With Poor Returns and Limited Funds, Private Equity Falters as REITs Surge

Private equity, the traditional bastion of institutional investors, is struggling with poor returns and regulatory troubles as REITs continue to grow.

(August 27, 2009) – It’s been a rough year for private equity. With returns low and regulators clamping down on where private equity firms can invest, institutional investors are looking increasingly looking elsewhere for outsized returns.


First, the poor returns. According to public records, three of the largest American public pension plans — The California Public Employees’ Retirement System, the Washington State Investment Board and the Oregon Public Employees’ Retirement Fund – have taken back just $22.1 billion in cash from buyout funds they invested in since 2000 – a figure that amounts to a 59% shortfall, according to Bloomberg. While the internal rate of return (IRR) figures for private equity funds are often better, these managers are griping over their inability to access their investments.

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“I work for over 400,000 employees, and they can’t eat IRRs,” said Gary Bruebaker, the chief investment officer of the Washington State Investment Board, told Bloomberg. “At the end of the day, I care about how much do I give you, and how much money do I get back.”


Then, the regulation. With pressure to regulate any institution that poses systemic risk, private equity has come under the regulators’ microscope. For example, the Federal Deposit Insurance Corporation (FDIC) has been in discussions over whether to enforce a rule that would see any investor holding over 24.9% of a bank’s ownership subject to bank-holding company regulation, which private equity investors clearly would want to avoid.  With many banks headed to the auction block following bankruptcy and seizure by the FDIC, these potential investments – enticing to risk-taking private equity groups – could effectively be off-limits if this rule is enforced.


The result: inflows into private equity funds are down significantly. According to Real Estate Alert, a trade publication, America’s 50 largest public pension plans are likely to commit only $5 billion to real-estate private equity vehicles in 2009, a figure not seen since 2003. By comparison, $36 billion flowed into such investment vehicles in 2007.


So who wins? Recent data show that a likely benefactor of private equity’s troubles are real estate investment trusts (REITs). Capital inflows into these public property companies have been robust in the past year as investors seek to profit from a recovering real estate market. According to data from the Wall Street Journal, REITs have raised nearly $15 billion in new equity in 2009, as well as $2 billion in unsecured debt this month alone. While institutional investors have traditionally gone the route of private equity funds, it is likely that REITs – who took on less debt and thus are more likely to have emerged from the real estate bust in healthier shape, and have easier access to capital – will be among the beneficiaries of private equity’s troubles.



To contact the <em>aiCIO</em> editor of this story: Kristopher McDaniel at <a href='mailto:kmcdaniel@assetinternational.com'>kmcdaniel@assetinternational.com</a>

In Symbolic Move, FSA Shutting Defined Benefit Scheme

Although small fish itself, the regulator’s initiative to move existing final-salary scheme members into a defined contribution plan signals the end of an era – and may in fact encourage others to do the same.

(August 27, 2009) – In a move that only highlights an ongoing trend, Britian’s financial regulator, the Financial Services Authority (FSA), has shut its defined benefit pension scheme to new contributions.

 


The independent British regulator, which oversees financial services companies, has told 500 of its employees that they will not be allowed to keep paying into the scheme, and instead will be directed towards a defined contribution pension system. While the scheme has been closed to new members since 1998, and while employees will still collect the benefits they have thus far accrued, the final payments into the fund will be made in March, 2010.

 

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While the FSA is small fish compared to the giants of the British pension world, it signifies a larger trend among British companies.

 


“It’s ‘when’ rather than ‘if’ with regards to the closing of British final salary schemes,” Sally Bridgeland, CEO of oil-giant BP’s pension scheme. The $TK billion fund will itself close to new members in April, 2010.

 


Others who have closed their schemes to new members in the past year include Barclays and Morrison’s, a British supermarket. IBM has also noted that it is considering such a move.

 


These moves signify a greater willingness in Britain for employees to support themselves in retirement – a system similar to that of the United States and its ubiquitous 401(k) plans. According to many, this is a result of continuing funding problems and longevity risk. In conjunction with the shutting of these plans, longevity swaps – where insurance funds take over the liabilities of pensioners after a certain age – and pension buyouts – where insurers provide annuity-like products to topped-up pension schemes – are becoming increasingly accepted and common.



To contact the <em>aiCIO</em> editor of this story: Kristopher McDaniel at <a href='mailto:kmcdaniel@assetinternational.com'>kmcdaniel@assetinternational.com</a>

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