You don’t need to work in the private markets to know about the term Internal Rate of Return (or IRR, if you’re a cool cat), but as it turns out many people, financial professionals included, bandy the term around a lot without actually understanding what it is, which is a bit of a challenge when understanding the quality of investment opportunities across industries and more, if not equally, importantly, across emerging markets like Southeast Asia and developed markets like North America and Europe.
The IRR simply represents the discount rate at which all discounted cash flows of an investment add up to zero.
It is not a rate of return by itself, as commonly understood, but a rate that when compared to a requisite rate of return, should advise if such an investment is financially appropriate or not.
It has also long been private equity's most controversial metric, just run a search and you’ll find more than a handful of opinions against the objectivity of IRR when used to evaluate private market investments. Among the fundamental characteristics critics often point out, two are particularly salient:
Why are these important to call out when comparing the dependability of IRR as a way to gauge investments in Southeast Asia’s emerging economies to that of developed markets?
The Southeast Asian Exception: Structural Factors That Neutralise IRR's Weaknesses
In the context of private equity, Southeast Asian private equity operates in a fundamentally different environment. Three structural factors combine to make IRR a more reliable performance indicator in these markets:
In markets growing at 4-6% annually, compared to 1-2% in developed economies, the reinvestment assumption becomes less distortive. Even if interim cash flows could only be reinvested at market rates, the gap between the IRR and realistic reinvestment returns narrows significantly. More importantly, the rapid economic expansion means attractive reinvestment opportunities genuinely exist. Unlike mature markets where excess capital chases scarce deals, Southeast Asian PE operates in a target-rich environment where access to capital remains the constraining factor.
An OECD report has highlighted that despite rapid growth, Asian (and in extension, Southeast Asian) corporate debt markets remain underrepresented relative to the region’s economic size, generally with limited foreign investor participation in key Asian corporate bond markets, which reduces liquidity and market depth. The relative underdevelopment of Southeast Asian debt markets, often cited as a weakness, actually enhances IRR's reliability.
Limited refinancing options mean fewer opportunities for dividend recapitalisations. The absence of robust high-yield markets makes leveraged distributions rare. Secondary buyout markets, even with recent rises in transaction volumes, remain nascent compared to the US or Europe. These "limitations" create cleaner investment profiles: capital goes in at acquisition, value is created through operations and growth, and returns are realized at exit. This simplified cash flow pattern aligns much better with IRR's mathematical assumptions.
Perhaps most importantly, as highlighted in a report from KPMG, Southeast Asian PE strategies tend to differ fundamentally from their developed market counterparts. With less access to financial engineering, private equity general partners focus on operational improvements, market expansion, and capability building. Value creation happens within the portfolio company rather than through balance sheet manipulation. This operational focus naturally leads to more selective interim distributions, as cash is better deployed funding growth than returned to investors.
The Practitioner's Reality
While alternatives to IRR exist for evaluating investment opportunities, like Multiple on Invested Capital (MOIC) or Public Market Equivalent (PME), they come with their own limitations in emerging market contexts. MOIC ignores timing entirely and is hardly ideal in high-growth markets where velocity matters. PME requires choosing benchmark indices that may poorly represent the opportunity set in fragmented Southeast Asian markets.
More fundamentally, the global limited partner community has developed an intuitive understanding around IRR. A 25% net IRR means something to institutional investors; they can contextualise it against their broader portfolio. Switching metrics in isolation, particularly for emerging market funds already facing perception challenges, may create more confusion than clarity.
This isn't to say IRR is perfect, merely that it applies better for current Southeast Asian market conditions. LPs investing in the region understand they're buying growth and transformation, not financial engineering. They evaluate IRR knowing the underlying return drivers differ from developed markets.
Right Metric, Right Time, Right Place
The debate around IRR too often devolves into absolute positions: the metric is either fatally flawed or indispensable; reality is often more nuanced. In Southeast Asian private equity's current development stage, IRR's mathematical assumptions align reasonably well with actual market conditions. Limited interim cash flows, abundant reinvestment opportunities, and operational value creation strategies make the metric more reliable than in financially engineered developed markets.
This won't last forever. As Southeast Asian markets mature, IRR's limitations will become more relevant; at the moment, in these high-growth, operationally focused, capital-constrained markets, IRR remains a useful tool for measuring private equity performance. The key is recognising this context dependency and preparing for the inevitable evolution ahead. But for now, the old tools work just fine.