PME (public market equivalent)
Also called Kaplan-Schoar PME, KS-PME, Direct alpha.
PME, public market equivalent, is a family of methods that compare a private fund's return with what the same cash flows would have earned had each capital contribution been invested in a public index and each distribution sold out of it on the same dates. It answers whether the fund beat the public market an LP could have bought instead.
Example
Using the Kaplan-Schoar method, an LP contributes $10M to a fund on a date when an index stands at 1,000. Five years later the fund returns $20M, and the index stands at 1,600. The $10M in the index would have grown to $16M. KS-PME is the fund's value divided by the index value, 20 / 16, or 1.25. Above 1.0 means the fund beat the index over the same dates; below 1.0 means the LP would have done better in the index. With several contributions and distributions, each is scaled by the index movement from its own date, so timing is built in rather than ignored.
Confused with
IRR against an index return. Comparing a fund's IRR with an index's annualised return over the same calendar period ignores when the fund actually held capital. PME applies the index to the fund's own cash-flow dates.
Quartile benchmarks. A quartile rank compares the fund with other funds of the same vintage. PME compares it with the public market.
In practice
The result depends on the index. A venture fund measured against a small-cap index and the same fund measured against a technology-heavy index will produce different PMEs, and GPs tend to choose the one that flatters. LPs ask which index was used and run their own.