PE Hub: Private Equity and Pensions: A Strong Partnership

Private equity has been widely recognized as the best investment for public pension funds, helping to secure the retirements of millions of teachers, firefighters, police officers, and public…

Private equity has been widely recognized as the best investment for public pension funds, helping to secure the retirements of millions of teachers, firefighters, police officers, and public servants. In fact, it is the highest performing asset class for these funds, returning over 12 percent, net of fees, over a 10-year horizon.

Not surprisingly, pension funds are the biggest investors in private equity, comprising 44 percent of total private equity investment. However, several recent articles wrongly suggest a rift between PE firms and pension funds. And they rely on mischaracterizing the PE industry – both its practices and its performance — to do so.

To start, it is important to recognize that private equity is essentially a partnership of investors (LPs) and fund sponsors (GPs). Successful partnerships rely on transparency and a free-flow of information between parties. But certain accounts portray private equity funds as opaque and, therefore, somehow unfair to investors, including pension funds. This is not correct.

Pension plans are among the largest and most sophisticated investors in the world. They understand very well the investments they are making: They receive extensive disclosure, conduct due diligence, heavily negotiate essentially every aspect of a fund’s terms before investing, and pension funds take very seriously their responsibilities to the pensioners they represent.

What’s more, pension plans are provided regularly updated information over the life of their investment in a PE fund. This typically includes quarterly reports and annual audited financial statements. They can request and receive additional information and be actively engaged with the PE firms during the entire term of the fund.

Pension plans invest in private equity in large part because it is less volatile than public equities, and over the long-term, it outperforms all other investments for pension funds. This is central to the private equity model: it is patient capital that allows investors to take the long-view. Instead of providing this context, however, critics use the recent performance of broad, but volatile, stock indexes to denigrate the value of private equity.

But PE returns, as reported by the Institutional Limited Partners Association (ILPA) — an organization of institutional investors in private equity, including CalPERS, City of Philadelphia Board of Pensions and Retirement, and Teacher Retirement System of Texas (TRS) — tell the full, accurate story. The 2014 year-end returns reported by the ILPA U.S. Private Equity Index (excluding venture capital) showed returns of 11.2 percent, 15.8 percent, and 12.8 percent, for one-year, five-year, and 10-year returns, respectively. And all of these figures are net of fees.

These consistent, high returns are the driving reason that pension plans have partnered with private equity — and why these partnerships remain strong.

Indeed, the nation’s largest pension plan, CalPERS, has provided positive reporting on its private equity investments. CalPERS’ most recent Private Equity Annual Program Review shows that over a 10-year period, private equity exceeded the Asset Liability Management (ALM) return expectation of the asset class by 4.3 percent, and exceeded the Global Equity portfolio performance by 5.7 percent. The Review cites, “continued high demand for private equity products by investors,” within its year-in-review analysis.

Along with the outperformance of private equity over an extended period of time, CalPERS’ report also provided a positive outlook for the future. The Review concludes with this forecast: “Overall, PE is making progress, reducing costs and complexity, in order to improve long-term performance.”

Pensions secure the retirement income of millions of hardworking Americans, so it is crucial that returns to these funds are consistent over the long term. Private equity has provided superior returns, and in doing so, has given retirees the peace of mind they deserve.

Steve Judge is the president and chief executive officer of the Private Equity Growth Capital Council (PEGCC), based in Washington, D.C.