What is a Fair Return Nowadays?

Just reviewed a couple PPMs -- from established international institutions and from small, regional start-ups. The one thing that jumps out to me is the Expected Returns are all over the map, seemingly regardless of the level of macro (asset sector and class) and micro (geographic focus, experience of GPs, risks, term/liquidity) factors that are typically collapsed into a return.

Having been in the market for the last nine months, raising investment capital and under-writing asset acquisitions, it has become clear to me that:

THERE NEEDS TO BE A RE-CALIBRATION OF RISK/REWARD EXPECTATIONS!

Sounds obvious, I know, but there are no longer "signs" available to investors that give them a sense of the reasonable return they should expect for the level of risk they will incur in a given investment.

If the last four years have taught us anything, they certainly proved that investors were carrying considerably more risk than they realized, although arguably the returns in the mid 2000s for some PERE investments reflected that risk i.e. IRRs in the mid- to high-20s. Ten to twenty years ago, if you offered an investment with a 25%+ IRR for a moderate term hold (say, 3-5 years), you were proposing a fairly risky investment. And I believe that investors understood that then. Hence, their expectations were reasonable --there was some possibility of total loss or outperformance, and a more likely expectation that the investment, if properly underwritten, would perform about as projected. What is important is that these investors understood that total loss was a small but real possibility -- and in exchange for taking on the relative risk of the project, they would be, more than likely, rewarded.

From 2005 to Lehman, it seemed as if investors took a projected 25+% IRR to be a rock-solid, iron clad return, devoid of any risks, systematic or otherwise. No one likes to lose money and no one invests money with the great expectation of losing it, but as you move out on the return spectrum, an investor is, by default, incurring an increasingly higher level of risk. Its a trade-off, and a fair one at that.

This could be true of the broader investment world, but it is certainly true in my observations that there are few, if any, good signposts as to what the "right" return should be for a given level of risk. I suspect it will take another 12-18 months of transaction volume, with winners and losers at various risk/return strata, to glean what is right. In the meantime, investors and advisors will continue their dance, underwriting and analyzing various acquisitions, trying to find the middle ground that will create the aforementioned transaction volume.

It should be an interesting 18 months.