US Think Tank: PE firms short-changing pension funds

 Maryland Public Policy Institute challenges PE industry on poor returns and high fees.  

State pensions are getting short-changed from their investments in private equity and the fees that come with managing capital commitments, according to new research from the Maryland Public Policy Institute.

In a new report by the think tank entitled Wall Street Fees and Investment Returns for 33 State Pension Funds, analysis was carried out on pension funds for the fiscal year ending 30 June 2014 by authors Jeff Hooke and John Walter.

The issue of retirement systems hiring Wall Street firms to select publicly traded securities was a key focus with the report noting that more fees generally equalled lower returns.

But the study also singles out private equity for generating inferior returns, finding that state pensions typically allocate 10 percent to the asset class and underperform relevant public indexes once fees are included. The private equity industry has yet to offer proof that private equity (PE) consistently outperforms the relevant public equity market index after fees, according to the report's authors.

“State pension funds would do better by indexing the stock market rather than investing in private equity funds,” Jeff Hooke, one of the study's authors and a managing director at Washington's Focus Investment Banking, which is not associated with the research. “In the last 10 years, I think it [private equity] has been an underperformer and will continue to be.”

The report didn't just focus solely on the fees associated with pension funds' hiring of Wall Street advisers to assist with investment decisions, but also noted that retirement systems hire outside consultants to advise on investment issues. However, Hooke said the amount of fees pensions pay to specialised private equity consultants are dwarfed by those paid to Wall Street banks such as Goldman Sachs and similar financial institutions.

It's hardly a secret that public pensions routinely hire consultants to advise on their private equity fund commitments. In July, one investment division of a state featured in the report for making the top five ranking of states in the study paying the highest “Wall Street” fee ratios – New Jersey – announced its retention of TorreyCove Capital Partners to advise it on private equity investments.

The MPPI notes that the private equity asset class produced a median 16.7 percent return as compared with 21.8 percent for the Standard & Poor's 500 Plus 3 percent index, which is comprised of low-tech, consistent earning and non-finance operating companies. However, the report took into account the results from a five-year period, rather than the 10-year life that most PE funds span.

Hooke said he believes 15 to 20 years ago leveraged buyout funds outperformed the S&P, but since then its own growth has impeded return performance. Moreover, he estimates that the extensive range of fees private equity fund managers are charging – annual commitment fees, monitoring and other expenses – drag return performance down by three to four percent each year for pensions even when it comes to good performing funds.

They also found that one state pension with a long history of supporting large cap private equity GPs like KKR and Blackstone, ranked fifth among state pensions with the highest Wall Street fee ratio: Oregon.  The Northwestern state pension has a 20 percent allocation to private equity and committed $2.9 billion to the asset class in 2014.