The slump in private equity returns in recent years has pushed U.S. pensions and endowments to lean on an old and familiar investment: stocks.
Large public pension funds including the $515 billion California Public Employees’ Retirement System, Sacramento, and $202 billion Texas Teacher Retirement System, Austin, as well as sovereign wealth fund the $78.6 billion Alaska Permanent Fund Corp., Juneau, and endowments at Ivy League schools have become heavily reliant on public market investments to both bolster performance and free up cash.
Chief investment officers know they’ve been playing for time, leaning on stocks until private equity starts to pay out again. It worked for the fiscal year that ended June 30 for most big institutional funds, but the recent selloff highlights the risks of that strategy.
Some 95% of shares in the S&P 500 fell Aug. 5, putting the index on pace for its biggest decline in almost two years. Weak economic data is stoking fears of a U.S. recession and new speculation on a response from the Federal Reserve.
It’s an abrupt reversal from the last 12 months, when institutional funds came to rely on stellar stock performances. In the last fiscal year from July 2023 to June 2024, the S&P 500’s 22.7% gain gave institutions much needed support, just as returns from private equity dwindled.
Alaska’s sovereign fund, for example, will use equity gains to make its next payment to the state treasury. In years past, it would typically rely on returns from all asset classes to do so, but with private equity returns dragging, stocks have been a nice reprieve, said Marcus Frampton, the fund’s chief investment officer.
“It’s so nice that stocks have been up so much — that’s freed up the money needed,” he said, noting that their private equity investments haven’t made a meaningful contribution since 2021.
Pension funds and endowments typically take a multidecade view to asset allocation and expected returns, rather than relying on daily gains and losses in the market. But on top of the deal drought, the current rout in stocks raises the stakes for Alaska and its peers. “If you have a 10% or 20% correction, it’ll be really painful,” Frampton said.
Funds are just beginning to report performance for the 2024 fiscal year that ended June 30, but pensions with higher proportions of stocks are expected to report better performance, according to a projection by Markov Process International, a research firm that studies pension fund and endowment investment returns.
CalPERS, the largest pension system in the country with more than $500 billion of assets, reported a 9.8% gain driven by a 17.5% return in public equity investments. The private equity return, which lags one quarter, was 10.9%.
Similarly, the $337.9 billion West Sacramento-based California State Teachers’ Retirement System reported an 8.4% return, bolstered by a 19% gain for public equity investments.
Investors have begun to reconsider their enthusiasm for private equity. A decade ago, it seemed reasonable to expect the asset class to return 4% over a similar basket of stocks, leading institutions to increase their allocations. Pension funds built their private equity stakes to 13% on average, up from 8% in 2014 and 3.5% in 2004. University endowments went further, with between 25% to 45% of their assets now in private market investments.
That expected premium is down to 1.5%, and deal-making has dried up, pushing private equity payouts to their investors to their lowest level since the financial crisis. Last year, distributions by some of the biggest private equity investment managers fell almost 50% compared with 2021.
