The Cost of Frictionless Benchmarking in Private Equity : Illiquidity, Uncalled Capital and Private Equity Performance Measurement

Sammanfattning

Standard public market equivalent (PME) benchmarking compares private equity fund cash flows to a frictionless public market counterfactual, ignoring two LP-relevant frictions: the illiquidity premium embedded in PE returns and the opportunity cost of committed but uncalled capital. This thesis quantifies the resulting measurement bias through a Monte Carlo simulation (10,000 paths) of a representative closed-end buyout fund calibrated to Swedish LP conditions. Two adjustments are applied separately and jointly: (i) raising the benchmark hurdle by an empirically grounded illiquidity premium and (ii) modelling uncalled commitments as earning a reserve return rather than the benchmark return. Under the baseline calibration, the joint framework reduces mean Direct Alpha approximation by 239 basis points, shifts median KS-PME from 1.166 to 0.913 and raises the probability of underperformance from 37% to 58.6%. The illiquidity adjustment dominates as a near-deterministic benchmark-hurdle shift; the commitment adjustment is meaningful but regime-dependent on the rate environment. Findings are robust across return levels, correlations, call-pacing patterns and carry inclusion. Under the calibrated conditions examined here, standard PME overstates LP-relative private equity performance once these frictions are incorporated.