What it means
The internal rate of return, or IRR, is the single yearly rate that makes the present value of all cash flows from an investment equal to zero. It takes into account the timing of every payment into and out of a fund.
The word net tells you that fees and charges have already been taken out. Gross IRR measures the performance of the investments before the fund manager is paid.
A fund might buy companies and sell them at a gain, producing a gross return that looks strong. Net IRR subtracts management fees, carried interest, which is the manager's share of profits, and fund expenses, so it reflects what the investor in the fund really keeps.
The gap between gross and net can be large. Fees of 1.5% to 2% a year on committed capital and a share of profits above a hurdle can cut several percentage points from the headline return.
When comparing funds, always compare like with like, since a gross figure from one manager and a net figure from another is not a fair contest. Net IRR is widely quoted but has quirks.
Because it is highly sensitive to timing, a fund that returns money early can show a high figure even if the total profit is modest. Many investors therefore also look at the multiple of money returned, which does not depend on timing, and at how much cash has actually been paid back.
The nuance is that fund managers can use credit lines to delay calling cash from investors, which boosts IRR without raising the real profit. Net figures should be read with the underlying assumptions in mind, and a careful investor asks how the number was calculated.
In practice
Real-world examples.
Example
A pension fund compares two private equity managers. Manager A advertises a 16% gross IRR and Manager B a 13% net IRR. After adjusting for fees, the trustees estimate Manager A's net figure at about 12%, so Manager B looks stronger.
Example
A property fund invests $50,000,000 and returns $72,000,000 over four years after all charges. The investors compute their net IRR on that cash flow. The result helps them decide whether to commit to the manager's next fund.
Example
A family office reviews its venture capital portfolio and finds that the net IRR is 7% while the headline gross figures averaged 15%. The difference comes from fees and from several investments that returned less than their cost. The office decides to cut the number of managers.
Formula
Calculation
Net IRR is the rate r that solves: investment = net distribution / (1 + r) to the power of the number of years
An investor puts $10,000,000 into a fund. After three years the underlying investments are worth $15,000,000, but fees and carried interest take $1,690,000, so the investor receives $13,310,000. Net IRR: 13,310,000 / 10,000,000 = 1.331, and since 1.1 x 1.1 x 1.1 = 1.331, the net IRR is 10% a year. The gross IRR is 1.5 raised to one-third, minus 1, which is about 14.5%, so fees cost about 4.5 percentage points.Case study
Seen in the real world.
Atlas Ridge Partners is a fictional private equity manager that presented a gross IRR of 20% in its marketing material. A prospective investor in this illustrative story, Harlow Pension Trust, asked for the net figure and found it was 14% after fees and profit share. The trust's investment committee had assumed the two were close.
The committee asked for a full breakdown and found that a credit line had been used to delay investor payments, which flattered the early numbers. It negotiated lower fees and requested the net multiple of money alongside net IRR. The case shows why a net measure, with the method explained, is the right basis for decisions.
Watch out
Common mistakes.
- Comparing a gross IRR with a net IRR. The gross figure ignores fees, so the comparison flatters the manager.
- Relying on IRR alone. It is sensitive to timing and should be read with the money multiple and actual cash returned.
- Assuming a high IRR on a small amount means a big profit. A quick return on a modest sum can produce a high rate and a small dollar gain.
Questions
People also ask.
What fees are deducted to get net IRR?
Management fees, carried interest, fund operating expenses and sometimes transaction fees paid by the fund are all deducted.
Why do managers prefer to quote gross?
Because the gross number is larger, which makes performance look more impressive.
Is net IRR the same as the return on my own investment?
It is close, but your own result also depends on when you actually paid in and received money, and on any taxes and fees outside the fund.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%