Pension Funds Investing in Private Equity
BY: Morgan Sciumbato
Public pension funds issue retirement benefits to many of the public servants in the United States. Beneficiaries contribute money to the fund throughout their careers, and then once they retire, they are guaranteed steady retirement payments from the pension fund. However, many of the public pension funds in the United States are underfunded due to investment choices and economic downturns. To make up for their underfunding, many public pensions funds have turned to alternative investments, like private equity. Pension fund managers are attracted to private equity because of the private equity industry’s reputation for high returns. [1]
While private equity’s reputation presents the hope of high returns and access to unique investments, it also has several detriments such as lack of transparency and high fees. These types of downfalls are exactly why many underperforming pension funds have recently faced criticism for their private equity investments. [2]
The State Teachers Retirement System of Ohio (STRS) is one pension fund that has been criticized. Over the past decade, STRS has paid over $4.1 billion in management fees for their alternative investments despite having to disappoint their beneficiaries by eliminating annual cost-of-living increases due to underfunding. [3] Another example is the Pennsylvania Public School Employees Retirement System (PSERS). PSERS has allocated more than half of its assets to alternative investments in recent year. [4] However, critics have argued that the fund would be better off with a strategy that favors stocks and bonds because their return over the last 10 years was only 7.7%, lower than the S&P 500. [5]
However, not all pension funds that invest in private equity suffer from bad performance. For example, the Illinois State Board of Investment has a private equity portfolio with a 10-year annualized return of 16.10%. [6] Pension funds with private equity portfolios that perform well prove that private equity investments can be lucrative. Further, private equity investments allow pension funds to diversify their portfolios by giving them access to assets that are not available on public markets.
So, should public pension funds invest in private equity? Many critics would be happy if pension funds steered clear of private equity and instead allocated their funds to more stable investments like index funds. [7] However, I think this would be unwise. Pension fund managers must take risks in order to fix their problem of being underfunded. [2] Further, many pension funds have proven to be successful in their private equity strategies. Thus, pension funds should take risks with private equity investments in their search for high returns, but they must be smart about where their money is going if they want the reward.
Sources:
[1] Jamal Hagler, Pension Funds and Private Equity, Am. Inv. Council 1 (2019), https://www.investmentcouncil.org/wp-content/uploads/pension-funds-and-private-equity.pdf
[2] Marc Joffe, Examining Private Equity In Public Pension Investments, Reason Found. (Jan. 2021), https://reason.org/wp-content/uploads/examining-private-equity-public-pension-investments.pdf
[3] Gretchen Morgenson, Private equity and hedge fund firms invested pension cash for retired Ohio teachers. Here’s what happened., NBC News (June 9, 2021, 6:00 AM),
[4] https://www.nbcnews.com/business/personal-finance/private-equity-hedge-fund-firms-invested-pension-cash-retired-ohio-n1269885 [https://perma.cc/M7AW-XHRT][4] Joseph DiStefano, Why PSERS investment strategy has failed to pay off for Pa. taxpayers and school employees, The Phila. Inquirer (Aug 8,2021),