The unhappiness over lack of transparency in public pension funds appears to be getting more and more interest with the public. It’s particularly timely because the rationalization for putting up with private equity general partners’ draconian demands for secrecy was that it was worth it for investors to tolerate it, since private equity delivered returns investors could not find elsewhere.
The belief that private equity delivers superior investment results is sorely outdated. It has proven to be untrue ever since capital committed to private equity investments grew rapidly in the runup to the crisis. Too many dollars bidding up deal prices means mediocre returns. PE has lagged public equity return since the crisis. CalPERS just disclosed that its returns from private equity were 20% in the last year, versus 24.8% for its public equity portfolio. And mind you, investors like CalPERS and Harvard expect private equity returns to beat those of public stocks by 300 to 400 basis points to compensate for illiquidity risk. That means the returns from private equity needed to be 28% to 29% to be competitive.
And the prospects for recovery are poor. McKinsey, which gets a large amount of fees from private equity firms, has (in a coded manner) ‘fessed up that private equity managers will have a tough time meeting investor expectations. CalPERS has gotten the message and is cutting its private equity allocations.
Yet despite what ought to be a sea change in the power dynamics between private equity firms and limited partners, public pension funds like CalPERS still exhibit an advanced case of Stockholm syndrome and behave as if their true loyalties are to the private equity firms rather than their beneficiaries.
An op-ed in the Orange Country Register is the latest to call out this misguided conduct. This article is noteworthy because the Orange County Register is one of the most conservative papers in the US. I encourage you to read it in full. Key sections:
Public pension funds are the biggest investors in private equity, a multi-trillion dollar industry. Both private equity and public pensions would say that the private equity industry has produced excellent returns over several decades.
However, the full risk-return profile of these investments is not fully disclosed, and for too long, public pensions have fought alongside their investment managers to avoid that disclosure.
For one, public pensions routinely deny freedom of information law requests. They refuse to provide investment contracts, such as limited partnership agreements, that govern the relationship between pensions and their investment managers. They also refuse to report basic information about the investment returns. Earlier this year, the financial news site Naked Capitalism sued the nation’s largest public pension, the California Public Employee Retirement System, for refusing to provide information about cash flows to the pension system.
There are good reasons why pensions should be subject to more transparency, though, including opportunities for graft and fraud.
In fact, CalPERS’ former CEO, Federico Buenrostro, recently pleaded guilty in connection with a pay-to-play scandal that involved steering CalPERS’ investment funds to private equity firms. When Buenrostro’s expected plea was announced, CalPERS released a statement highlighting its “continued focus on integrity and transparency” – an ironic reference given its refusal to release more information to the public about alternative investments.
As it turns out, the lack of transparency may be costing the public real money. The Securities and Exchange Commission has recently indicated that public pensions may be getting ripped off by their private equity managers, who are taking “bogus fees” from their portfolio companies.
And in some cases, it appears that public pensions may be entitled to a portion of revenue that they are not receiving. Given that public pensions have not insisted on more robust disclosures from private equity firms and that they resist public oversight, it is little surprise they may be getting shortchanged.
We have now seen in Detroit what can happen when outsized public pension obligations outpace the assets available to meet them.
Taxpayers have an interest in knowing that public pension money is invested wisely and by whom and for what price. For too long, a veil of secrecy has made that sort of oversight difficult.
With the financial noose tightening throughout the country, the public can no longer put blind faith in the judgment of public pension managers. It’s time to pull back the curtain and start demanding visibility.