Institutional investors might be better off making leveraged public equity investments than investing in private equity, said Gordon Fyfe, president and CEO of the C$95 billion (US$86 billion) Public Sector Pension Investment Board, Montreal, speaking on a panel Tuesday at the Milken Institute Global Conference in Beverly Hills, Calif.
In comparing private equity returns as reported by Cambridge Associates' U.S. Private Equity index returns to returns of the S&P 500 with 50% leverage, PSP officials found private equity underperformed the leveraged S&P 500 in most time periods, he said.
“There are some great managers, great (general partners) that exist, and we have both in our portfolio,” Mr. Fyfe said.
The pension plan's C$26 billion private asset portfolio includes C$4 billion in hedge funds, he said. Some 75% of the hedge fund portfolio is managed internally.
The challenge for investors is to find great managers in private equity, he said. “They all tell you they are ... top quartile,” Mr. Fyfe said. But the private equity fee structure doesn't distinguish between good and bad managers, he said.
Another investor challenge is to make sure private equity managers' interests are aligned with the investors' interests. “This means putting real cash alongside your cash and not deferred fees,” in lieu of cash, Mr. Fyfe said.
The Canadian model — in which pension plans invest directly in private equity — eliminates the high fees that cut into returns. One strategy that PSP is employing is to fund new private equity firms that are started by private equity executives from existing firms “who are tired of working with asset gatherers,” Mr. Fyfe said.
“We do large co-investments where there are no fees, no carry,” he said. “We are willing to put $500 million in a fund and have $500 million on the side to do a co-investment with them.”
Fellow panel member Kneeland Youngblood, founding partner of middle-market buyout firm Pharos Capital Group, countered he could not see the Canadian model being exported to the U.S. because of the inability of public pension plans to attract the “best and the brightest” due to a failure to match private-sector pay.