Pension funds and other asset owners are turning up the heat on their private equity managers that have been criticized for portfolio companies' less-than-stellar behavior.
Private equity firms are under investigation by Congress as well as the subject of state and federal legislation and federal regulations. Private equity managers are also being sued for cutting costs at the expense of employees, their customers and society, in industries ranging from healthcare and rental homes to childcare.
Asset owners are taking notice.
Some investors are meeting with money managers, sometimes threatening to stop making new commitments, and many are adopting policies on human capital to put their private equity partners on notice.
To be sure, asset owners are still keen on the asset class, especially as the public market retrenches, but a growing number of investors are considering portfolio company behavior as an investment risk when deciding whether to make a commitment to a manager’s latest investment strategy.
“Our council members are certainly concerned whenever they see allegations of troublesome or controversial business practices from GPs (general partners) or companies in the portfolio,” said Charles Wollmann, director, communications, legislative and client relations of the $61 billion New Mexico State Investment Council, Santa Fe. “While we have worked to avoid certain problematic strategies for that reason, private market investments have long tails, and things like labor disputes do unavoidably occur.”
In October, executives at Blackstone, one of the council’s private equity managers, appeared before the council to explain how the firm had made changes in the way it handles portfolio company employee relations and discussed council members’ concerns with Blackstone’s single-family-for-rent business negatively impacting housing affordability in New Mexico.
Several commissioners had in 2023 voiced concerns after hearing about ongoing labor disputes at Blackstone portfolio company hotels in Arizona and California.
One commissioner suggested that the council’s relationship with Blackstone could present a business and reputational risk. Another commissioner, New Mexico Treasurer Laura Montoya, suggested that the council discontinue making commitments as it had in 2012 until the firm's portfolio companies improved labor practices.
At the October meeting, Montoya said that after more recent discussions she was confident in the council’s partnership with Blackstone. At the same meeting, Jon Clark, New Mexico's new state investment officer, said that staff lets its partners know when it has concerns.
“We don’t want to be investing in things that will negatively impact society,” Clark said. “Social risks are definitely on our radar and we do engage with managers when concerns arise.”
But he added, “At the same time we have to do what’s best for beneficiaries” and that is getting returns on investments.
Profits over patients, and investigations
Investors continue to be enthusiastic about the private equity asset class but they are mindful of certain “topics and considerations” such as the U.S. Justice Department’s investigation into private equity anticompetitive practices in healthcare, said Steven Hartt, managing principal at consulting firm Meketa Investment Group.
Among recent headlines was a bipartisan Senate Budget Committee report released in January that said that private equity-owned healthcare companies are putting “profits over patients” by underinvesting in critical hospital infrastructure and understaffing often to the detriment of patients.
On the local level, a number of state legislatures including California, Massachusetts and Connecticut are considering bills that would put guardrails on private equity investing in healthcare. And Connecticut, Massachusetts, Vermont, and New Jersey have bills that would put controls on ownership of childcare chains by private equity firms, which the bills’ backers say are charging fees and cutting costs including staff layoffs at the expense of children and families.
These sorts of topics concerning private equity-owned companies come up, and “will get attention by the boards,” Meketa’s Hartt said.
Also in January, the U.S. Justice Department accused six single-family housing landlords including real estate managers and private equity portfolio companies including Blackstone's LivCor for price fixing rents using each other’s competitively sensitive information through common pricing algorithms.
Institutional landlords like Blackstone own 0.5% of all single-family housing in the U.S., said Kathleen McCarthy, global co-head of Blackstone Real Estate, the firm’s $315.4 billion real estate business, at the October New Mexico State Investment Council meeting. Her comments were in response to a council member’s question, according to a recording of the meeting and the meeting minutes.
McCarthy said that Blackstone executives are mindful of the affordability of housing and that rent reflects the supply of housing and comparable rents in the area. She added that Blackstone’s build-to-rent strategy is part of the solution by developing more homes.
Private equity industry executives say they are hopeful that things will cool off in Washington.
“We’re working with the Trump administration and Congress on policies that encourage more private investment across our country and eliminate unnecessary red tape that stifles American innovation and job creation,” said Drew Maloney, president and chief executive officer of private equity lobbying group American Investment Council. “The AIC team will also continue to work in the states to protect private equity’s license to operate and build better businesses of all sizes.”
At the same time, the industry trade group is working to overturn regulations it says could drive up costs and discourages capital investment into businesses. In January, the AIC filed a joint lawsuit with the U.S. Chamber of Commerce, the Business Roundtable and the Longview Chamber of Commerce opposing the Federal Trade Commission’s and Department of Justice’s new premerger notification requirements. That lawsuit is ongoing, an AIC spokesperson said.
California pension funds
CalSTRS will be spending the next two fiscal years, in part, taking on the issue of effectively overseeing private equity investments.
The California State Teachers' Retirement System, West Sacramento, in fiscal years 2025 and 2026 will be considering an additional investment belief stressing the importance of private markets engagement. CalSTRS will also be reviewing and possibly amending its responsible contractor policy, corporate governance principles and ESG risk factors policy to see how effectively they address private markets investing.
Alternative investments are no longer a sexy niche but are making up an increasingly large slice of asset owners’ portfolios.
The U.S. defined benefit plans among the 200 largest plan sponsors had 34% invested in private markets as of Sept. 30, according to P&I data. Many investors are looking to private markets for diversification and return enhancement over public markets.
At CalSTRS, private markets make up 44% of its $349.7 billion portfolio, up from 9% in 2000, said CIO Scott Chan at the investment committee’s Jan. 8 meeting. CalSTRS' $55.2 billion private equity portfolio outperformed its benchmark for the one-, five- and 10-year periods ended Dec. 31. The pension fund earned a net 8.9% above its 7% benchmark for the year, 14.9% vs. 13.1% benchmark for the five years and 12.9% vs. 11.4% for the 10 years.
Private companies have unique challenges, such as they are less regulated and there is less transparency, Chan said.
That is more reason for CalSTRS to engage with its private markets partners, he said.
In the traditional private equity commingled fund model, limited partners don’t own the underlying assets, Chan said. However, CalSTRS has been steering its entire portfolio, including private markets, toward a collaborative model that gives the pension fund more control.
CalSTRS is aligning its interests with its private markets GPs through “collaborative model structures with more control, ownership and ultimately hold them accountable,” Chan said.
Officials at the second-largest U.S. pension fund are also planning a private markets education program for the investment committee that will include topics on engagement practices with private market partners and how staff seeks to respond if and when stakeholders raise concerns, as well as effective board oversight in private markets investing, optimal governance and engagement practices.
When they have become aware of issues at private equity-backed companies, the CalSTRS team has not stood by quietly, former CIO Christopher J. Ailman said at his last investment committee meeting before retiring in 2024.
Blackstone portfolio company Packers Sanitation Services in 2023 paid $1.5 million to the Department of Labor for employing at least 102 children, ages 13 to 17, to work overnight shifts at 13 meat processing plants in eight states. Packers Sanitation was a portfolio company of Blackstone Core Equity Partners, a fund in which CalSTRS is an investor.
At the time, Blackstone said in a statement that it stands “unequivocally against child labor violations — which are fully opposed to our values and PSSI’s own hiring policies.” Packers enhanced its extensive procedures to prevent identity theft, hired a new CEO, established a $10 million charitable fund to combat the broader child labor crisis in America, and implemented a wide-ranging remediation plan to address this issue, Blackstone said.
One board member, California Superintendent of Public Instruction Tony Thurmond, during a January 2024 discussion of stewardship priorities, said he was concerned that there were young people working in dangerous conditions at a private equity portfolio company.
“I don’t want to leave it and say it gets handled by a framework (for GP engagement),” Thurmond said.
Ailman responded that CalSTRS officials flew to New York and met with Blackstone.
“We felt they took sufficient action to ensure that it would never occur again,” including making personnel changes at Packers, Ailman said. “We were satisfied but we never stop. ... We will monitor the heck out of them.”
“They have obviously heard from other” investors, he said.
This was not the first time CalSTRS officials were persistent in their engagement with a GP, Ailman said.
“We met with one GP five times to get us out of an investment,” over issues at portfolio companies, he said. “They have a very good idea what it means to manage money for California teachers and what we want in terms of return and their effect on society.”
For its part, Blackstone is showing it is serious about human capital issues, creating workforce principles in 2024.
“We believe that being attentive to the well-being of our portfolio companies’ employees is foundational to building successful businesses — and is aligned with our duty as fiduciaries,” said Blackstone spokesperson Matthew Anderson in an email. “We have long encouraged our portfolio companies to adopt and maintain strong workforce management principles for their employees — as part of creating long-term value for our investors.”
Blackstone’s principles include that portfolio companies should invest in worker training, comply with national, state and local laws concerning worker health, safety, wages, labor relations, pensions and insurance, and prohibit underage and forced labor.
Some asset owners have put their expectations for treatment of workers in writing.
CalPERS, NY Common adopt principles
The $533.4 billion California Public Employees’ Retirement System, Sacramento and $273.4 billion New York State Common Retirement Fund, Albany, adopted labor principles for private equity portfolio companies.
The American Federation of Teachers in July released its Labor Standards Platform to help guard against human capital issues, such as child labor, at private equity portfolio companies. The AFT has close to 1.8 million members, who participate in public and private-sector retirement funds with about a combined $3.4 trillion in assets.
A CalPERS spokesperson said that the market has taken notice of its labor principles since their adoption in November 2023; New York adopted principles in 2024. CalPERS’ labor principles include support for workers’ freedom of association and collective bargaining while asking managers to attest that their portfolio companies do not use forced or child labor.
“There has been a significant increase in awareness of CalPERS’ views on labor issues and what our expectations are of managers,” the spokesperson said.
In April, CalPERS asked its private markets managers to attest to its labor principles and most have done so, the spokesperson said.
Indeed, all new private market investments have included CalPERS labor principles attestation and all public managers, including affiliates, have attested to the principles as well, Tamara Sells, associate investment manager at CalPERS, told the investment committee at its November meeting.
“Ultimately, the greatest impact has been to shine a light on labor issues which we view as a financially material issue,” the spokesperson said.
In general, CalPERS officials believe that “sensitizing asset managers and investee companies to labor standards and principles can lead to increased awareness and can help mitigate and even prevent certain labor issues from occurring,” the spokesperson said.
And if that doesn’t work, CalPERS officials are not afraid to take actions affecting the managers’ pocketbooks.
Anton Orlich, managing investment director, private equity, said during a June investment committee meeting that there have been situations “where the stakeholder engagement process has resulted in a reduction in a commitment size,” which in some cases resulted in a commitment that was 60% or 70% less than originally contemplated.
Many asset owners take note of issues during their ongoing due diligence of private equity managers.
Jonathan Grabel, chief investment officer of the Los Angeles County Employees Retirement Association, Pasadena, Calif., declined to speak about any particular private equity firm but said that pension fund officials not only do due diligence before making a commitment but that oversight continues throughout the life of the investment.
“One of the dimensions in underwriting an investment is by looking at the firm from a policy and practices standpoint as it relates to stewardship,” Grabel said. In addition, LACERA is an active voice in serving on LP advisory committees at private equity firms, he said.
Adams Street Partners, a $62 billion private markets manager, also leans heavily on its due diligence process.
“We have ESG screens to identify untoward human capital practices by managers,” said Jeffrey Diehl, a managing partner and head of investments at Adams Street.
