Private Equity Giant CVC Sells Stake to KIA, GIC

CVC Capital Partners, one of the biggest private equity firms in the world, is selling a 10% stake to three sovereign wealth funds, Reuters has reported.

(September 20, 2012) — UK-based private equity firm CVC Capital Partners has sold a 10% stake of the firm to a group of powerful, private investors, including the Kuwait Investment Authority (KIA), the Government Investment Corporation of Singapore (GIC), and an unnamed Asian fund.

CVC Capital — which manages capital on behalf of around 300 institutional, governmental and private investors worldwide — was formerly the private-equity business for Citicorp, now Citigroup Inc. It bought about 63% of Formula One in 2005 and 2006. In May and June, the private equity firm sold a $2.1 billion stake to Waddell & Reed Financial, BlackRock, and Norges Bank Investment Management. These deals valued the auto-racing company at $9.1 billion, according to Bloomberg.

CVC’s move to sell a chunk of its parent company to a group of private investors follows similar actions by rival Apax Partners. In February 2010, buyout firm Apax Partners sold off a 10% stake to investors including the China Investment Corporation, China’s sovereign wealth fund.

Leading private equity firms are increasingly seeking to deepen relationships with their largest investors to ensure their survival. In June, for example, Kohlberg Kravis Roberts & Co. won a $225 million commitment from the Oregon Investment Council for the investment firm’s buyout fund investing in Asia.

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KKR manages a total of nearly $3 billion, or 6%, of Oregon’s roughly $58 billion in pension fund investments. The council, which manages assets for the Oregon Public Employees Retirement Fund and Oregon’s Common School Fund, revealed at the time that it was committing $6 billion for KKR Asian Fund II LP to invest across Asia. Oregon’s pension was an investor in the first Asia fund operated by KKR, which has posted net returns of 19% in the last roughly three decades.

The Director of the Rotman International Centre for Pension Management thinks it’s time to quit the DB vs. DC argument, and come up with a new breed of pension plan.

(September 20, 2012) – Traditional defined-benefit (DB) and defined contribution (DC) plans both fail to meet plan sponsors’ dual goals of adequacy and affordability, according to Keith Ambachtsheer, head of the University of Toronto’s Rotman International Centre for Pension Management.

“The time has come to stop defending the indefensible,” Ambachtsheer writes in a just-published article for the Rotman International Journal of Pension Management, which he also heads.

He argues that one of DB plans’ oft-touted advantages—that they provide simple and complete contracts between retirees, employees, and employers—doesn’t hold water: “The value of the guarantees embedded in DB contracts is often understated by using discount rates that embody the assumption that projected risk premiums will become realized risk premiums. In game theory terms, this is a mechanism for shifting wealth to current plan participants from whoever is underwriting the embedded payment guarantees. These “paper” wealth transfers are eventually realized through demands that benefits be increased in good times, and by enforcing the embedded payment guarantees unwittingly made by guarantors in bad times. The seriously underfunded condition of many public-sector plans today is finally forcing public-sector employers to recognize these fundamental design problems of traditional DB plans.”

Where DB plans by nature tend to become excessively expensive, he argues, DC plans tend to fall down on both the affordability and adequacy fronts.

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The Teachers Retirement System of Texas (TRS), a $107.4 billion DB plan, came to the same conclusion about DC earlier this month. At the behest of the Texas Legislature, the fund studied a potential switch to DC and hybrid structures. According to the pension’s models, switching new members to either a self-directed or pooled defined contribution plan would increase unfunded liabilities by $14.7 billion, or 61%. “It is important to understand why the alternative plans modeled by TRS are more expensive than the current defined benefit plan to provide the same level of benefits,” TRS’ report explained. “The main reason for the expense difference is that most alternative plans do not generate the same level of investment returns as the defined benefit plan.”

While Texas Teachers’ doesn’t seem keen on restructuring any time soon, Ambachtsheer did come up with a set of design questions for modern employment-based pension plans:

1) How much is the employee/employer willing to pay to achieve that target pension?

2) What is a reasonable prospective net real investment return that can be assumed on a conservatively invested portfolio of retirement savings today? What additional reward for risk taking is it reasonable to project?

3) What respective lengths of the work and post-work periods should be assumed in funding the plan? How is retirement-age flexibility best built into the plan design?

4) To what degree, and how, should uncertainties about net real returns, inflation, and longevity be mitigated? If the plan offers guarantees, what are the mechanisms through which these guarantees are priced and enforced?

In conclusion, Ambachtsheer makes the point that many major pensions, and Texas Teachers’ would surely qualify, are well-governed, modern and high-performance organizations. These institutions, he argues, would be better off dropping the DC vs. DB debate and focus on crafting plan structures that “strike an intelligent balance between the dual goals of adequacy and affordability.”

Read Ambachtsheer’s whole article, titled “The Dysfunctional ‘DB vs. DC’ Pensions Debate: Why and How to Move Beyond It,” here.