Performance appraisal of alternative investments

Learning Outcome Statement

Describe the performance appraisal of alternative investments.

On the exam: The question gives committed and invested capital, appraisal and transaction values, liquidity and fee terms, then asks for a comparison, a fee bridge, or labels such as gross or net, levered or unlevered, and time-weighted, money-weighted, or multiple-based.

An alternative investment may carry an estimated value before a sale, then produce transaction proceeds when an asset exits. You first identify the valuation basis and the capital actually at risk. The cash actually deployed is invested capital, $I$. The value under review is $V$.

The denominator tells you what the result claims. A stale appraisal value can diverge from a later transaction value when illiquidity delays a sale.

Keep the three capital figures separate as you read the diagram. Commitment describes the fund's promised capacity, invested capital records what has actually been deployed, and remaining commitment is the portion still uncalled. Only the deployed amount belongs in this multiple's denominator. That distinction lets you explain both the fund's available capital and the investor's actual exposure without treating them as the same thing.

🔒Capital basis: committed capital, invested capital and remaining commitment

With the capital basis fixed, a multiple compares the selected value with cash deployed.

$$ \text{Multiple} = \frac{V}{I} $$

Use appraisal or market value for an estimate and transaction value for sale proceeds. A larger $V$ raises the multiple, while a larger $I$ lowers it. Gross return excludes fees, while net return includes the applicable management and performance fees. Label each result as levered or unlevered and as time-weighted, money-weighted, or multiple-based, with time-weighted results separating external cash timing, money-weighted results reflecting investor cash-flow timing, and multiple-based results comparing value or proceeds with invested capital.

Worked example

You are handed a fund's commitment, deployed cash, an appraisal value, and sale proceeds. You need to compare the estimate with the actual transaction and show what an investor keeps after fees. Read the cash amounts from the investor perspective. The amounts are unlevered fund-level figures, so you do not add a borrowing adjustment.

Start by keeping the estimate and realized cash distinct. The appraisal is a current estimate, while exit proceeds are the amount received at sale. The committed amount also differs from deployed cash, so it does not replace invested capital in either multiple. Here, the fee terms give you the deductions needed to move from gross proceeds to the investor's net amount.

Transaction proceeds are $E$. The management fee is $F$. The performance fee is $P$. The chart uses one bar series for the investor's fee bridge, with fee deductions shown as negative investor amounts.

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Read the chart from left to right as a sequence of investor cash amounts. Gross proceeds begin at USD 1,500,000. The management fee and performance fee reduce that amount, so each deduction appears below zero in the series. After both charges, net proceeds are USD 1,344,000. The bridge keeps each fee visible, making it easier to check how the gross amount becomes the cash retained by the investor.

Once the fees are known, the after-fee result follows this bridge.

$$ \text{Net proceeds} = E - F - P $$

1. Use the appraisal value as $V$ because it is the current estimate, not cash received. Divide USD 1,300,000 by USD 800,000 to produce the appraisal multiple, $1.625$. This is a gross, unlevered, multiple-based result.
2. Use transaction value after the sale because it is realized rather than estimated. Divide USD 1,500,000 by USD 800,000 to produce the transaction multiple, $1.875$. This is also gross, unlevered, and multiple-based.
3. Subtract invested capital from exit proceeds to isolate gross profit for the performance fee. The result is USD 700,000.00.
4. Charge the management fee on invested capital for the fee period. Compute $800,000 \times 0.02 \times 1$, which produces USD 16,000.00.
5. Charge the performance fee on gross profit. Compute $700,000.00 \times 0.2$, which produces USD 140,000.00.
6. Apply the bridge $E - F - P$ to transaction proceeds because the investor receives the after-fee amount. Net proceeds are USD 1,344,000.00.
7. Divide net proceeds by invested capital. The net multiple is $1.680$. It is net, unlevered, and multiple-based.

For the decision, use the transaction value for the realized appraisal comparison, and use the net multiple when judging what the investor retained.

Changed condition

The same fund now charges a higher management fee rate, while all other terms stay fixed.

The higher rate should raise the management fee, lower net proceeds, and lower the net multiple. The fee rises from USD 16,000.00 to USD 20,000.00, so net proceeds fall and the net multiple falls. The performance fee stays at USD 140,000.00, and gross appraisal and transaction multiples stay unchanged because those inputs did not move. Calculate the higher-fee management fee yourself before reading on.

Common error

You may divide value or proceeds by committed capital because the fund manager presents commitment as the headline fund size. It feels right because the investor sees one commitment and wants the ratio to compare performance with the fund’s full opportunity. The denominator exposes the mistake: an invested-capital multiple uses cash the fund actually deployed, while remaining commitment is only an uncalled promise.

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