The PE S-Curve, Dug Out

There are a couple of concepts that qualify a discovery – even if just stumbled upon: novelty and usefulness. With respect to private equity, the S-Curve adds the notion of decreasing marginal returns to improve the mainstream J-Curve notion, and this clears novelty. What’s left now is to dig out its usefulness.

To set the stage, it is probably helpful drawing an S-Curve. We do so by breaking down the life of a private equity fund in stages, timed by duration and marked off by value creation.


What the S-Curve shows if that most of the value creation happens in the “Traction” phase (i.e. when portfolio assets exploit operational and financial leverage potential) of the life of funds.

This is why I keep reminding that, from a fund performance (and valuation) perspective, it’s not only the “how much” but also the how long and when of the Traction phase that matters. Never neglect duration.

A numerical example should help. Let’s consider an investment that after 8 year is worth 1.6 times the original amount and has therefore generated a return (compound average growth rate – CAGR) of 6.05% p.a.: more money, say 10% more that is 1.76 times the original investment but after 10 years, may (as in this case) imply lower total returns (5.82% CAGR) because of decreasing marginal returns (4.88% CAGR).

Duration is an industry’s consolidated notion – although not adequately qualified (i.e. not unambiguously and objectively defined) by current performance standards.

To prove this, I’d like to ask readers about your perception of the average duration of a private equity fund.

Please don’t look for the right answer (if any) now – you’ll find out, but more importantly you will hopefully see the point that I am trying to make (and that makes more than one answer correct).

In fact, the answer depends on the perspective you take in considering the how long and when elements of the duration, individually and combined.

Because of this and by the way, the results of the poll will probably be influenced by whether you are acting for the sell-side or buy-side, GP or LP. Perhaps you do not mind letting us know here:

Thanks for taking the time – I cannot predict what the data will say, but everyone will be able to speculate about them. I will comment (if it’ll make sense) as soon as I will see sedimented results.

Back to the duration, both its how long and when, and how the S-Curve better qualifies the notion through its connection with real life time – that I call “calendarization”.

Duration and calendarization allow putting private equity performance in the unambiguous context of all other asset classes but within the specific benchmarking framework of total return yield curves, because, like bonds, private equity funds mature and liquidate.


Hence the critical and distinctive element of usefulness of the S-Curve, setting realistic time boundaries to comparability and insulating it from illogical reinvestment risk assumptions.

  • It signals the moment in time when expected value creation and distributions may become negligible relative to total value already generated and benchmarking loses meaningfulness.

Using Michael Porter’s perspective, usefulness implies being exploited for gain. So, let’s check if you too see ways to realize benefits from “riding” the S-Curve.

My hint is that you can think of the different maturities over the total return curve as a series of pictures in which the NAV component ties unrealised performance with future expected realizations under the control (and conditions’ constraints ) of the public markets.

If fund performance co-moves with its comparable public index, “equilibrium” NAV pricing can be inferred from the forward markets.


_ _ _ _ _ _


1. It depends: the traction phase usually lasts (i.e. has a duration of) 3-5 years but to get there it usually takes another 3-5 years. The study that I referenced in my previous post has found that value creation and cash generation were limited after year nine in the life of a private equity fund.

2. There is no right answer – just data about the universe of voters.

3. There is no right answer – just data about the opinions voters.



One thought on “The PE S-Curve, Dug Out

  1. Valerio December 21, 2014 / 10:23 am

    Caro Massimiliano, complimenti per l’interessante articolo.
    Il problema è, almeno nella mia esperienza, che lo IRR, non è tutto.
    IRR è un indicatore sintetico fondamentale per valutare un investimento, ma forse ancor più importante è la cassa generata. Ovviamente, più è lunga la duration è più lo IRR tenderà a diminuire ( a parità di altre condizioni), ma molti investitori, soprattutto quelli previdenziali, o comunque Long Term, si concentreranno più sulla generazione di cassa nel tempo che non sul solo IRR.
    Un caro saluto
    Valerio Pacelli

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