Listen to the critics

LPs and GPs need to be able to make the case for PE in simple terms; like it or not, that includes fees.

Pennsylvania state treasurer Joe Torsella has become the latest public official to cause ripples in private markets.

In a speech in May, Torsella claimed Pennsylvania Public School Employees’ Retirement System and Pennsylvania State Employees’ Retirement System had wasted up to $5.5 billion in investment expenses, and that “at least one simple, low-cost passive strategy would have performed far better, and saved a fortune”.

Torsella’s comments taken in isolation miss some important points, as two industry experts told us this week. For example, not all 10-year periods are created equal; the last decade in public markets looks very different to the one before. And focusing on fees rather than net returns is not the way to invest.

But before we dismiss Torsella out of hand, it’s worth noting he was drawing on a fair amount of data. He said in his speech that, according to Boston College’s database of the 63 US public plans with more than $10 billion in assets, one of Pennsylvania’s state funds was the third worst performer over the last 10 years, and yet the 13th highest in terms of fees paid. The other was eighth worst, and fifth highest in fees paid. He referenced academic studies, including one that shows only 3 percent of managers which outperformed their benchmark for a three-year period continued to outperform through the next three-year period, casting doubt on past success as an indicator of future performance. He talked of benchmarks that have become “so complex, so opaque and so individualised” that it’s near impossible to understand how investments are doing; something we have explored.

To be clear, Torsella was not singling out private equity – his complaint was with all active investment managers. But he makes some particularly salient points on alternatives, notably the use of subscription credit lines to manipulate IRRs and the “huge gulf” between top-quartile managers and the rest of the universe.

The latter is evident in the numbers: according to data from Cambridge Associates, the average dispersion in returns from managers at the median and managers in the fifth percentile in alternative asset strategies from 2008-17 was 17 percent. The importance of good manager selection, then, cannot be overstated.

It’s easy for those of us who drink the private equity Kool-Aid to write off comments from public officials – be they treasurers like Torsella, public pension fund board members or even regulators – as misinformed, overly simplistic or unfairly prejudiced against the asset class.

But let’s not forget, these are the people responsible for capital that will or will not be invested into private equity. Their opinions matter.

It is not the case that private equity’s value to public pension investors is so self-evident that it needs no explanation. Fund managers must make a compelling case time and again that LPs really do get what they pay for – and make that case in a way that, as Torsella puts it, “any taxpayer can understand, without having to hire their own consultant”.

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