Companies should be wary of investing their DB plans with buyout firms.
A new study by academics at Yale and Maastricht University shows that over the past 10 years, private equity returns after fees have lagged substantially those of the market at large. The study, prepared for the Financial Times, showed that the average private equity fund returned 4.5 percent, as opposed to 6.7 percent for the S&P 400 index of medium-sized firms.
The administrators of defined benefit plans should take notice. Many have ridden on the coattails of pension giant CalPERS, which started to plow money into buyout funds in the late 1990s. CalPERS was seen as the test case for so-called absolute return investments, which were meant to both beat the market and be countercyclical.
But the fee structures built into these vehicles – the “2 and 20” template – has gutted the returns of those funds that were able to invest profitably. According to the study, investors paid 4 percent of invested capital to buyout funds each year since 2001.
The counter-cyclical or diversification benefits of these funds has also evanesced. Hedge funds, in particular, but buyout firms also endured waves of collateral calls as their portfolios declined in value and lending dried up in 2007-08.
The buyout funds’ rapacity, which has spurred even Mitt Romney’s Republican presidential opponents to complain about his line of work, has been on display via fees extracted from investors and from target companies themselves. Given the growing political uproar over LBO shops’ tax advantages and lobbying muscle, that may change. But for the time being, it appears that private equity is an asset class that corporates can do without.