- Om Singh
- Feb 27, 2021
- 17 min read
Updated: Jan 1
Recorded Convo – They Can’t Figure Their Own IRR
(This article was on the SEC public comments page for over a year.)
(see the list of FINRA/SEC rules they are violating at the bottom)
Apollo doesn’t have a way to get to their own 22%
(4/18/23)-
speaking to the
Apollo wholesaler ( PE.A)
Apollo product specialist. (PE.B)
Wealth manager (WM)
The WM doesn’t know how Apollo gets to the 22% which is the most important number on the page. He spoke to his wholesaler who didn’t know how it was calculated. The wholesaler called the home office and got the product specialist who - supposedly- calculates this number every quarter. However, she can’t figure out how they get it.
Operator: You are in the meeting now. There are two participants in the meeting. You are muted. You can mute or unmute yourself by pressing star six.
Operator: You are unmuted.
PE A: Hello.
WM: Hey PE.A.
PE.A: Yeah. Yeah, it's Me here and I've got PE.B
PE.B Hi WM.
WM: Okay. Who am I speaking to?
PE.B .from the product group
PE. B I work as a product specialist on the private Equity team at PE FIRM and we work with PE.A .
This is my second call with This team. The wholesaler couldn’t figure out how they got to the 22% so I asked him to get me on with the product specialist who had ample time to prepare. The product specialist has about 10 years of industry experience and is a Wharton MBA.
WM: Fine. are you located in New York?
PE.B : Yes, I'm based in New York.
I wanted to make sure I could record legally and NY is a one party consent state.
PA.A You had requested just to quickly discuss our IRR calculation. So PE.B is going to walk us through. You know how we get that 22% IRR.
WM: There were eight, eight funds? .
PE.B Nine funds we have.
WM: Correct. Nine funds? [crosstalk]
PE.A Nine funds. Yes.
WM: Okay. One second here. Okay. Nine.. if I get stuck I'm going to pull it up but nine funds. And I think if you add it up, it went to 20% but you guys had something 22%. Correct?
If you add it up, you get 160/9=17.77. They have 22% as the IRR. They don’t define it and it is not footnoted. It seems like they think everyone should just trust them. FINRA 2210 (d) states you have to explain things so the audience understands them and you can’t use footnotes. Reg BI says you have to tell the customer "ALL material information" in a "full and fair" manner that is "sufficiently specific" so that they can make an "informed decision.". The person who defines those terms is the retail customer. To be clear, the industry can no longer rely on disclosing something in the fine print- the retail customer has to know the information and be able to use the information to make an informed decision.
This is what the retail customer thinks has been happening all along, but the industry has been hiding behind "reasonably disclose"- thanks to President Trump and Reg BI, the customers have to receive the information they thought they were getting.
PE.A What? How are you adding? What are the numbers that you're adding together?
WM: I think if we added up all those funds and divided by nine, we got to 20. Is that correct?
PE.B So, so the way that IRR is calculated, it's not like an average.
I know that. I am playing dumb.
WM: Just give, give, and just give me a minute to find a piece of paper. I had it here somewhere. So I can look at it.
PE.A I know you don't have the slide in front of you. I could pull it up if we need it. But you're just looking at the slide that lists the IRR of all our funds. [(4:00)] But what you were doing was I think adding them all together and then dividing by nine, which is not the correct way to get to the calculation of the 22%. So, I mean, PE.B feel free to, you know, take over,
PE.B : Yes.
PE.A And let him know just exactly how we're going to get that calculation.
The wholesaler is on board. He tells the product specialist to tell me exactly how they got to the 22%. He knows that when you are selling a locked up product with the promise of a high return, you sure as better know how you got to the high return number that you have on the pitchbook. He is selling this every day and that is the number he is using.
WM: I thought you take the nine funds, it will be 160 divided by 9,
PE.B But the IRR is not calculated by dividing. You, you don't divide it by the number of funds. It's basically a measure of cash flow. So it really is an aggregation of all the cash flows that all of our funds since inception have done. And so it's a pretty complicated formula. That is, you're not going to get to it by just adding and dividing because it also takes into account the time value of money. So it's really looking at all the cash flows from all of our funds since inception and aggregating those. And then deducting fees, carried interest and all the relevant expenses to get to the net IRR figure.
Since it is a “pretty complicated formula”, they really need to explain it in order to comply with FINRA 2210 (d). However, since she- the product specialist- calculates this formula every quarter, she should be able to explain it. She can’t. The wholesaler also said it is a complicated formula. When both the wholesaler and the product specialist are telling you the number is complicated, the customer is in trouble. Reg BI requires that you give a “full and fair” explanation of all important information as defined by the retail customer.
WM So there were nine funds. Correct?
PE.B: Yes, but that doesn't really matter the number of funds. It's really based on all the cash flows that are behind those funds.
WM: So Is it the individual deals inside those funds, is that what you're looking at? [crosstalk]
PE.B: Exactly. Yes, that's correct.
WM: So how many deals..
PE.B: So that we can find..
WM: Oops, oops, oops. Slow down. slow down. How many deals inside the funds are there?
PE.B: There's usually 25 to 30 companies per fund.
WM: okay. So, if we say...
PE.B: But again, adding…
(She is speeding up because I think she realizes that I am going to be asking specific questions that she can’t answer)
WM: One sec, one second. you are going to fast for me, 9 times 25 would be 225 deals inside that number. Correct?
PE.B: Um, that's an approximation, it's like 27 in fund nine for example. So I would say it's in that [(6:00)] ballpark. In our earlier funds, we had fewer deals. So, it's..
WM: Gotcha.
PE.B: ..it's not scientifically like 25 times 9.
WM: But, it's 200, 250. It's not six and it's not 5,000, something like that. Right?
The 22% comes from some combination of the 200 individual deals inside the 9 funds. Some deals did well, some did poorly. Some are still active. Some are using the credit line. How exactly are they weighting each of the 200 deals to get to 22%.
PE.B: Right, right. in that ballpark.
WM: Okay. And then how.. So, how do you get to the 22%? PE.A said to me one time, it's coming back to me now, you market cap weight them??
She says they don’t market cap weight them. However, a few minutes later, she changes her mind and says they do market cap weight them. Of course they do, it makes no sense otherwise and this is the product specialist who was brought on specifically to explain this number. If she is calculating the numbers every quarter, a crucial- maybe the most crucial- assumption is the market-cap weight. When companies report earnings they have to list the assumptions they are making and they have to list which assumptions are important. This is certainly a really important assumption and she has no idea.
PE.B: No. So it's all the cash flows. And so if we look up on fund nine for example, there are twenty seven companies. Each company has their cash flows based on invested capital and proceeds. So basically cash in and out of the companies. And then if we aggregate that on the fund level for all the portfolio companies and their income and invested capital, we get different cash flow on different dates. So every quarter in the beginning, the cash flows are going out to fund the growth of the company. And then in the later stages of the investment period, you're getting cash flow back from those companies as they exit. So every quarter we get cash flows in and out to get a net cash flow for that period. And then at the end of the period, you take from that gross cash flow, you deduct out management fees, expenses, etc. And then you get the net cash flow. And then you run an IRR calculation on those cash flows to get the IRR.
A huge problem with this is the credit line. If they borrow on Jan 1 and only ask for client money on December 1 and return the client money on December 31st, they have artificially manipulated the IRR by borrowing. How do they account for that?
WM: So let's, let's say last month or last quarter of January to December 30th. There were 225 just to make a number. But..
PE. B 225, what?
WM: 225 different deals that you're looking at having cash flows that are coming in and out. Correct?
PE. B Well, right now, all the earlier funds are fully realized. So the only deals that are generating cash flows still, are only in funds eight and nine, really.[(8:00)] So it's really two active funds that still have cash flow movements because fund seven and before those deals are fully realized. We're not in those companies. We've gotten our money back from that.
WM: Aha.
PE.B: So those numbers are not impacting quarter to quarter.
WM: Okay. so You have 25 deals or 50 deals, let's say. In these two funds, 25, 50 deals. Correct?
PE. B: Um, , 25 to 35? Yeah.
WM: Let's say 35. There are two funds left with 35 active deals. So this last quarter, you used some weighting on those 35 deals and some weighting for the prior seven funds of those completed deals, right? So let's assume there were 150 deals or let's say it's 170 deals. I'll make a number. 200 deals total , it will just be easier that way. So you're saying there are 30 or 35 deals still active, which means 170 deals were prior to that. Correct?
If we have 170 completed deals and those were smaller funds, we now have 35 deals which are much larger in size than the 170 completed deals. The two most recent funds with active deals are 44 Billion in size. The new deals are making much more use of the credit line. The prior 170 deals (in the prior 7 funds) are 33 Billion in size. You have to weight the 35 current deals more than the prior 170 deals to make the market cap fair.
PE.B : Yes
WM: So of those 170 completed deals, and 30 active deals, you have to measure the IRRs. You have to weight each of those a certain amount, correct? Meaning if it was 100 deals at 1% each, you would then have a very simple calculation. With 200 deals at 50 basis points, you know, you would have a different calculation but still kind of simple. So, how do you weight those numbers to get 22%?
PE.B It's, um, weighting is kind of more of an average or weighted average concept. The IRR is basically , a calculation that takes all the cash flows. And then uses the time value of money to derive a return. So as an example, if I take a $100 from you, and then tomorrow, I give you $200. That's a really high IRR because you're getting your money back immediately. Whereas, if I take $100 from you and then 10 years down the road, then I give you $200, then [(10:00)] your IRR is going to be a lot lower than if I give you back all of your money immediately. It's really on a company level. You're looking at how much money you're taking and when you are giving it back. So, once the company is fully realized, the IRR doesn't change because you have gotten your money back. But all those factors kind of flow into the final IRR of our strategy. But it's not so much a weighting of this company, it may be weighted higher because it's lower in terms of timeframe. Once the IRR is fully realized, it doesn't really change.
She is great at defining IRR but doesn’t explain what she is there for, which is to tell me how the IRR of the 200 deals combines to get to 22%.
WMt: Okay. So, I think I understand that. But I'm still trying to get, if, if there are 170 companies that are totally done.
PE.B: Mmm.
WM: And a long time ago, the funds were small and they only did five deals. I mean, the funds now are much bigger, how much is the recent one?
PE. B: 25 billion is our most recent fund.
WM: 25 billion. So..
PE. B So yeah, I guess that's a good point. In the past, it was a few $100,000,000 million. (now its 25 billion) Larger investments do have a greater impact on IRR. So, there is the component of size. So for any larger deals that did extremely well or really poorly that would skew the IRR of the overall fund.
Just like I said, of course you have to market cap weight it. Of course it is a good point-DUH!. Isn’t she using the market cap weight each quarter to calculate the 22%? The most recent funds are more heavily weighted. Doesn’t she know how this number is calculated. It is the most important number on the pitchbook. The most recent deals are also using the credit line more. So they are totally skewing the IRR to a false positive.
WM: Well, I see, so there is some market cap weighting. So if you have 200 deals total. And the most recent deal, I'm simply making up a number here to express a point,. If the most recent deals were five times the size. You'd have to weight the most recent deals at Five times the size of the of the prior deals to make it like a fair comparison. Correct?
PE. B: Um, Sorry say that again?
WM: I'm saying, in the very beginning that the funds were smaller. But, you said the current fund is a 25 billion dollar fund, if the deals are bigger, that would skew the IRR in favor of a large deal.? You know, if you did really good or really bad with A [(12:00)] recent deal, that would skew the average because there is a market cap weighting . Is that right? Or wrong?
PE. B That would impact it definitely. But there are a number of factors that impact the IRR, including the timing of the cash flows. So one of the factors is the size of the transactions but that's one of the many factors that drives the IRR.
Just above she said the size of the transaction didn’t matter and now she is saying the size of the transaction does matter. .
WM: Okay, well, Let's assume that the deal today has an IRR of 25%. With a lot of money. And let's say a deal in the first fund, had a return of 10%. Or we can reverse it, we can say A deal today had an IRR of 10% and deal back had an IRR of 25%? How do you weight the 25% and the 10% to get this 22% at the bottom of the column? I know there's some calculation to make an IRR for each deal. Let's say we agree on that number. You bought a widget and you sold the widget. And you got the money back kind of quickly and you made 25% today. But a long time ago, you bought a widget and sold a widget and you only made 10%. But that was a long time ago with a small amount of money and today it's a lot of money. Those two numbers are part of the 200 deals in the calculation. How do you weight those two numbers to get this 22 percent?
PE. B: [(14:00)] It's, it's weighted using the IRR formula which is by taking all the cash flows and then discounting those cash flows and aggregating that. (She realizes we are at an impasse and she is repeating herself and can’t answer the question-but she says she is about to send me the file so I back off a bit as I want to get the file. )
PE.B I can show you our cash flow file which shows the formula. But not, it's not like an adding or dividing type of situation because it takes into account the timing of the cash flows. And then, it's basically a cash flow over 1+ the IRR over a time exponential Quantum. So it's, it's like, it's not very straight forward to just say, since this is from five years ago. So, it's worth like one-fifth the amount of the other one. it's a Nuanced calculation.
(whenever you hear it is a “nuanced” calculation, investors are headed for trouble- this is now a “complicated” and a “nuanced” calculation)- again, Reg BI requires the retail customers to get ALL important information- in a way that they can process it. If the numbers on the pitchbook are fake, the retail customer has recourse.
WM: What if on the other hand, a fund, a long time ago made 25% IRR and a fund today made a 10% IRR. How would the Nuance work with that?
PE.B: They would both be taken into consideration for the final calculation. But it really depends on the timing of the fund.
(Again, what is she talking about- how do they put a number with no backup on a pitchbook)
WM: What does that mean?
PE.B: It’s basically taking every single cash flow that we have had in the deals and all the funds. And aggregating them together. So it would be like if you had a really long fund from 1990 until 2022. So, it's basically pretending all the deals add up to one fund, if that makes sense.
WM: It sort of does, but I have been in alot of these funds and they overlap each other. Do you understand what I am saying. [(16:00)]
PE. B: They do, Yes, .
WM: ..then it is really not fair to say it is one big fund because some of the old funds start and they take six, seven years even 10 years to work out. But since you start a new fund just three or four years later? So what does that mean that it is all one fund?
She has no clue. These deals and funds overlap. There is no such thing as a great big fund from 1990 until 2022.
PE.A It all has to do with the cash flow. So when the money is coming in and out of each individual deal. And then that 22% is just taking into account, when you go all the way back to fund one.
The original wholesaler realizing that his product specialist is having trouble is coming in to try and save the day.
WM: I get the principle. I just feel like it just falls apart. I mean, I get the idea but really, really if there's 200 individual deals in there, right?
PE.B Um, yeah.
WM: Okay. Fine. If there's 200 deals and only 30 are active right now, so 170 of those deals are totally done. Correct? So whatever the IRRs is on those completed funds is totally done ?
PE.B: Yeah, yes.
WM: So those 170 funds are given some weighting in the total weighting. There are only 30 funds left. And there are 200 funds total. When you do a market cap weighting for regular stuff. You know, so the weightings get to 100, you say it is 20% times this plus 20% times that plus 20% from a third and so on and then you get a number at the bottom. And that's the market cap weighting. It's simple. This feels to me like it's sort of like that but not really.
(What I am saying is 7th grade math and she doesn’t understand it)
PE.B: I'm, I'm not sure what you mean, by it feels like that, but not really.
WMt: Do you have a spreadsheet that gets that 22% number?
PE.B: We do have a backup. I can give you a, [(18:00)] cash flow synopsis that we can send you. Sure.
WM: It'll, it'll show the 200 funds and they get to the 22%..??
PEB: That might be the easiest.
WM: .. and gets to the 22%?
PE.B: It will show all of our funds since inception and the cash flows for each of those funds. And the IRR for each of those. Both on the deal level and on a fund level.
The numbers for the IRR for each deal for the active deals are artificially high because of the credit line. They are also over 50% of the market cap weight. The whole thing falls apart when you ask how they weight each individual deal. However, if she is going to send it to me, terrific.
WM: .. You are market cap weighting all of the deals and changing the new deals as they change and the old deals are constant? If you have a spreadsheet that supports what you are saying and that shows all the confidence factors? It spells out how you get to the 22? Well, then you have a spreadsheet. It is just not on the piece of paper on the pitchbook.. you know what I mean?
PE.B: Yeah, I think the cash flows will help you. It's basically any deals that are realized are just not generating more cash flow.
WM: No. I get that. If you have a backup, that is fine.
PE.B: Yes, we have a backup that we can send.
WM: Okay. Great. That would be great. I'm just, I'm just curious how that works. I won't send it to any clients. Whenever I can't get to a number, I'm always concerned about showing it to somebody else. And then they ask me how you got to that number. And I am in trouble if there is no back up for it.
PE.B Right. Sure. Yeah. We definitely have a backup. So we can send that, that might help.
WM: Okay. Great. Okay. why don't you send me that when you have a chance.
PE.A: Okay.
WM: Hey, PE.A, Do me a favor. Give me one sec. I wanna call somebody. Give me five, I'm coming right back. Okay?
PE.A: Okay. Got you. I'll give you a call a little...
WM: Give me five, give me five minutes. Bye. Bye.
[END]
Again, FINRA 2210 (d) says you have to explain things according to the audience and you can’t use footnotes. They can’t even explain the number according to themselves. The product specialist who is a Wharton MBA and was called in to explain a number that she is calculating every quarter has no idea how they got that number. She is making basic conceptual mistakes in explaining how they got the number. They are simply violating the industry rules of selling securities. This fund is being sold at Goldman Sachs, Merrill Lynch and numerous other “reputable” places.
---------- Forwarded message ---------
From: Wholesaler: >
Date: Wed, Apr 19, 2023 at 4:41 PM
Subject: PE Fund X Cash Flows
To: WM
Hi WM,
Sorry for the delay in reaching out.
After connecting with our PE Team, we are unable to disclosure and send out the Cashflows per our compliance.
Sorry for the miscommunication.
Best,
FINRA 2210- Communications with the public.
No member may make any false, exaggerated, unwarranted, promissory or misleading statement or claim in any communication. No member may publish, circulate or distribute any communication that the member knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading.
Information may be placed in a legend or footnote only in the event that such placement would not inhibit an investor's understanding of the communication.
Members must consider the nature of the audience to which the communication will be directed and must provide details and explanations appropriate to the audience. (This is crucial- retail customers, even QP's have no idea how IRR works,
the industry intentionally manipulates IRR and FINRA 2210 can be used against them-you have to explain things according to the audience.)
FINRA 2010: A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.
Reg BI makes the above stronger, but you can't sell securities when the numbers on the pitchbooks are misleading.