Tuesday, October 2, 2012

A bad idea: when pension plans own a piece of a money manager

A bad idea: when pension plans own a piece of a money manager

I guess my exit from money management is not yet complete, since I still read Pensions and Investments, one of the industry’s publications.  Recently, I learned that the Florida Retirement System had purchased a minority stake in Provident Equity Partners, a private equity firm for $150 million.  Florida is not the first pension plan to buy a stake in a money manager, and this is not Florida’s first foray into this type of investment.   This is merely the most recent mistake of this type.

Final Agenda (1997)

Why should you care?  These are the kinds of investments that create conflicts of interest and undermine confidence in pension plans.  The last we thing we need is a bone-headed investment that gives critics another excuse to attack public employee pensions.  The Florida Board of Administration, controlled by the Governor, Chief Financial Officer, and Attorney General are hoping that Provident Equity Partners will be highly profitable and earn a sizable return, and they have a some reason to believe that the investment will work as Provident has been very successful.  Even if the investment turns out okay, this is still a bad idea.

The real reason for this type of investment is that the boards and staff of pension plans like to be viewed as “sophisticated” players.    There’s a great deal of excitement in putting together an investment in a private equity firm.  However, the playing field is hardly level.  The private equity firm is, after all, in the business of buying and selling companies.  The folks on the other side of the table, even if they’re advised by an investment bankers, are completely outmatched.

The core of the problem is that Florida is also an investor in several of Provident’s private equity products to the tune of $450 million, which is the more significant and appropriate way for them to build the assets and returns of the pension plan.  Now that they have made an investment in the manager, they’ve gotten too close and intimate.

How can Florida objectively review the investment performance of Provident and decide whether to continue to participate in their investment products when they also own a piece of the manager?  Normally, if investment performance deteriorates, a private equity investor can simply decide not to participate in any new funds.  However, Florida will now face a dilemma; if they choose not to invest, they will be hurting their economic interest in the manager.  If they decide to participate, they will be not be acting as good stewards of the plan.

For Provident Equity Partners this investment is a nice win.  They’ve managed to extract $150 million from one of their clients and haven’t given up one iota of control.  If this investment doesn’t work or the products don’t perform, it will hurt the Florida retirement plan, far more than the amount of the investment.

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