The House Always Wins

Numerous pension funds piled into private equity funds, lured by the promise of good returns.

Of course, PE has never delivered, particularly when you count their fees, but if you clap loudly enough, Tinkerbell will survive.

Now these funds are discovering that once they needc the money, they cannot get their money out:

Private-equity and pension funds seemed like a match made in heaven. U.S. companies and states handed over control of some worker retirement savings. In exchange, they got a promise of high returns after a decade—and often received healthy cash payouts in the years before that.

Yes, they got a promise. They never got the returns.

Now the honeymoon is over. The payouts have dried up, creating an expensive problem for investment managers overseeing the savings of workers retired from big corporations and state and city governments. 

To keep benefit checks coming on time, those managers are unloading investments on the cheap or turning to borrowing—costly measures that eat into returns. California’s worker pension, the nation’s largest, will be paying more money into its private-equity portfolio than it receives from those investments for eight years in a row. The engine maker Cummins took a 4.4% loss in its U.K. pension last year, in large part because it sold private assets at a discount.

………

Pensions, sovereign-wealth funds, university endowments and other institutions often promise their money to private-equity managers for a decade or so. Over that time, the managers draw down the cash and use it to buy companies, then overhaul and sell them. Those sales and the resulting cash distributions to investors have slowed markedly as high interest rates have made buying and owning companies more complicated and expensive.

Unable to sell without denting returns, private-equity managers are keeping workers’ retirement savings locked up for longer—sometimes past the promised maturity date. Nearly half of private-equity investors surveyed by the investment firm Coller Capital earlier this year said they had money tied up in so-called zombie funds—private-equity funds that didn’t pay out on the expected timetable,leaving investors in limbo. 

So pension funds are selling private-equity fund stakes secondhand—often taking a financial hit in the process. Secondary-market buyers last year paid an average of 85% of the value the assets were assigned three to six months before the sale, according to Jefferies Financial Group. Secondhand sales by private-equity investors increased 7% to $60 billion last year.

This was foreseeable, but the people working the investment side of pension funds know that if they play ball with PE, they can get a very good paying job with PE firms.

It's corrupt, but that is a feature, not a bug.