{"id":1114,"date":"2020-06-11T13:27:47","date_gmt":"2020-06-11T17:27:47","guid":{"rendered":"https:\/\/americancompass.beckandstone.com\/what-are-americas-pensioners-getting-from-private-equity\/"},"modified":"2022-11-07T16:32:45","modified_gmt":"2022-11-07T21:32:45","slug":"what-are-americas-pensioners-getting-from-private-equity","status":"publish","type":"post","link":"https:\/\/americancompass.org\/what-are-americas-pensioners-getting-from-private-equity\/","title":{"rendered":"What are America\u2019s Pensioners Getting from Private Equity?"},"content":{"rendered":"\n

Imagine a schoolteacher in a mid-sized American city. She earns approximately $60,000 per year<\/a> and each month contributes somewhere between 6 and 12 percent of her wages<\/a> to the state\u2019s public employee pension plan. Given her salary and associated living expenses, a robust personal savings plan seems out of the question. For the teacher \u2013 and the firefighter, the police officer, and many other public employees \u2013 pension benefits are the only hope for financial security in retirement.<\/p>\n\n\n\n

The managers of the teacher\u2019s pension fund allocate a significant portion of the teacher and her peers\u2019 contributions to several private equity funds. The employees of one of those funds identify a profitable, mid-sized business to buy, one of many companies they will acquire that year. The company\u2019s cost structure appears heavy, and the investors reason that the business could get by with fewer managers. Consultants hired by the investors identify an overseas factory that can replace part of the company\u2019s U.S.-based production at much lower costs.<\/p>\n\n\n\n

The investors take this plan to America\u2019s booming private credit market<\/a>. Debt funds \u2013 some also comprised of pensioner capital \u2013 compete to lend against the company\u2019s assets. The investors acquire the business, putting up thirty cents of every dollar, with the rest coming from lenders.<\/p>\n\n\n\n

Coincidentally, the company happens to be located in the same city in which the teacher \u2013 its ultimate, unwitting, indirect part-owner \u2013 resides. For decades, the company has been a leading employer in the region and an important component of the regional economy and its tax base. This scenario, though hypothetical, is not implausible. According to the Milken Institute, in 2018 there were over 8,000 private equity-backed companies in the U.S.<\/a>, up from less than 2,000 two decades earlier. The industry\u2019s rapid growth has increased competition, driving capital into smaller and more regionally diverse businesses as investors broaden their search for acquisition candidates. Some pension systems even have special vehicles to invest locally, such as the California Public Employees\u2019 Retirement System\u2019s (CalPERS) $1 billion CalPERS for California<\/a> initiative.<\/p>\n\n\n\n

Over the next five years, the investors \u201cimprove\u201d the business. More consultants manage the outsourcing and ensuing layoffs. Revenues grow slightly, but this growth is driven by \u201cprice optimization\u201d rather than increasing sales volumes. Profits, however, increase substantially. After five years, the company is put up for sale. With the company producing more cash, it fetches a higher valuation, selling for 50 percent more than its original purchase price. The investors have generated an annualized return of around 15 percent. Counting dividends, returns may even approach 20 percent – at least before fees and carried interest knock a few points off the gross return.<\/p>\n\n\n\n

The experience has irrevocably changed the teacher\u2019s community and consequently, her quality of life. The layoffs struck a body blow to the regional economy. When the company\u2019s laid-off managers departed, so too did the town\u2019s little league coaches, PTO presidents, and neighborhood watch captains. Workers fared even worse. As income per capita tumbled, neighborhoods fell into disrepair. Home prices fell, crushing net worth. Crime and drug abuse increased, but the budget-constrained local government struggled to provide adequate services. The teacher\u2019s job became much harder.<\/p>\n\n\n\n

Over the same five-year period, a low-cost index fund tracking the S&P 500 would have generated a 15% annualized return. In a best-case scenario, investors working on the teachers\u2019 behalf may have beat the market by a few percentage points. One has to wonder, however: if given a choice in the matter, would the teacher trade a few points of alpha on her retirement money for a life lived in a more vibrant and prosperous community?<\/p>\n\n\n\n

It is worth noting here that private equity, as an investment construct, is neither good nor bad. Pooling money and investing it is a core behavior of a capitalist economy. And there are indeed skilled, growth-oriented private equity and venture capital investors. Their firms earn handsome profits while fueling job creation, innovation, and the growth of small and mid-sized enterprises. But, in aggregate, the industry is generating mediocre returns relative to much cheaper alternatives, all while relying heavily on unproductive financial engineering techniques that too often harm American communities.<\/p>\n\n\n\n

Even if we momentarily set aside the societal impacts and thorny questions of political economy, we still face an important question: in what other industry does aggregate underperformance mint hundreds of millionaires and tens of billionaires each year<\/a>?<\/p>\n\n\n\n

This is why The Returns Counter<\/a> and the Coin-Flip Capitalism<\/a> project at American Compass are important. Much has been written about the financialization of the economy. Our financial elites\u2019 sense of detachment from their countrymen is also well-trodden ground. These are subjective, politically charged discourses. What is not up for debate is that American pensioners and universities paid $100 billion in fees alone from 2006 to 2015<\/a> for the privilege of investing in private equity and venture capital. Much of that went to firms that did not beat the stock market. Would our teachers, firefighters, and civil servants be better off if their pension fund managers revisited their assumptions around so-called alternative investments? The answer seems clear.<\/p>\n\n\n\n

Despite this apparent mediocrity, the industry is booming. Private equity has tripled in size over the last two decades. The number of American businesses owned by private equity firms has quintupled over the same period<\/a>. As pension funds and endowments chase returns, their appetites mirror that of CalPERS\u2019 Chief Investment Officer, who last year declared<\/a>, \u201cwe need private equity, we need more of it, and we need it now.\u201d<\/p>\n\n\n\n

For better or worse, Americans are about to get more private equity. In yet another handout to their friends in finance, Wall Street Republicans in the Trump Administration last week removed the barriers<\/a> that for decades had prevented ordinary Americans from investing in private equity via their 401(k) plans. Analysts say the move could open up another $6 trillion in previously restricted retirement savings to the world of private equity, hedge funds, and venture capital. Secretary of Labor Eugene Scalia said the move would<\/a> \u201chelp Americans saving for retirement gain access to alternative investments that often provide strong returns.\u201d If only that were the case.<\/p>\n\n\n\n

Americans are right to want to understand how underperformance can generate so much wealth. The business model of private equity, where fund managers earn years of fees before facing judgment on their investment results, plays a significant role. So too do factors on Main Street. Too many mayors and governors refuse to address unfunded pension liabilities, opting instead for voodoo budgets that promise to plug gaps with higher future returns. Low interest rates have also contributed by depriving portfolio managers of many of their traditional options. Though these issues are complex, the role and impact of private equity in the economy deserve a more robust discourse. Equipping ourselves with a clear-eyed, empirical view of performance is a great place to start.<\/p>\n","protected":false},"excerpt":{"rendered":"

Imagine a schoolteacher in a mid-sized American city. She earns approximately $60,000 per year and each month contributes somewhere between 6 and 12 percent of her wages to the state\u2019s public employee pension plan. Given her salary and associated living expenses, a robust personal savings plan seems out of the question. For the teacher \u2013 and the firefighter, the police officer, and many other public employees \u2013 pension benefits are the only hope for financial security in retirement.<\/p>\n","protected":false},"author":44,"featured_media":1115,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_tec_requires_first_save":true,"_price":"","_stock":"","_tribe_ticket_header":"","_tribe_default_ticket_provider":"","_tribe_ticket_capacity":"0","_ticket_start_date":"","_ticket_end_date":"","_tribe_ticket_show_description":"","_tribe_ticket_show_not_going":false,"_tribe_ticket_use_global_stock":"","_tribe_ticket_global_stock_level":"","_global_stock_mode":"","_global_stock_cap":"","_tribe_rsvp_for_event":"","_tribe_ticket_going_count":"","_tribe_ticket_not_going_count":"","_tribe_tickets_list":"[]","_tribe_ticket_has_attendee_info_fields":false,"_EventAllDay":false,"_EventTimezone":"","_EventStartDate":"","_EventEndDate":"","_EventStartDateUTC":"","_EventEndDateUTC":"","_EventShowMap":false,"_EventShowMapLink":false,"_EventURL":"","_EventCost":"","_EventCostDescription":"","_EventCurrencySymbol":"","_EventCurrencyCode":"","_EventCurrencyPosition":"","_EventDateTimeSeparator":"","_EventTimeRangeSeparator":"","_EventOrganizerID":[],"_EventVenueID":[],"_OrganizerEmail":"","_OrganizerPhone":"","_OrganizerWebsite":"","_VenueAddress":"","_VenueCity":"","_VenueCountry":"","_VenueProvince":"","_VenueState":"","_VenueZip":"","_VenuePhone":"","_VenueURL":"","_VenueStateProvince":"","_VenueLat":"","_VenueLng":"","_VenueShowMap":false,"_VenueShowMapLink":false,"_tribe_blocks_recurrence_rules":"","_tribe_blocks_recurrence_description":"","_tribe_blocks_recurrence_exclusions":"","footnotes":""},"categories":[7],"tags":[25],"acf":[],"yoast_head":"\nWhat are America\u2019s Pensioners Getting from Private Equity? | American Compass<\/title>\n<meta name=\"description\" content=\"Imagine a schoolteacher in a mid-sized American city. 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