IRR as a Service
Private Equity Return Under Scrutiny: A Memorial Day Dispatch
Happy Memorial Day Weekend, everyone! Hope you’re making the most of it. I’m stepping away from my usual AI infrastructure and enterprise application. If you’ve been watching the drama unfold around university administrations and their endowments, you know PE is under pressure. And this weekend, it’s getting lit up again—thanks to Ludovic Phalippou, an Oxford professor who’s been dragging the private equity industry for years. His 2020 hit paper, An Inconvenient Fact: Private Equity Returns & The Billionaire Factory, is making the rounds again, boosted by a spicy follow-up he just published in the Financial Times.
The core argument is that PE’s favorite performance metric, the Internal Rate of Return (IRR), is basically a misleading marketing tool. I love a good intellectual takedown of broken metrics and benchmark manipulation, and this one’s a classic. I am on a train from Boston and have free time. So let’s break down what Phalippou’s saying.
PE Returns Are No Better Than Public Markets (Since 2006): Phalippou’s 2020 paper says: since 2006, PE funds have returned about 11% annually, matching public stock markets like the S&P 500 (with a net Multiple of Money, or MoM, of 1.50). PE funds clocked MoMs of 1.55 to 1.63 across datasets like Burgiss and Preqin, while big pension funds and the big four PE firms hit 1.51 to 1.67. That 11% matches small-cap indices like DFA’s micro-cap fund (1.51 MoM) but beats large-cap ones like the S&P 500 pre-2006—only because of cherry-picked benchmarks.
IRR Is a Total Marketing / Scam Metric ( I love this part): Phalippou goes hard on one central idea: IRR isn’t a real return—it’s a “mathematical artefact.” IRR assumes that all cash payouts you receive from an investment are instantly reinvested at the same rate as the IRR itself. So, if a fund exits a deal early and earns a strong return, IRR assumes that return can be compounded at the exact same rate indefinitely. That’s just unrealistic. There’s no market in the world where that kind of reinvestment is possible across decades, and yet this number is used to justify billions in capital allocation. Phalippou illustrates just how ridiculous this gets with simple math. Some more calculations from his FT article, I am just going to show you the section here.
This has real consequences. It lets firms front-load their performance marketing. A couple of strong deals in the early years - IRR locked and loaded. Later flops barely register. Fund managers know this. They actively game it by quickly exiting their best deals to boost IRR and deferring capital calls or using leverage to delay drawdowns. These tactics skew the cash flow profile in a way that flatters IRR without delivering better long-term value to investors.
Phalippou also points out that IRR disproportionately benefits large U.S. buyout funds, where early distributions and debt structuring are easier to optimize. In contrast, smaller or emerging market funds can’t manipulate capital flows the same way, making them look worse on IRR even if they’re delivering real value.
So what should we use instead? Phalippou advocates for more grounded, transparent metrics like:
MoM (Multiple on Money): Shows how much an investor actually made, net of fees.
PME (Public Market Equivalent): Compares PE cash flows to public benchmarks over the same time period.
These aren’t perfect either, but at least they’re based on real-world cash movements—not fantasy reinvestment rates. In short, IRR’s not just imperfect—it’s structurally misleading. It rewards gamesmanship, hides underperformance, and seduces institutions with numbers that don’t reflect reality. Phalippou’s takedown is brutal, but fair. And after reading it, you can’t look at IRR the same way again.
Obscene Fees for Mediocre Returns: Despite matching public markets, PE charges a fortune—$100 billion annually to manage $600 billion in assets, with $50 billion in fees for $200 billion in equity and $20 billion to borrow $400 billion in debt. They pocketed $230 billion in “carry” from 2006-2015 ($370 billion including all vintages to 2015), mostly for a tiny elite, while investors got no premium. The 2020 paper highlights a single fund where fees and carry ate $2.8 billion for a $10 billion investment, leaving investors with the same 1.5x return as public stocks. Well.
The Billionaire Factory Is Real: PE’s fee structure has minted billionaires - there were 3 PE billionaires in 2005, the number grew to 22 in 2020.
Agency Conflicts Keep the Game Going: Why do endowments like Yale and pensions keep buying in? Phalippou points to agency conflicts and financial illiteracy. Managers won’t admit PE’s a bust. Trustees lean on consultants who profit from the PE gravy train. Yale’s stuck hyping its 26% IRR, but its real returns are 11% post-2006. The 2020 paper notes PE’s “quasi-religious” status: question the outperformance mantra, and you’re an outcast.
The Hilton Deal: Phalippou’s 2020 paper dissects Blackstone’s 2007 Hilton deal, dubbed the “best LBO ever.” They turned $6.4 billion into $20 billion by 2018, a $13.8 billion gain. But after $685 million in fees and $2.6 billion in carry, the net return matched Marriott’s 9.2% annual return. Investors got nada extra, while Blackstone execs and Hilton’s CEO cashed out millions.
IRR Screws Over Emerging Markets: The 2020 paper and FT article highlight IRR’s unfairness—US buyout funds can game it, but emerging market funds can’t, stuck with “real” 10% returns that look weak next to KKR’s 25.5%. This misallocates capital, starving regions that need it.
Annnnyway, I wish I’d learned more about this back in the day—but I was late for registration. Timing is everything, right?