Understanding Private Fund Return Concentration with Return Curve Analysis
by Andrés Ramos, Content Marketing Specialist – Nasdaq Private Fund Solutions
The return curve is a data visualization technique that, when applied to a private markets fund or track record, acts as a powerful tool to help identify how value has been created. It plots the percent contribution of each deal to the overall return of a portfolio – in essence the return curve is an inverted Lorenz curve.
Return curve analysis allows users to see how returns were distributed across a portfolio. On the surface, a fund may have healthy returns, but a return curve can show whether those returns were driven by consistent solid performance across all portfolio companies or if a handful of deals drove the net IRRs and TVPIs.
What does a “good” return curve look like?
In general, the definition of “good” depends on the fund’s strategy and your risk tolerance. For example, return curves for buyout and venture strategies might look very different.
In buyout funds, a steep return curve (indicating a concentration of value creation in a small number of deals) may be a red flag for an investor, telling them that the GP may be unable to deliver strong returns without one or two moonshots in the portfolio. Stable, solid returns across the portfolio would be represented but a steadier, more consistent curve.
On the other hand, when assessing an early stage venture fund, where one could reasonable expect to see more deals fail, a steep curve, with a few deals acting as the overall performance drivers, may not be as concerning. As with any due diligence or analysis the numbers won’t provide all the answers. But they will prompt the questions you need to ask of a GP – or if a GP, the questions you should be prepared to answer yourself.
In this sample return curve from TopQ, we can see that 24% of deals delivered 75% of the fund’s return.
Watch our short video to get more insight into how to use return curves in conjunction with other key metrics to understand return concentration.
How can return curve analysis be applied in due diligence or a fund review?
For private fund managers seeking to move beyond loss ratios and other simple deal-level metrics, return curve analysis offers an ideal method for tracking portfolio performance and understanding if the NAV is being propped up by a small proportion of deals. The visualization can clearly illustrate a GP’s portfolio value creation strategy to prospective investors or existing limited partners, and also help verify the narrative of a GP. While many middle-market buyout GP may boast of their strengths in capital preservation: a return curve can clearly show what proportion of deals actually were reductive to overall performance and help validate or refute these claims.