Pension funds belatedly are doing more due diligence of, demanding more information from, private equity partnerships. More than a dozen large funds have banded together to develop and circulate a questionnaire seeking detailed information from private equity firms.
It's about time.
For too long, pension funds have let the general partners in private equity deals set the rules. This is dangerous, and, if something went wrong, it would expose the pension fund trustees to fiduciary liability.
The laxity is explained, in part, by the excess of demand for private investments over the supply. For most of the past decade, there have been too many pension funds chasing too few private equity funds. And too many private equity funds chasing too few deals.
That's just the unhealthy kind of situation likely to lead investors to take too much risk. The likely results: A decline in the quality of the deals; lower risk-adjusted returns; and, ultimately, a disaster or two.
Pension funds have been investing in private equity deals now for more than 15 years, with a great surge in participation in the past 10 years. There must be enough data available to determine if such deals really are producing risk-adjusted returns, net of all fees and costs, in excess of those produced by the public equity market.
It is unlikely that all partnerships are producing such risk-adjusted excess returns. Which ones are the successful?
The pension funds should be demanding enough information from all partnerships seeking their business to make that determination. And they should be demanding analytical help from their consultants.
The questionnaire developed by the large pension funds is a good start. The questions they ask are a bare minimum.
Some private equity executives say they will resist answering questions about general partners' net worth and figures on the partnerships' profitability and costs.
But funds need to know this information. The partners' net worth gives an indication of just how motivated the partners are likely to be. The profitability information shows how viable the partnership is likely to be in the long run.
The pension funds must keep pushing until they get the information they need to fulfill their fiduciary obligations. They must not allow themselves to be fobbed off, as investors in Long Term Capital Management were fobbed off when they asked how the model worked.
That way lies disaster.