Private equity benchmarks test advisors’ fiduciary duty

Financial advisors are finding it harder to measure private equity returns because benchmarks use different methods and report divergent results. The variation complicates performance evaluation and client reporting.

Private equity benchmarks are built in two main ways. One method aggregates fund-level reports to produce a high-level view across funds. Those fund-level benchmarks can help evaluate manager selection but do not show what drives returns or the condition of the underlying portfolio companies.

The other method compiles performance at the investment level, using results from the private companies that funds hold. Investment-level benchmarks allow sector, industry and regional breakdowns and more closely mirror how public market indexes are constructed.

Fund structure affects which benchmark fits a vehicle. Closed-end private equity funds have fixed start and end dates. Evergreen funds accept periodic entries and exits and continuously reinvest capital. Applying a closed-end benchmark to an evergreen vehicle can misstate performance because the timing and profile of cash flows differ.

Industry practitioners say investment-level benchmarks more closely reflect the continuous cash flows of evergreen funds, making some comparisons more directly comparable when a fund operates on an ongoing basis rather than a fixed lifecycle.

Advisors also need to compare private equity returns with public-market equivalents. Investment-level data enables comparisons such as private health-care company returns against public health-care stocks, which can help identify whether returns stem from manager decisions or from broader sector movements.

Opacity in private market data carries regulatory and fiduciary implications. If advisors cannot explain where returns come from, or if they use benchmarks that do not match the invested vehicle, they may face questions about suitability and disclosure.

Sofia Gertsberg, managing director and head of quantitative investment science at HarbourVest Partners, described the variability in benchmark performance as “frustrating” and noted that opacity has long been tolerated in the asset class.

Several firms now offer both fund-level and investment-level benchmarking approaches. Experts recommend that advisors confirm the data source behind a benchmark, verify that its methodology aligns with the fund structure, and use public-market comparisons when reporting results to clients.

Industry practitioners also recommend matching benchmark methodology to the investment vehicle and applying investment-level data where appropriate to make performance reviews and client disclosures clearer.