The bigger they are the harder they fall
By Paul Mackintosh - 16/04/12
Private equity, even more than most asset classes, is wedded to the interests and fortunes of institutional investors. The free-for-all rough-and-tumble environment of publicly traded securities, where even the retail punters can ginger up the market, is a world away from the asset class’s long investment periods and large allocations. Only the big institutional investors are really cut out for this.
So upsets among pension funds are commensurately worrisome for GPs. And the current situation is alarming. The US$144 billion California State Teachers’ Retirement System (CalSTRS), the world’s second largest pension fund and a major private equity LP, has just released an actuarial report stating that “as of June 30, 2011, the future revenue from contributions and appropriations for the DB program is not expected to be sufficient to finance its obligations”. In fact, CalSTRS has only funds to cover 69% of its obligations. And this after a year that saw it contribute some $2 billion to private equity.
What CalSTRS does matters in private equity. One of the fund’s managers was recently reported as saying that CalSTRS has almost 15% of its assets in private equity (around $21 billion) and may be ready to commit up to $2.5-4 billion a year to the asset class in future. Also, the LP has reportedly been looking at separate account commitments to GPs where each account could run up to $2 billion.
CalSTRS is not alone. The problem prevails across national, municipal and corporate pensions. In many US states, unions are fighting in courts to defeat changes to the pensions systems. According to Credit Suisse, as of January this year, low rates “have pushed pension underfunding to a new year-end high (or low) of $458 billion”, adding that “mediocre asset returns weren’t good enough to keep pace with growing pension obligations”. As a result, Credit Suisse estimates “that companies will have to continue contributing significant amounts to their pension plans for the foreseeable future”. Furthermore, March 2012 data from BNY Mellon Asset Management shows multi-company pension plans in the US at a very worrying 54% funded level. And considering the crisis-hit sovereign finances of Europe, other Western economies are unlikely to show better figures.
Private equity has always claimed to be able to deliver the kind of outperformance that could push pension fund returns closer to their obligations. But if one of the asset class’s key institutional supporters cannot balance its portfolio against revenue and expected obligations, that is a worrying trend indeed. The only silver lining is that pension funds are almost certainly going to have to raise more – and invest more.