Private equity investments underperformed broad US stock indexes for the fiscal year that ended June 30, 2020. Importantly for taxpayers and governments, this underperformance of private equity weighed down public pension system asset returns during a particularly difficult year for investments.
These investment results may mark the beginning of the end of superior private equity returns that have characterized early 21st century institutional investing. If private equity returns have now fallen “back to earth,” many public pension systems can expect heightened scrutiny over their allocations to this asset class and the high investment costs that go with it.
The Cambridge Associates US Private Equity Index rose 3.40 percent in the fiscal year ending June 30, 2020. This increase was well below returns on several broad US stock indexes, including the S&P 500 (7.51 percent increase), the Russell 1000 Index (a 7.48 percent return), and the Wilshire 5000 Total Market Index (6.78 percent).
The nation’s largest public pension system was hurt by its private equity investments: The California Public Employees’ Retirement System’s (CalPERS) private equity investments lost money, -5.1 percent in 2020, while its public equity investments returned 0.6 percent over the same period. The CalPERS return data does not differentiate between US stocks and relatively poorly performing international equities.
California’s other large statewide system, the California State Teachers’ Retirement System, or CalSTRS, reported one-year private equity returns of -0.1 percent, significantly below its public equity returns of 1.2 percent for the same 2019-2020 fiscal year period. These results are broadly consistent with those reported by the South Carolina Retirement System, which was discussed in my recent study on pension investments in private equity.
In Ohio, all five state pension plans tracked by the state’s Retirement Study Council reported returns on domestic public equities substantially exceeded their private equity returns.
Private equity’s failure to keep pace with broad stock market indexes may heighten demands for investment transparency in Ohio and elsewhere. The Ohio Retired Teachers Association (ORTA) raised $75,000 in small contributions to fund a forensic audit of the Ohio State Teachers Retirement System (STRS). The auditor, former U.S. Securities and Exchange Commission attorney Edward Siedle, plans to make all documents he obtains during the investigation public. His initial public records request asks Ohio STRS to disclose the information it received from private equity and other alternative investment managers. The disclosures should provide insight into how the board selects and monitors investment managers as well as how much these managers charge in fees.
ORTA’s action came a few months after two Ohio state legislators filed a bill that would have required Ohio pension funds to provide greater investment transparency. State Reps. Haraz Ghanbari (R-Perrysburg) and Brigid Kelly (D-Cincinnati) offered House Bill 515, which would have obliged the state’s pension systems to report data on fees, expenses, and investment performance for each alternative investment vehicle the plan holds. Unfortunately, the bill did not advance in the 133rd Assembly in 2020 and it remains to be seen whether the sponsors will propose it in the current session.
ORTA’s concerns about private equity are shared by at least one national teacher’s union. A recent study of pension fund investments in private equity, sponsored by the American Federation of Teachers (AFT), also endorsed greater transparency. Author Samir Sonti of the The City University of New York School of Labor and Urban Studies concluded:
“By supporting certain public policy measures and undertaking new initiatives in limited partner agreements, however, investors may begin to mitigate some of the direct and indirect risks associated with investment in private equity. First, institutional investors and elected officials can take steps to increase transparency around the investment management relationship. Doing so would begin to address some of the direct risks faced by LPs (limited partners). Second, they can implement measures to increase the accountability of GPs (general partners) to both LPs and portfolio companies. Together, such policies would serve to improve the alignment of interest and best protect investors’ fiduciary obligations.”
Active and retired teachers have valid reasons to worry about pension fund investment policies. Insufficient net returns can inhibit the ability of public pension plans to fund cost-of-living adjustments today and for promised retirement benefits tomorrow. Prolonged pension funding shortfalls also lead to increases in contribution requirements in many cases, for both employers and employees.
It may be a good time for public pension systems across the country to revisit their private equity allocations as part of a broader effort to de-risk their plans.
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