How is performance reported in Alternative Investments?
Unlike publicly traded investments with daily pricing, Alternative Investment strategies typically report performance periodically and often with a delay. Methods for calculating returns can also vary based on investment structure. Understanding how assets are valued and performance is presented can help investors interpret results more clearly and set appropriate expectations.
Published by the Investment Solutions Group | Alternative Investments Team
Key takeaways
- Alternative Investment funds usually calculate net asset values (NAVs), but these are reported periodically and often begin as estimates.
- Performance reporting can lag 30 to 90 days or more, depending on the fund and its holdings.
- Hedge funds and other evergreen funds generally report time-weighted returns (TWR), providing standardized results for the product.
- Drawdown funds typically report performance using internal rate of return (IRR) and total value to paid-in (TVPI).
How NAV is calculated in Alternative Investments
Alts can offer differentiated return drivers and reduce reliance on public market performance patterns, but their performance reporting can also differ from traditional investments.
Most of these strategies calculate a net asset value (NAV), similar in concept to mutual funds and exchange traded funds. However, the valuation process differs due to the nature of the underlying assets.
Drawdown funds and evergreen funds often hold assets such as:
- Privately held businesses
- Direct real estate investments
- Private loans
Unlike public markets which are priced daily, these assets rely on fair value methodologies, comparable transactions and other analytical inputs.
Even hedge funds and other evergreen funds may hold positions that require additional verification and reconciliation before valuations are finalized.
As a result, these strategies typically report valuations less frequently than public market investments. NAVs tend to be provided periodically rather than daily, and often first released as estimates, with final values available after a lag that can range from 30 to 90 days or more.
Estimated versus final NAVs
NAVs are often first reported as estimated valuations, reflecting preliminary assessments of the fund's holdings based on fair-value appraisals, comparable transactions and proprietary valuation methods. These estimates provide a more timely, periodic view of performance but can change as additional information is reconciled.
Final NAVs are generally released by the fund manager and administrator using the fund’s valuation policies. Auditors typically review valuations as part of the annual financial-statement audit rather than confirming each periodic NAV. These final values can lag by roughly 30 to 90 days or more, depending on the fund type and the nature of its holdings.
Performance frequency and reporting lags
The frequency and timing of performance reporting depend largely on the liquidity and complexity of a strategy's underlying assets.
- Drawdown funds typically report performance quarterly, often with a three-month lag. For example, a June 30 statement may reflect values as of March 31.
- Hedge funds and evergreen funds typically report performance monthly, with shorter lags of approximately three weeks.
These timelines help ensure valuations are accurate and appropriately reflect fair value.
Return calculations explained: How TWR, IRR, TVPI and DPI measure performance
In addition to NAV, different types of structures tend to use specific return methodologies to report performance, depending on fund structure and reflecting how capital flows are handled in the calculations.
Time-weighted return (TWR)
Time-weight return (TWR)
TWRs are typically used by hedge funds and other evergreen funds. They are designed to measure the performance of the investment strategy itself, without the impact of investor cash flow timing.
TWR shows how the underlying investments performed over a specific period. This approach is also commonly used for traditional mutual funds and other investments where investors can enter or exit at different points. It helps answer the question: "How did the strategy perform?" by removing the impact of individual cash flow timing. Returns are typically reported as annualized percentages over fixed periods such as year-to-date, one year, three years, five years or since inception, making it useful for comparing performance across managers and time horizons.
Internal rate of return (IRR), total value to paid-in (TVPI) and Distributed to paid-in capital (DPI)
IRR, TVPI, DPI
Money-weighted returns, including IRR and TVPI, are commonly used by drawdown funds and reflect performance from the investor's perspective, incorporating the timing and size of cash flows.
IRR measures the annualized return experienced by investors, based on the timing and size of each individual investor's capital contributions and distributions. It helps answer the question: "What return did the investor actually earn based on the timing of their investment and distributions?" Because it is based on each individual's experience, investors in the same fund may experience different IRRs depending on when their capital is invested and returned.
In other words, early returns can look negative simply because money has been invested but few gains have yet been realized. In the early years of a fund, IRRs may appear flat or even negative due to the effects of early-stage capital deployment, even when value is being created. That is because investments are still being built and few, if any, distributions have occurred. This pattern is often referred to as the J-curve, where performance may initially appear muted before improving as investments mature and are realized.
TVPI measures the total value generated relative to the capital invested by each investor and includes both realized distributions and the estimated value of remaining investments. It helps answer the question: "How much value has the fund created compared with the capital invested?" When used alongside IRR, TVPI provides a more complete picture of performance by showing total value creation regardless of the timing of returns.
TVPI is sometimes also called a multiple of invested capital (MOIC) or a cash-on-cash multiple. A MOIC of 1.5x means that the investment has generated total value equal to 1.5 times the capital invested.
Distributed to paid-in capital (DPI) measures the cumulative cash distributions an investor has received to date, expressed as a multiple of capital paid into the fund. It is sometimes called the realization multiple. DPI typically remains at or near zero in a fund's early years, since few investments have been realized, and increases as the manager exits and distributes proceeds from underlying investments over the fund's life. Because DPI reflects only cash actually distributed, it is often reviewed alongside IRR and TVPI to gauge how much of a fund's value creation has been converted into realized returns.
Used together, IRR,TVPI (MOIC) and DPI help investors understand both the rate of return on invested capital and the total value created by a drawdown fund.
Why drawdown fund NAVs can fall even as returns grow
As drawdown funds mature and enter their harvesting or wind-down phases, their NAVs often decline as assets are sold and distributions are made to investors. A declining NAV does not necessarily indicate underperformance.
NOTE
As investments are realized and proceeds are distributed, NAV reflects only the value of the remaining portfolio. At the same time, investor returns may continue to grow through distributions, creating a difference between NAV and the total value investors have received.
Understanding this dynamic helps investors focus on total value and distributions, rather than NAV alone, when evaluating performance.
How to read your statement
Investor statements provide a snapshot of performance and activity for a specific reporting period. Available information and calculations may vary between firm-produced monthly or quarterly account statements versus fund-issued capital account statements (for example, one may include fees and expenses while another does now). While formats vary by structure and provider, statements typically include information like:
- Current and prior NAVs
- Performance metrics and returns
- Capital calls and distributions
- Fees and expenses
Reviewing these sections together can provide a more complete view of how an investment is performing over time.
Also, keep in mind that unlike traditional investments, Alts often may not have straightforward, traditional return benchmark comparisons. This is due to differences in liquidity, valuation timing and cash flow structures that can make direct performance comparisons more nuanced.
Why your statement may not match your total return
Your statement typically displays the current NAV and unrealized gain or loss based on your original cost. This figure may not capture all sources of return. Distributions, reinvested income and capital gains are examples of additional components of value that may not be reflected in a single line or number on your statement. For a mor complete picture, review your statement alongside your distribution history and the strategy's most recent fact card, performance report and/or capital account statement, or ask your Merrill advisor for help.
How return-of-capital distributions affect your cost basis
For certain Alts strategies, distributions may include a return-of-capital component rather than taxable income. Return-of-capital distributions are not immediately taxable; instead, they generally reduce your cost basis in the investment. A lower cost basis can result in a larger taxable gain (or smaller loss) when the investment is eventually sold or redeemed.
Because these adjustments accumulate over time and are not always reflected on your statement (as your cost basis for Alts are generally maintained only by the fund), review your tax documents to understand your current cost basis. Your tax advisor can help you understand how return-of-capital distributions have affected your basis in a specific holding.
Why your reported value may differ online
Your online portal displays the most recent valuation received and processed by the firm. It may temporarily differ from a newer fund report if the pricing agent’s update has not yet been received or loaded into firmwide systems. Your Merrill advisor can help compare the valuation dates and reconcile any differences.
“Your G/L%” may reflect account-specific cost basis and transaction history and may therefore differ from the position’s G/L%.
What this means for you
Alts strategies operate differently from traditional public-market investments. Periodic reporting and information lags reflect the valuation processes and reporting cycles required for the underlying assets. By understanding how NAV is calculated, how and when performance is reported, and the meaning of return metrics such as TWR, IRR and TVPI, investors can better interpret results and evaluate how each strategy contributes to their overall portfolio. Your Merrill advisor can help compare valuation dates, return metrics and account information so results can be interpreted in the appropriate context.
Alternative Investments are speculative and involve a high degree of risk.
Alternative Investments are intended for qualified investors only. Alternative Investments such as derivatives, hedge funds, private market offerings, and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in Alternative Investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity, and your tolerance for risk.
When considering the appropriateness of mutual funds or Alternative Investments, please be aware that there are significant differences between these investments which will cause their investment portfolios, performance, tax treatment and other factors to differ. These differences include the types, availability and diversity of securities that can be purchased, economies of scale, regulations and other factors applicable to their management.
