Appraising one fund: where returns came from, and how often deals lost money

A buyout track record is judged by its dispersion, its loss rate and the source of its gains, not by the average multiple.

13 min read · Level 4

The point

In buyouts I would weight a low loss ratio above a high average return. A manager who rarely loses money on established businesses has a process that can survive a period without rising valuations. A manager whose record rests on a few big wins and high leverage has shown they can win in a favourable market, which is less informative about the market ahead.

What is it?

Unlike venture, a buyout fund should not need one extraordinary deal to succeed. Its companies are established, so a good manager should make money on most of them. That changes what to look for.

Question Why it matters Deal-level results, not fund averages shows dispersion and one-off wins Loss ratio share of capital in deals returning under 1x Source of gains earnings growth vs debt vs multiple Typical leverage at entry higher leverage raises loss risk Interest coverage across the portfolio can companies carry their debt if rates rise Team and attribution who did the deals, and are they staying Fees beyond management fee transaction and monitoring fees charged to companies

The loss ratio is especially useful. Suppose a fund invested 500,000,000 across 12 deals, and three deals totalling 90,000,000 returned 30,000,000 between them. Its loss ratio is 90,000,000 / 500,000,000 = 18% of capital in loss-making deals, and those deals lost 60,000,000.

Fees charged directly to portfolio companies - for completing deals or ongoing monitoring - reduce company value and therefore LP returns unless they are fully offset against the management fee. Ask how they are treated.

Why does an investor care?

Because an average multiple hides the pattern. A fund at 2.0x could be many steady 2x deals, or several losses rescued by one big win bought cheaply before multiples rose. Those are different managers.

Leverage is where buyout risk concentrates, so a manager's leverage habits and their companies' ability to service debt tell you more about future losses than past averages do.

And fees in private equity have historically extended beyond the headline terms, so knowing the full fee picture matters for net returns.

This is educational information, not investment, securities or financial advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.

Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.

Sources: U.S. SEC - Investor.gov, protecting your investments; U.S. SEC; CFA Institute

Example

Two funds, both 1.9x net.

Measure Fund A Fund B Deals 14 11 Loss ratio 7% 31% Best deal share of gains 18% 55% Gain from multiple change 15% 48% Average entry leverage 4.5x EBITDA 6.5x EBITDA

Fund A made steady money across most deals, mostly from improving companies, with moderate debt. Fund B lost money on nearly a third of its capital, relied on one deal for over half its gains, and benefited heavily from rising multiples using high leverage. An investor expecting the next decade to have less multiple expansion should strongly prefer Fund A, despite identical headline results.

The common mistake

Comparing buyout managers only on net IRR or net multiple. Those figures do not show how many deals lost money, how much leverage produced the gains, or whether the market did most of the work.

How it works

Step 1: Get deal-by-deal results

Ask for each deal's invested capital, realised and unrealised value, and multiple. Averages alone are not enough.

Step 2: Compute the loss ratio

Add the capital invested in deals below 1x and divide by total invested. Compare across managers.

Step 3: Build a value-creation bridge for the top deals

Split gains into earnings growth, debt paydown and multiple change, as in the returns lesson.

Step 4: Review current portfolio leverage and coverage

Ask for debt to EBITDA and interest coverage across current companies, and how they change if rates rise.

Step 5: List every fee charged to companies

Ask whether transaction and monitoring fees are fully offset against the management fee.

When to use this

Before committing to any buyout fund or evaluating a private equity product that selects funds for you.

When not to use it

Do not rely on marketing summaries alone. If a manager will not provide deal-level data, treat that as a reason to decline.

How investors actually did it

A recurring pattern: regulatory attention to fees charged to portfolio companies

The U.S. SEC has brought enforcement actions against private fund advisers over undisclosed or improperly allocated fees and expenses, including monitoring and transaction fees charged to portfolio companies, and has published risk alerts on fee and expense practices at private fund advisers.

Read the fee offset provisions carefully and ask for a full list of fees charged at the company level.

Do this now

Ask any buyout manager for their loss ratio
Find the entry leverage on their three largest deals

Create a free account to read the rest and apply it to your own investing.

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