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Our Bloomberg OpEd on Public Pensions’ Failure to Stand Up to Private Equity Stealing and Other Abuses

I didn’t realize Bloomberg was running it today! It’s called How to Make Private Equity Honest. We argue that public pension funds have done such a lousy job of negotiating and overseeing private equity investments that they should lose their accredited investor status if they don’t shape up pronto.

Here’s the opening:

The people who manage some of the country’s largest public pension funds — money that ensures the retirements of teachers, police officers, firefighters and other state employees — say they want government regulators to help them avoid getting ripped off when they invest in private equity firms.

Instead, regulators should push them to do a better job of monitoring the investments on their own.

In a letter last month to Securities and Exchange Commission Chair Mary Jo White, 11 state treasurers, plus the New York state and New York City comptrollers, asked for “better disclosure” of expenses at private equity firms, which typically generate returns by buying companies, restructuring them and selling them at higher prices. The officials’ complaint: The firms have been levying all sorts of suspicious fees without their knowledge, effectively siphoning money away from future retirees.

The accusations are well-founded….

Read the rest here. Enjoy!

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24 comments

  1. lambert strether

    “If public pension funds persist in feigning helplessness, the agency [SEC] should consider rescinding their accredited status.”

    That would sting….

    1. flora

      And if the SEC rescinds their accredited status pension plan beneficiaries might start getting better results.
      A win-win.

    2. different clue

      Perhaps the public pension fund managers are not feigning helplessness. Perhaps they really are psychologically helpless . . . in the sense of being incurable rubes and marks. Perhaps the SEC and the pirate equity operators both know this and are co-racketeering together to keep the public pension fund rubes exploitable and bleedable and shearable by keeping them “accredited” investors. The reason cancelling that “accredited” status would sting is because it would force the public fund managers to see the whole world see what hopelessly incurable rubes and marks they are finally declared to have been all along.

      Perhaps politically activist bunchloads of people whose money is being managed by the public rube funds should work to get these funds “dis-accredited” and therefor air-gapped from steady ripoff by pirate equity operators who are more clever than the rubes are. (This would only apply to those funds run by rubes, not to those pirate-immune funds which are run by cynical suspicionists).

  2. MikeNY

    Excellent placement and well-written piece. Nice to see this effort getting traction. PE is one of the heads of the fish — and we know how the fish rots.

  3. grayslady

    Tightly written and concisely explained. I think the article could have benefited from even one example of hard numbers, even if it was only an estimate based on other known fees. Make it a story of “here’s how much private equity is stealing from widows and orphans” and I think you’ll see more movement on the issue. Fiduciary responsibility isn’t a term that’s likely to be a rallying cry for most pensioners.

    1. Vatch

      An article for a general interest publication could emphasize the “widows and orphans” angle. But isn’t “Bloomberg View” a little more specialized? Isn’t it read by the sort of people who understand the implications of a failure to fulfill a fiduciary duty?

      1. grayslady

        Bloomberg should merely represent the tip of the iceberg. Yves presumably wants the issue to be picked up by other publications, not to mention politicians and pensioners. This story affects the future retirement security of real people, and it needs to be picked up by non-financial media, as well, if it’s going to develop traction.

  4. participant-observer-observed

    Thanks for giving us the opportunity to say WELL DONE and thanks for this work!

  5. john c. halasz

    I attended a VT state hearing for pension fund disinvestment from fossil fuels. (I later remarked that it was the 4 most wasted hours of my life. My sister gave me the skunk eye, but, of course, I meant in my illustrious activist career). I was in ironical agreement with the board with respect to the disinvestment movement, but I was struck by how in thrall the board was to their financial advisers and how much they bought into the Wall St. version of financial “economics”, discussing only how many bps. they were paying in relation to “alpha”, all in the name of their “fiduciary responsibility” which depended on maximizing portfolio diversification, according to their advisers’ schemes.

    At any rate, this is prologue to my basic comment here. Why are pension funds, presumably investing for the sake of workers, investing in ways, such as PE (or commodity funds, as if that were a separate “asset class”, independently of the way IBs have promoted it), that are fundamentally deleterious to the welfare of workers? PE largely amounts to 1) tax arbitrage and evasion, 2) asset stripping and under-investment and 3) bankruptcy fraud. (Back in 2011 there was a story about a PE firm, Sun-something, not a really large one, that had put a company into bankruptcy with one arm and bought it out of bankruptcy with another arm. Pretty fancy lawyering, but how was that not, for any ordinary company, an instance of “fraudulent conveyance”?)

    Fee-gouging is one thing, and Yves is to be congratulated for bringing it to light, but doesn’t the overall problem lie more deeply and extensively? Pension fund managers, even if there is no de jure or de facto corruption involved, (as is often enough the case), belong to the class of “asset managers” and they are rewarded according to “benchmarks”, which, Lake Wobegon style, encourage everyone to be above average, to claim “alpha”? But how much value-added are such money managers actually producing? And what is their effect on the allocations to actual production? Don’t they resemble Keynes’ “sound bankers”, who aren’t especially prudent in their underwriting of loans, nor especially prescient about future economic conditions or events, but rather, when they all go down, they all go down together?

    1. Yves Smith Post author

      While I agree with everything you said, you can’t delegitimate PE by going at it in the manner you suggest. The problems you describe are well known and yet money keeps flowing into PE. As long as investors believe the myth that it delivers superior returns (which is most assuredly does not when you compute returns properly, and IRR is a bad metric, and adjust for risk and illiquidity), they will keep throwing money at PE funds.

      Like it or not, pension fund management is about complying with ERISA, not about anything sensible. The Department of Labor reinterpreted ERISA rules in 1978 so that the “prudent man” requirement would be satisfied not by looking at investments on an individual basis but on a portfolio basis. That change came about via lobbying by the venture capital industry to put pension fund investing on a more “modern” footing, as in permit riskier investments like venture capital.

      That meant pension investing became entirely about all the things you deride: diversification by asset class, trying to pick winners (managers who produce “alpha”) within each asset class (even though as you suggest, that exercise is pretty much bogus). The staff and boards are in the clear if they follow the advice of all those consultants faithfully.

      So the point of going after the fee issue is to show that all these fiduciaries and their advisers have fallen down on the most basic aspects of their job. It is to demonstrate how they are not actually serving their putative clients, but that their survival and prosperity depends on not asking tough questions of the PE fund managers.

    2. vlade

      PE can actually work, as can funds and similar. The problem is, that with the current model, it’s cheaper and more efficient to grow in size (and hence to grow revenues) by getting more investors than by growing the assets you manage.

      There is actually a reasonably good answer to that – limit the AUM one can manage (definitely at a group level, quite possibly at a “person” level – i.e. inability to be a director of or involved in any role with companies with AUM of more than X, where X is rather small – 100s milions $, not billions+).

      While there are cost efficiencies in size, the important word there is cost. There are important investment inefficiencies in size -for example, if you’ve 100m AUM, 5m investment that can generate 20% return is good, it generates 1% of your overall portfolio return. If you have 10bn AUM, it’s way below your recognition level, you’d need 500m/20% investment to get the same. There’s many more 5m investments able to generate 20% than 500m ones.

      So not only does current model incentivizes to grow AUM instead of returns, I also believe it misallocates capital.

      1. Yves Smith Post author

        I hate to tell you but that is not true. It use to be that top quartile performance in private equity persisted. There is now no longer any persistence in top quartile performance. So you cannot pick a strategy in PE or a type of firm that will outperfrom. Na ga happen.

        Moreover, the PE firms have been aggressively moving out of megadeals as they have recently been too picked over. The focus is now (even more than ever!) on mid-range and smaller deals that are less levered. So your “smaller is better” view is dated. This seems to be a response to the insane EBIDA multiples being paid now, an average of 12X. There is just no way deals done at these rich prices will work out of much of anything goes wrong….a Fed tightening or a weakening of our so-called recovery.

        The big reason PE got away with the insane peak of cycle deals in 2006 through early 2008 was that they were big time accidental beneficiaries of the “goose asset prices and make borrowing cheap” program to save the banks. PE would have otherwise done disastrously and would have had another protracted dry spell as it did after the later 1980s deals virtually all went bad. Remember Campeau? Ohio Mattress?

        The way PE might be viable longer-term is to go the way that some Canadian pension funds and the Dutch are starting to go: cut out the middleman and run PE in house. Not surprisingly, by cutting out all the fee grifting, and hiring people who don’t need to become billionaires to feel adequately paid, they’ve beaten industry averages nicely. They are still somewhat dependent on existing PE contacts for deal flow, but they should get past that phase pretty soon.

        1. Fool

          …hiring people who don’t need to become billionaires to feel adequately paid…

          Isn’t becoming billionaires the reason people get into PE in the first place?

        2. vlade

          Ok, my view may be dated, but my personal experience with PE (all non US, mostly non UK) is that there’s a number of small, very successful funds. But they investors aren’t pension funds or other “middlemen” in general, but the LPs are private investors/family offices and most of the time it’s “invitation only”.

          So, for example, they don’t need to run the 3-5 year “investment” cycle – a friend of mine is CEO of a PE owned company, and has been for the last 12 years reporting to the same people, who are very happy to collect the fat dividend they get every year (and it’s not like they didn’t get a number of offers from taking it public to MBO to an PE on-sell).

          But you’d not be able to buy in into that PE fund anymore, at about any price pretty much until an LP dies and the estate needs liquidity (and if the existing LPs wouldn’t want to increase their share).

          So maybe it’s not “small” but “widely offered” – which is really the same as poorly performing active investment managers (you can’t buy into Soros’s hedge fund anymore)

  6. griffen

    Well thought, and reasonable. Very nice work. The pension managers seem a little “toothless” in their fight, but come on – most of the management / executive level personnel are paid an above peanuts wage. Especially at the largest outfits such as CalPers or similar.

  7. Jim Haygood

    ‘What is seldom acknowledged is the public funds’ outside counsel often invest in private equity funds, sometimes on a preferred basis relative to their clients.’

    Unbelievable. I must have missed last year’s exposé of Ropes & Gray, linked in the editorial.

    Besides the creative sanction of yanking accredited investor status, disbarment of law firms that fail to recuse themselves from irresolvable conflicts of interest would be another appealing avenue to pursue.

    Up against the wall, barristers!

  8. reslez

    Excellent and much needed. PE practically get away with murder these days. The pension funds are abdicating their duty and should be held to account.

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