Private equity, venture capital, and other private-market strategies claim to outperform public markets — but how can investors verify that claim when private assets don’t trade daily?

Enter the Public Market Equivalent (PME).

PME is one of the most important tools in institutional investing.
It allows allocators to compare the performance of private funds against public benchmarks (like the S&P 500) using the actual timing of cash flows, something IRR alone cannot accomplish.

This article explains what PME is, how it works, the different PME methodologies, and how investors use it to evaluate whether private-market returns truly justify their fees, illiquidity, and complexity.

1. Why PME Exists

Private investments do not have:

• daily pricing
• market-to-market transparency
• continuous liquidity

Instead, they generate:

• capital calls
• distributions
• irregular cash flows
• valuation marks based on models or appraisals

Because of this, comparing their performance to public markets is difficult.

IRR alone is not enough.

IRR measures the speed of return, not whether the investment beats a public benchmark.

PME solves this problem by using private-fund cash flows to simulate how an equivalent public-market investment would have performed.

2. How PME Works (Simple Explanation)

PME takes the exact cash flows of a private fund:

• capital calls (cash out)
• distributions (cash in)
• residual value (NAV at the end)

…and compares them to how those same cash flows would have grown if invested in a public index.

If PME > 1.0

Private fund outperformed the public benchmark.

If PME < 1.0

Public benchmark would have been the better investment.

If PME = 1.0

Performance is equivalent.

PME answers the core allocator question:
“Did the manager generate true alpha relative to public markets?”

3. Different Types of PME

Institutional investors use several PME methodologies.
Below are the three most common.

1. Long-Nickels PME (LN-PME)

The original — and simplest — PME method.

Method:

• Capital calls are invested into the benchmark index.
• Distributions are treated as withdrawals.
• Final NAV of the private fund is compared to the hypothetical public-market portfolio.

Interpretation:

• LN-PME > 1.0 = private asset beats benchmark
• LN-PME < 1.0 = benchmark wins

Advantages:

• simple
• intuitive

Limitations:

• assumes unlimited liquidity
• sensitive to timing mismatches

2. Kaplan-Schoar PME (KS-PME)

The most widely used PME variant today.

PME=Sum of discounted contributions Sum of discounted distributions + NAV​

Discounting uses public benchmark returns, not a fixed rate.

Advantages:

• more mathematically robust
• avoids LN-PME's reinvestment distortions
• used by most institutional LPs

Interpretation:

• KS-PME > 1.0 = outperformance
• KS-PME < 1.0 = underperformance

3. Direct Alpha (PME Alpha)

Transforms PME results into an annualized alpha figure.

Meaning:

• α > 0 → private fund adds positive alpha
• α < 0 → private fund lags benchmark

Advantage:

Creates a direct apples-to-apples comparison of annualized outperformance.

4. What PME Reveals That IRR Cannot

1. IRR can be inflated by early cash flows.

PME neutralizes this by comparing against public markets.

2. IRR doesn’t benchmark performance.

A high IRR may still underperform the S&P 500.

3. IRR hides economic cycle effects.

PME incorporates public-market timing directly.

4. IRR cannot measure opportunity cost.

PME asks the right question:
“Would I have been better off buying the index?”

PME is essential for distinguishing true skill from market beta + leverage.

5. How Institutional Investors Use PME

A. Manager Evaluation

LPs compare PME across:

• vintages
• strategies
• geographies
• GPs

B. Portfolio Construction

Used to:

• justify allocation to PE/VC
• target strategies with demonstrated alpha
• balance public vs. private exposures

C. Compensation & Carried Interest

Some LPs structure:

• hurdle rates
• carry calculations
  based partially on PME-style comparisons.

D. Performance Attribution

PME helps identify whether:

• returns come from skill
• or simply favorable market timing

6. Typical PME Results by Asset Class

Buyout Private Equity

• Often 1.1–1.4× PME
• Strong value creation but varies by GP

Venture Capital

• High dispersion
• Some funds produce PME > 2.0
• Many underperform public markets

Private Credit

• PME often near 1.0
• More about stability than alpha

Real Estate

• PME varies by property cycle
• Opportunistic funds may outperform during recovery periods

Hedge Funds

• PME equivalent used less frequently
• Alpha measured via information ratio instead

7. Pitfalls and Limitations of PME

1. Benchmark Choice Matters

Choosing:

• S&P 500
• Russell 2000
• MSCI World

…can materially change PME.

2. Private Valuations Are Estimated

NAV smoothing understates volatility.

3. PME may penalize liquidity premiums

Private returns include illiquidity compensation, which PME does not directly address.

4. PME struggles with unusual cash-flow patterns

e.g., funds with large early distributions.

Despite limitations, PME remains the most reliable tool for benchmarking private-market returns.

Final Takeaway

PME is essential for evaluating whether private-market investments — private equity, venture, real estate, private credit — actually outperform public benchmarks when adjusting for cash-flow timing.

It provides the answer to the most important question in alternative investing:

“Did this fund truly generate alpha, or would I have been better off in a public index?”

Understanding PME makes investors better at manager selection, benchmarking, and allocating capital between public and private markets.