West News Wire: An alarm just went out for anyone paying attention as public leaders across America prepare to give private equity tycoons even more of government workers’ savings. Wall Street CEOs, who are busy taking fees out of your retirement savings, want you to ignore this warning. However, the greater the potential financial time bomb for employees, retirees, and the governments that fund them may be the longer the warning goes unheeded.
The leading news source for the private equity sector, PitchBook, stated earlier this month that “private equity returns pose a big danger to pension plans’ capacity to pay retirees in 2023.”
PitchBook cited a new study that found losses from the investments may be on the horizon for retirement systems that support millions of teachers, firefighters, first responders, and other government employees. The study found that since more than one in ten public pension dollars are invested in private equity assets and states continue to keep their private equity contracts secret, losses from the investments may be imminent.
According to the study from the Equable Institute, “Private equity returns are reported with a lag of up to six months, and with each update in 2022 values were declining, which means 2022 numbers were including inflated private equity asset valuations and 2023 numbers are going to incorporate those losses.”
Private equity firms typically employ pension funds to acquire and reorganize businesses in order to sell them later for a profit. Private equity firms can fabricate a claimed value to tell pension investors throughout the period between buying and selling because there are no clear measures for valuing the purchased asset (and there is evidence they inflate valuations when looking for new investments).
Institutional Investor highlighted the ridiculousness in a tale about an investor who received two appraisals for the same business: “Everyone Wants to Know What Private Assets Are Really Worth. The Reality is Complicated.
Private equity firms and public pensions enter into contracts, which are exempt from open records laws, that are kept confidential and exclude the valuation and fee terms.
The new cautions are straightforward in light of this information: private equity firms may have misled pension officials by representing that their assets were worth far more than they actually are, all while the firms were pocketing billions of dollars in fees from retiree funds.
If write-downs now take place, pension funds may find themselves with far less cash on hand than they had been led to expect by private equity firms when it comes time to sell the assets to pay for promised retiree benefits. At such moment, there are three difficult options: reduce social programs that support retirement benefits, increase taxes to make up for the losses, or reduce retirement benefits.
The world’s leading private equity companies have been reporting sharp earnings drops, and federal authorities are apparently increasing their scrutiny of the industry’s asset valuation write-downs. These are two telltale signs of a doomsday scenario. One investment bank, however, revealed that private equity assets only brought 86% of their claimed value from the previous year in its 2021 transactions.
However, Wall Street CEOs are safe because of their heads-we-win-tails-you-lose business model, while pensioners may be in danger. While disclosing asset losses to investors, some of the companies handling retirees’ funds are increasing executive compensation and collecting even more fees from investors.
In a call with investors last week, Blackstone President Jon Gray stated that “the desire for alternatives remains quite robust.” The funding for the major three pension systems was actually increased by about a third by the state assembly of New York.
The legislation passed by Democratic lawmakers in New York, to which Gray was alluding, considerably increased the amount of retiree money that pension authorities may transfer to Wall Street. Just weeks after becoming a Democrat and promising to “examine the funds’ positions with dangerous and speculative assets such hedge funds, private equity, and private real estate funds,” New York City Comptroller Brad Lander led the charge for the bill.
The measure was discreetly approved by Kathy Hochul, the governor of New York, on the Saturday before Christmas, just weeks after the Wall Street Journal reported that experts have begun alerting pension funds to impending losses from private equity. Separate measure that would have allowed employees and retirees to view the agreements made between state pension officials and Wall Street businesses handling their money was also rejected by New York lawmakers.
From California to Texas to Iowa, pension funds controlling hundreds of billions of dollars in worker retirement savings are planning to pour more money into private equity while keeping the terms of the investments secret. The Empire State is far from alone in continuing to use retirees’ money to enrich the world’s wealthiest financial speculators.
Pension administrators have justified the high-fee investments by reiterating Wall Street executives’ claims that private equity consistently outperforms low-fee stock index funds while traveling the world to exclusive conferences in exotic locations. Meanwhile, those officials continue to conceal the terms of the investments, raising the question: if the investments are so great, why are the details being hidden?
Maybe it’s because the investments aren’t as great as they were advertised to be. Private equity funds “have returned about the same as public equity indices since at least 2006,” according to Oxford University’s Ludovic Phalippou, while taking nearly a quarter of a trillion dollars in fees from public pension systems, according to his seminal study An Inconvenient Fact: Private Equity Returns & the Billionaire Factory.
According to a 2018 Yahoo News research, US pension systems spent more than $600 billion over a ten-year period on fees for hedge funds, private equity, real estate, and other alternative investments.
In 2021, Phalippou told the New York Times, “The larger picture is that they’re collecting a lot of money for what they’re doing, and they’re not delivering what they have promised or what they pretend they’re giving.”
Even some on Wall Street acknowledge the truth: a 2021 JP Morgan study found that private equity has only just outperformed the stock market. However, it is still debatable whether this “very thin” outperformance is worth the risk of opaque and illiquid investments, whose actual value is frequently impossible to determine investments, which could tank when the money is most needed.
The concerns have at least partially penetrated American politics, even though they haven’t been able to stop the flow of pension funds to private equity.
The Securities and Exchange Commission is thinking about new regulations that will make private equity firms more transparent about the costs they charge.
Similar to this, Ohio’s state auditor, Keith Faber, recently released a report raising concerns about state pension officials around the nation hiding private equity contracts.
A potential financial earthquake has emerged in the wake of a pension corruption scandal in Pennsylvania, where the state government is in charge of managing nearly $100 billion in pension funds. During his first week in office, Governor Josh Shapiro made a commitment to get pensioners’ money out of the hands of Wall Street companies.
Shapiro stated to the biggest newspaper in his state, “We need to get rid of these dangerous assets. We must stop depending on Wall Street money managers.
The unholy partnership between some unions and Wall Street businesses went unnoticed while investment returns were somewhat better, even pension funds were ravaged by fees. But with warnings of write-downs and losses getting louder, the dynamic could change.