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PE Panorama: Yet more pushback on private equity fees

private equity
By Paul Mackintosh   
November 29, 2021

Here’s one Newsweek headline I could guess the subject of without reading any further: “The Secret Is, 'Everybody Gets Rich Except the People Who Put Money In’”. Yes, sure enough, it’s private equity and its pension fund supporters.

The November 22 report covers an investigation into the State Teachers Retirement System of Ohio by the state’s auditor and securities department, thanks to pressure by a former Ohio attorney general. On the surface, the pension fund is in good shape. Its return on investments for the financial year ended June 30 was over 29%, and assets were just under US$95 billion.

But it does have a high allocation to alternatives – 17.9% of its portfolio as at June 30, 2020, the latest available figure. And according to the Newsweek report, the pension fund has resisted disclosure of performance information, fund terms, fees, and other key data regarding its private equity investments.

The article highlights “efforts to increase transparency and expose the widespread abuses by high-flying Wall Street players of the pension funds of teachers, firefighters, cops, and bus drivers”. It’s hard to argue against language so populist when it’s also so true.

Regardless of the merits of the Ohio case, there is one fundamental question that the article skewers. Under the default two-and-20 compensation model for private equity funds, fund managers’ fees “can be 10,000% higher than the fees paid to low-cost index fund managers, who can charge fees as low as 0.035% of invested assets”. Yet those private equity funds often fail to beat the performance of the index.

Of course, some funds do perform better. Certain big Wall Street firms spend a lot of marketing dollars convincing pension funds that they do. Do they outperform by 10,000%? Not very likely.

Stephen Schwarzman, the head of private equity giant Blackstone Group, has an estimated personal net worth of over $41 billion. That’s almost half the size of the entire Ohio teachers’ pension fund. And all of it built out of the investments of pension funds and other institutions. Good news for pensioners?

There are many things about private equity that are justifiable. But the disproportion between compensation to fund managers and performance for limited partners is unjustifiable, and always has been. Private equity general partners still can get more than rich enough from a lower compensation scale.

Private equity is one of the few disciplines that investment bankers scramble to get into. What does that tell you? Let’s put those private equity general partners on investment bankers’ starvation wages instead.

Institutional investors may have excellent reasons for getting into private equity. You also have excellent reasons for insisting that you receive a better deal than two-and-20. You have very good reasons for combining with your peers to insist collectively on a better deal. Otherwise, good luck dealing with the kind of pushback that we're already seeing in Ohio.