 memo.

In March, analysts at private-market data provider PitchBook released their own findings regarding the effects of subscription credit lines. But unlike the Tepper professors’ study, their analysis — which focused on whether IRRs have increased over time as the loans have become more widespread — didn’t produce “any evidence that IRR is being distorted for funds of more recent vintages.”

Despite this finding, the PitchBook analysts warned against over-reliance on IRR as a measure of performance — a conclusion that Albertus and Denes also reached in their research.

“If investors do not understand how [subscription credit lines] adjust IRR-based performance, then a private equity firm could potentially raise additional capital for future funds using the relatively higher measure of performance,” they warned.