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The Center Square) \u2013 Pennsylvania\u2019s public-school employees\u2019 pension fund is $41 billion short of what it needs to pay promised benefits. Last year, it missed the investment benchmark that officials set, a result they said was \u201cprimarily due to performance within private equity.\u201d<\/p>\n
As of Dec. 31, Pennsylvania\u2019s Public School Employees\u2019 Retirement System held $85.3 billion in assets, making it one of the nation\u2019s largest public pension funds. PSERS invested $10.1 billion in private equity with a goal of earning a 10.06% return. It returned just 2.59%. According to PSERS, private equity reduced the fund\u2019s overall return by 0.59 percentage points \u2014 more than any other asset class. <\/p>\n
The $41 billion shortfall is more than an accounting figure.<\/p>\n
Pennsylvania taxpayers will ultimately bear much of the cost as the state spends more to keep its promises to the fund\u2019s 500,000 members and their beneficiaries or survivors, said Leonard Gilroy, senior managing director of the pension integrity project for the Reason Foundation, a free market think tank.<\/p>\n
Private equity has put state officials in a bind, he added.<\/p>\n
\u201cFor most state pensions, they\u2019re not getting outsized returns; they\u2019re taking on a bunch of risk; and they pay fees to limited partners at private equity firms,\u201d he said in an interview. \u201cThat puts state officials in the position of either needing to invest more taxpayer funds or find better investments.\u201d <\/p>\n
An investigation by The Center Square found that private equity was the only one of PSERS\u2019 eight asset classes to miss its benchmarks over one-, three-, five-, 10- and 15-year periods.<\/p>\n
A record of underperformance<\/p>\n
PSERS officials declined a request for an interview.<\/p>\n
Instead, Chief Investment Officer Ben Cotton emailed a statement. He said the benchmark doesn\u2019t precisely match its private equity portfolio because it has a different mix of investment strategies and older and newer funds than the benchmark.<\/p>\n
PSERS is \u201cunderweight in some strategies and newer vintages have outperformed over the most recent periods,\u201d he wrote.<\/p>\n
Cotton\u2019s explanation echoed comments from PSERS\u2019 head of private markets last year. <\/p>\n
\u201cAssets held for 10-plus years tend to have diminished return potential thereafter, often underperforming the portfolio\u2019s cost of capital,\u201d James Del Gaudio told the trade publication Markets Group.<\/p>\n
The possible end of a \u2018golden era\u2019<\/p>\n
Private equity invests in companies that aren\u2019t publicly traded. Pension funds have embraced the asset class. It had outperformed stocks and bonds, although it charges higher fees and ties up investors\u2019 money for years.<\/p>\n
That may be changing.<\/p>\n
PSERS has pulled back from private equity. As of fiscal year 2024, it held $12.2 billion. By last December, that had fallen to $10.1 billion. Private equity\u2019s share of the portfolio fell from 16.3% to 11.8%.<\/p>\n
\u201cWe have consciously chosen to reduce our allocation by moderating our investment pacing in recent years and selectively and opportunistically selling some of our exposure in secondary markets,\u201d Cotton, PSERS\u2019 CIO, wrote in his statement.<\/p>\n
Other states reduce private equity<\/p>\n
Since last year, pension systems in at least six other states have reduced their private equity holdings\u2013Alaska, Maine, Washington, Ohio, Nevada, and Virginia. <\/p>\n
Last October, Alaska pension officials concluded that \u201ckey drivers of private equity\u2019s \u2018golden era\u2019 in the past couple of decades may have reversed,\u201d referring to tightened credit, geopolitical tensions, and increased borrowing costs.<\/p>\n
\u201cThat period was unusually favorable and it\u2019s unlikely PE returns will snap back to those averages.\u201d They predicted returns from private equity investments to fall to high single-digits to low double-digits from the mid-to-high teens that many investors expected. <\/p>\n
\u201cIf the expected future returns are not adequately higher for private equity,\u201d the Alaska Permanent Fund Corporation, a state agency, wrote in a report last October, \u201cthe rationale for taking on higher risks (illiquid, levered, idiosyncratic, high fees) may have eroded.\u201d<\/p>\n
Private equity has not always lagged.<\/p>\n
PSERS began investing in private equity in 1998. Since then, the asset class has produced an annualized return of 10.96%, according to state records.<\/p>\n
Last year, PSERS invested through 67 private equity firms overseeing 209 funds. Some investments generated strong returns. Others lost money.<\/p>\n
HgCapital 8 and New Mountain Partners III and V more than doubled investors\u2019 money. First Reserve XII, an oil and gas fund, generated only 55 cents of value for every dollar invested. Interactions returned 2 cents.<\/p>\n
Gilroy said private equity firms have a tall order. They must pick not only the right companies and industries but also at the right time.<\/p>\n
\u201cTiming matters a lot,\u201d he said. \u201cIf you\u2019re California\u2019s pension funds, you got into private equity early and made money. Other pension funds haven\u2019t done as well.\u201d<\/p>\n
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