Pension Funds Failed to Collect Private Equity's Promised Returns

(April 5, 2010) – Steep fees for private equity investments are hindering gains in pension fund assets, despite increasing amounts of contributions to alternative assets for market-beating returns, according to a New York Times analysis.

That “raises the question as to why they accept to pay this level of fees,” said Oliver Gottschalg, a professor at the HEC School of Management in Paris who conducted the study on private equity fees, the NYT reported.

Since 2000 as alternative investments, such as private equity, gained in popularity among investors who hoped to take advantage of more lucrative payoff, the 10 biggest public pension funds in the US have paid private equity firms more than $17 billion in fees, taking a large chunk out of investment gains. Pension funds invested heavily in private equity investments to help mitigate the loss of fund assets, which declined by 27.6% from the end of 2007 to the end of 2008. Yet, pensions are still struggling to recover from the financial blow.

According to the NYT analysis, few big public pension funds have been able to collect private equity managers’ 20% to 30% returns that attracted pension money in the first place.

While private equity executives generally say their market-beating returns make their fees worthwhile, chief investment officers at pension funds express a less rosy sentiment. “The fees paid to private equity managers has been a source of great frustration,” Joseph A. Dear, the CIO for the California Public Employees’ Retirement System (CalPERS), said in an interview with the NYT, adding that the managers “shouldn’t be making a profit on the management fee. They should make money when their investors make money.”

Internal private equity teams may be one solution to avoid fees for more cost-savings and increased control. Leo de Bever, the CEO of the Alberta Investment Management Corporation — the firm created to manage the province’s pension and sovereign wealth fund — spoke positively of internal private equity teams to ai5000. “I paid [US $160 million] in external fees last year,” he said in a December interview. “I think we can cut that down by four times if we move some of it internally.” His outlook mirrors other large Canadian institutions, which have created internal private equity team to pursue direct investments and avoid external fees.