Public market equivalent (PME) is a benchmarking methodology that answers the question every LP eventually asks: would I have been better off just putting this money in the S&P 500? It does this by taking a fund’s actual capital call and distribution timing and simulating what would have happened if those same cash flows had been invested in a public market index instead.
Why PME Exists
Comparing private fund IRR to a public index return is fundamentally flawed. A fund’s IRR is a dollar-weighted return that reflects irregular cash flows over many years. An index return is typically time-weighted, assuming a single investment at the start. These are different calculations measuring different things.
PME solves this problem by putting both investments on equal footing. It uses the fund’s actual cash flow schedule, applies it to the public index, and generates a comparable return figure.
How PME Is Calculated
The original and most widely used approach is the Kaplan-Schoar PME, developed by Steven Kaplan and Antoinette Schoar. The process:
- Each capital call is treated as a purchase of the public index on the date it occurred.
- Each distribution is treated as a sale of index units on the date it occurred.
- Any remaining NAV is compared to the remaining hypothetical index position.
- The ratio of the fund’s total value to the hypothetical index portfolio’s total value produces the PME ratio.
A Kaplan-Schoar PME above 1.0 means the fund outperformed the index. Below 1.0 means the LP would have been better off in public markets.
PME Variants
Several refinements have been developed to address limitations of the original method:
- PME+ (Long-Nickels). Adjusts distribution amounts to ensure the hypothetical index portfolio is never driven negative, which can happen with the original method when a fund returns capital faster than the index grows.
- Direct Alpha (Capital Dynamics). Converts the PME comparison into an annualized return spread over the index. If Direct Alpha is +300 basis points, the fund outperformed the index by 3% per year on a cash-flow-adjusted basis.
- mPME (modified PME). Scales cash flows to keep the index investment proportional to the fund’s NAV at each period, avoiding some of the scaling issues in other methods.
Cambridge Associates and Burgiss report PME figures alongside IRR and multiple data in their industry benchmarks.
Why PME Matters for Fundraising
PME is increasingly central to LP allocation decisions. Institutional investors use it to justify the illiquidity premium they pay for private market exposure. If a fund cannot demonstrate PME above 1.0 against the relevant public index, LPs may question why they should lock up capital for 10+ years.
According to research by Bain & Company and others, the median buyout fund has historically outperformed the S&P 500 on a PME basis, but the margin has narrowed during prolonged bull markets. This makes PME especially important during strong public market cycles, when the bar for private equity outperformance is higher.
Choosing the Right Index
The benchmark index matters. A U.S. buyout fund is typically compared to the S&P 500 or Russell 2000. A European fund might use the MSCI Europe. Growth equity may benchmark against the Russell 2000 Growth or NASDAQ. The choice should reflect the opportunity cost for the LP: what would they have invested in if not this fund?
For fund managers building a track record, demonstrating strong PME alongside top-quartile IRR and DPI makes the most compelling case for limited partners evaluating their next allocation.
Frequently Asked Questions
How does PME work?
PME takes a fund's actual capital call and distribution dates and simulates investing and divesting the same amounts in a public index like the S&P 500 on the same dates. The resulting value is compared to the fund's actual performance. A PME above 1.0 means the fund outperformed the public market; below 1.0 means it underperformed.
What are the different PME methodologies?
The most common are Kaplan-Schoar PME (the original ratio-based method), Long-Nickels PME+ (which adjusts for scale differences), and the Capital Dynamics Direct Alpha method (which calculates an annualized spread over the index). Each handles edge cases differently, but all use the fund's actual cash flow timing to enable a fair comparison.
Why is PME better than simply comparing IRR to index returns?
Comparing a fund's IRR to an index's time-weighted return is an apples-to-oranges comparison. The fund deploys and returns capital at irregular intervals, while the index return assumes a lump-sum investment. PME solves this by applying the fund's actual cash flow pattern to the index, creating a true like-for-like comparison.
