Large Institutions Going Direct: Disintermediating Private Equity
A growing group of large public pension plans and sovereign wealth funds have decided to bypass private equity managers and begin making direct investments in private companies. They’ve tired of the so-so returns and exorbitant fees. Nathaniel Popper in a New York Times article entitled “Public Funds Take Control of Assets, Dodging Wall St” captures the “do-it-yourself” movement. Michael Williamson, my friend and former colleague at North Carolina and currently the executive director of the State Wisconsin Investment Board, captured the sentiment rather well:
The market giveth and the market taketh away, and there’s not much we can control out there — but fees are one area where we can.
Wisconsin has been at the forefront of bringing more and more of its assets under internal management. It is now taking the next logical step by beginning to manage a small portion of its private equity exposure internally. The Canadian pension plans, such as the Alberta Investment Management Company, the Ontario Municipal Employees Retirement System (OPERS), and the Canadian Pension Plan Investment Board (CPP), have been directly engaged in private equity for well over a decade.
|Merger Details (1997)|
Predictably, Steve Judge, President of the Private Equity Growth Capital Council, PE’s lobbying organization, lauds its “superior returns” and warns that:
Those investing outside of traditional private equity partnerships will find it very challenging and expensive to recruit the talent and experience necessary to replicate those results.
While I have more than a minor quibble with Mr. Judge’s assertion that private equity produces superior returns, he’s got a point about the challenges. The problem, however, isn’t economic. Rather, it is political. Sovereign wealth funds, such as Abu Dhabi Investment Authority and Singapore's Temasek Holdings, may have the governance structure to create the appropriate compensation plans necessary to attract and retain talent.
However, most domestic public pension plans don’t have the political support necessary to hire the requisite employees. Although legislatures are happy to see private equity firms paid 2% management fees plus incentives, they’re reluctant to approve compensation plans that could pay pension employees six or even seven figure salaries and bonuses. By the way, they don’t have the same reluctance when it comes to hiring athletic directors or coaches for their public universities. As the Times points out, Wisconsin has made progress on allowing bonuses for its investment employees, while Oregon recently failed.
Even after a decade, I still bear the scars of trying to get modest salary increases for the Investment Division of the North Carolina Department of State Treasurer. I can’t imagine our General Assembly approving the kind of salaries and flexibility that would be required to operate a direct investment program.
I laud Wisconsin’s efforts, and I think it would be worthwhile for public pension plans to follow its direction. However, I doubt that most legislators and governors have the long-term commitment to public pension plans needed to make this effort feasible. Moreover, even those political officials willing to give support to direct investment and the requisite compensation plans are probably only bull market supporters. Private equity is a long-term endeavor and will hit periods when, as Michael Williamson says, the market “taketh away.”
During the Great Recession, Canadian politicians asked a lot of questions about the alternative investment programs conducted by their public pension plans. However, they didn’t dismantle the programs. I’m not sure our politicians have a similar level of resolve.