Pension funds, which generally have been increasing their allocations to private equity investments, should be distressed at the attacks on the asset class as the presidential campaign heats up.
Pension funds have a lot to lose in expected future growth of their assets, if the attacks make private equity investments politically untenable. Such a development also would reduce the diversification of their portfolios.
The 200 largest U.S. defined benefit pension plans have allocated, on average, 8.6% of their assets to private equity, an exposure that has been steadily rising.
Pension fund trustees — particularly at consumer-sensitive companies and public funds subjected to activist demands and political pressure — might seek relief by reducing or eliminating their allocations for fear of rebuke and accusations of investing on the backs of the unemployed.
Without taking a partisan stance, pension fund executives ought to stand up in defense of private equity investing, which they have enthusiastically embraced for more than two decades.
It has come under assault lately in the Republican presidential nomination campaigns, particularly from Newt Gingrich and Rick Perry against Mitt Romney, a founder of Boston-based Bain Capital, a leading private equity firm.
Mr. Perry, governor of Texas, called it “vulture” capitalism. He has since withdrawn from the race for the nomination.
But did Mr. Perry make the connection that state retirement systems in Texas invest in private equity? The Teacher Retirement System of Texas, for example, has allocated 11.5% of its $101.1 billion fund to private equity, an allocation it has been increasing.
If private equity is so toxic, Texans ought to call out Mr. Perry for appointing trustees to the retirement systems for, as he believes, profiting at the expense of wrecking the economy.
Wall Street is out of favor with the public, and private equity occupies a complex, hard-to-understand segment of the financial system. Criticism could step up if Mr. Romney wins the nomination as the presidential campaign moves into its final stretch. The actions of Mr. Romney and Bain are fair game for criticism, but Mr. Romney should rebut the critics by providing details of the jobs he claims he created or saved while at Bain.
But in general, private equity has played a vital role in pension fund allocations, its higher returns contributing toward funding retirement income, while also contributing positively to the economy by creating and/or saving jobs.
It has been an anchor of stability and source of outperformance compared to publicly traded equities, especially in the past decade and in the financial market crisis.
Any investment should draw scrutiny and ought to be able to withstand it; otherwise, it shouldn't be in a pension fund portfolio. But attacks on private equity have tarred the entire asset class without a fair analysis.
Private equity has been an easy target for public criticism. It faces what analysts call “headline risk” from say, a big layoff that might be necessary to save the whole company, or a financier who has stretched ethical boundaries or violated the law.
But it operates in a confidential manner, without the regular public financial and operational disclosures of public companies.
In fact, that confidentiality is often trumpeted by pension funds and private equity managers as part of the ingredient for the asset class' success, allowing them to take a longer-term view, away from typical public shareholder demands for quarterly earnings boosts.
Pension funds are ideally suited to invest in private equity. Because of their far liability horizons, they have the long-term capital and patience to allow time to turn around a failing or underperforming company.
But pension funds as well as private equity managers generally have sown the seeds of the current discord by failing to communicate to retirement plan participants and the broader public the investment and economic advantages of the asset class.
CalPERS had 15.6% or $34.23 billion of its total assets in private equity, including $18.8 billion in buyout funds, as of Sept. 30. Yet until recent years, it declined to reveal the funds in which it invested.
William R. Atwood, executive director of the Illinois State Investment Board, said, in part, in an e-mail that private equity “as a strategy, performs a vital role in the economy: It acts as a critical funding source and option for companies of all stripes, all over the world. Lacking private equity's ability to aggregate capital, and source and underwrite deals, it's hard to imagine how else companies might arrange requisite financing.
“Further, although history is replete with stories of private equity firms breaking apart companies, firing workers, and selling off corporate remains, such stories are far more the exception than the rule. The only way for private equity firms to succeed in the long run is to facilitate corporate growth in their portfolio companies at rates surpassing that of their competition. The path to private equity prosperity is, and has been, accelerated growth — not corporate demolition. With that growth comes corporate expansion and increased employment.
“Only with such growth, and associated multiple expansions, can private equity firms continue to recruit capital from the limited partners, their investors.”
Private equity firms aim to save and improve sick companies by cutting away deadwood and improving efficiency so they can grow again, much as doctors cut away gangrenous limbs to save patients. If the companies die despite their best efforts, as they sometimes do, the private equity firms and their investors don't get paid.
Pension funds bring a disciplined scrutiny to investments, including private equity, setting rigorous benchmarks for performance as well as ethical standards. They would not have increased their allocations had private equity not preformed well.
Layoffs come with an awful human cost. That is sometimes a price for building a dynamic economy. But the layoffs are greater in a weak economy. Employees need a vibrant economy, which creates new prospects, a dynamic and competitive workforce, and opportunities for higher pay and challenging opportunities.
The U.S. economy could use a private equity restructuring to move toward stronger growth, increasing productivity, creating more employment and better investment returns for pension funds.