Earlier this month, PitchBook \u2013 the go-to news outlet of the private equity industry \u2013 declared that \u201cprivate equity returns are a major threat to pension plans\u2019 ability to pay retirees in 2023\u201d.
\nWith more than one in 10 public pension dollars invested in private equity assets \u2013 and with states continuing to keep their private equity contracts secret \u2013 PitchBook cited a new study finding that losses from the investments may be on the horizon for retirement systems that support millions of teachers, firefighters, first responders and other government employees.
\n\u201cPrivate equity returns get reported on a lag of up to six months, and with each update in 2022 values were coming down \u2013 which means 2022 numbers were including overstated private equity asset valuations and 2023 numbers are going to incorporate those losses,\u201d noted the study from the Equable Institute.
\nTo comprehend this timebomb, you have to understand private equity\u2019s business model.
\nIn general, private equity firms use pension money to buy up and restructure companies to then sell them at a higher price than they were purchased. In between buying and selling, there are no transparent metrics for valuing the purchased asset \u2013 private equity firms can manufacture an alleged value to tell pension investors (and there\u2019s evidence they inflate valuations when seeking new investments).
\nIn a story about an investor receiving two different valuations for the same company, Institutional Investor underscored the absurdity: \u201cEveryone Wants to Know What Private Assets Are Really Worth. The Truth: It\u2019s Complicated.\u201d
\nMeanwhile, valuation and fee terms in contracts between private equity firms and public pensions are kept secret, exempt from open records laws.
\nWith that in mind, the new warnings are simple: private equity firms may have told their pension officials that their assets were worth much more than they actually are, all while the firms were skimming billions of dollars of fees off retirees\u2019 money.
\nIf write-downs now happen, it could mean that when it\u2019s time to sell the assets to pay promised retiree benefits, pension funds would have far less money available than private equity firms led them to believe. At that point, there are three painful choices: cut retirement benefits, slash social programs to fund the benefits, or raise taxes to recoup the losses.
\nSigns of a doomsday scenario are already evident: some of the world\u2019s largest private equity firms have been reporting big declines in earnings, and federal regulators are reportedly intensifying their scrutiny of the industry\u2019s write-downs of asset valuations. Meanwhile, one investment bank reported that in its 2021 transactions, private equity assets sold for just 86% of their stated value last year.
\nBut while pensioners may be imperiled, Wall Street executives are protected thanks to their heads-we-win-tails-you-lose business model. While reporting asset losses for investors, some of the firms managing pensioners\u2019 money are raking in even more fees from investors and continuing to raise executives\u2019 pay.
\nMeanwhile, even as some sophisticated private investors rush to get out of private equity, the world\u2019s largest private equity firm, Blackstone, recently reassured Wall Street analysts that state pension officials will continue using retirees\u2019 savings to boost revenues for private equity firms, hedge funds, real estate funds and other so-called \u201calternative investments\u201d.
\n\u201cThe desire for alternatives remains very strong,\u201d the president of Blackstone, Jon Gray, said in an investor call last week. \u201cNew York\u2019s state legislature actually increased the allocation for the big three pension funds here by roughly a third.\u201d
\nGray was referring to New York Democratic lawmakers passing legislation significantly increasing the amount of retiree money that pension officials can deliver to Wall Street. The bill was championed by the New York City comptroller, Brad Lander, just weeks after the Democrat won office promising he would be \u201creviewing the funds\u2019 positions with risky and speculative assets including hedge funds, private equity, and private real estate funds\u201d.
\nThe New York governor, Kathy Hochul, quietly signed the legislation on the Saturday before Christmas, just weeks after the Wall Street Journal reported that analysts have started warning pension funds of looming private equity losses. New York lawmakers simultaneously rejected separate legislation that would have allowed workers and retirees to see the contracts signed between state pension officials and Wall Street firms managing their money.
\nThe Empire State is hardly alone in continuing to use retirees\u2019 money to enrich the planet\u2019s wealthiest financial speculators \u2013 from California to Texas to Iowa, pension funds controlling hundreds of billions of dollars of workers\u2019 retirement savings are planning to dump more money into private equity, while keeping the terms of the investments secret.
\nWhile globetrotting to elite conferences in exotic locales, pension officials have defended the high-fee investments by parroting Wall Street executives\u2019 claim that private equity reliably outperforms low-fee stock index funds. At the same time, those officials continue to conceal the terms of the investments, raising the question: if the investments are so great, why are the details being hidden?
\nPerhaps because the investments aren\u2019t as wonderful as advertised. In a landmark study entitled An Inconvenient Fact: Private Equity Returns & the Billionaire Factory, Oxford University\u2019s Ludovic Phalippou documented that private equity funds \u201chave returned about the same as public equity indices since at least 2006\u201d, while extracting nearly a quarter-trillion dollars in fees from public pension systems.
\nA 2018 Yahoo News analysis found that US pension systems had paid more than $600bn in fees for hedge fund, private equity, real estate and other alternative investments over a decade.
\n\u201cThe big picture is that they\u2019re getting a lot of money for what they\u2019re doing, and they\u2019re not delivering what they have promised or what they pretend they\u2019re delivering,\u201d Phalippou told the New York Times in 2021.
\nEven some on Wall Street admit the truth: a JP Morgan study in 2021 found that private equity has barely outperformed the stock market, but it remains unclear whether that \u201cvery thin\u201d outperformance is worth the risk of opaque and illiquid investments whose actual value is often impossible to determine \u2013 investments that could crater when the money is most needed.
\nWhile the warnings have not halted the flood of pension cash to private equity, they have broken through in at least some corners of American politics.
\nThe Securities and Exchange Commission is considering new rules to require private equity firms to better disclose the fees they charge.
\nSimilarly, Ohio\u2019s state auditor, Keith Faber, just issued a report sounding an alarm about state pension officials keeping private equity contracts secret \u2013 a practice replicated in states across the country.
\nAnd following a pension corruption scandal in Pennsylvania \u2013 whose state government oversees nearly $100bn in pension money \u2013 there\u2019s a potential financial earthquake: during his first week in office, Governor Josh Shapiro promised to shift pensioners\u2019 money out of the hands of Wall Street firms.
\n\u201cWe need to get rid of these risky investments,\u201d Shapiro told his state\u2019s largest newspaper. \u201cWe need to move away from relying on Wall Street money managers.\u201d
\nShapiro could face opposition not only from private equity moguls and their lobbyists but also from the pension boards\u2019 union-affiliated trustees. As the Philadelphia Inquirer reported: \u201cUnion members [on the boards] have mostly favored the old strategy of private investments, even when challenged by governors\u2019 reps and the last couple of state treasurers.\u201d
\nWhen investment returns were somewhat better, the unholy alliance between some unions and Wall Street firms flew under the radar, even as pension funds were ravaged by fees. But with warnings of write-downs and losses getting louder, the dynamic could change.
\nBetter late than never \u2013 though the later it gets, the bigger the risk for millions of workers and retirees.<\/p>\n
Theguardian<\/p>\n
Tags: pension funds<\/p>\n","protected":false},"excerpt":{"rendered":"
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