What is the difference between IRR and MOIC in private equity, and why can IRR be misleading?

PE performance measurement uses multiple metrics because no single number tells the whole story. Understanding each metric's strengths and weaknesses is critical for CFA Level II.

Key Metrics:

1. IRR (Internal Rate of Return):

• The discount rate that makes the NPV of all cash flows (capital calls and distributions) equal to zero
• Time-weighted — penalizes late returns, rewards early returns
• Industry standard for PE performance reporting

2. MOIC (Multiple on Invested Capital) / TVPI (Total Value to Paid-In):

• TVPI = (Distributions + Remaining NAV) / Total Capital Called
• Ignores the time dimension entirely
• A 2.0x MOIC means the fund returned $2 for every $1 invested

3. DPI (Distributions to Paid-In):

• DPI = Distributions / Total Capital Called
• Only counts actual cash returned (ignores unrealized NAV)
• Called the 'realization ratio'

4. RVPI (Residual Value to Paid-In):

• RVPI = Remaining NAV / Total Capital Called
• Represents unrealized value still in the fund
• TVPI = DPI + RVPI

Why IRR Can Be Misleading:

Example — Two PE Funds:

Fund A has a higher IRR (18.9% vs 12.1%) because it returned capital faster. But Fund B generated more total wealth (2.50x vs 1.80x). Which is better? It depends on the LP's situation:

• If the LP can reinvest distributions at 18.9%, Fund A's higher IRR is genuinely better
• If reinvestment opportunities only yield 6%, Fund B's higher MOIC creates more total wealth

How IRR Can Be Manipulated:

1. Subscription credit lines: GP borrows at the fund level before calling capital from LPs, making the capital call later and inflating IRR
2. Early exits: Selling the easiest wins first to show a high early IRR during fundraising for the next fund
3. Timing of capital calls: Delaying calls until just before a distribution boosts IRR

Best Practice:

Sophisticated LPs look at all four metrics together:

• High IRR + High MOIC = genuine outperformance
• High IRR + Low MOIC = fast returns but limited wealth creation
• Low IRR + High MOIC = patience rewarded with large total returns
• High DPI = cash has actually been returned (not just paper gains)

Exam tip: CFA Level II frequently presents cash flow timelines for a PE fund and asks you to calculate or interpret IRR vs. MOIC. Be prepared to explain why two funds can rank differently on IRR vs. MOIC and why subscription credit lines inflate IRR without increasing MOIC.

For more on PE performance measurement, explore our CFA Level II alternatives course on AcadiFi.