Of Pension Funds and Private Equity. Odd Couple or Meant to be?

Now this comes as a surprise to no one, but still makes me smack my forehead and just shake my head. I understand the idea of driving out the risk curve and most places really have absolutely no choice to do it... but really?! Have we learned nothing!? Just read through this.

The $114 billion Texas fund has hit the trend particularly hard. It now boasts some of the splashiest bets in the industry, having committed about $30 billion to private equity, real estate and other so-called alternatives since early 2008. That makes it the biggest such investor among the 10 largest U.S. public pensions, according to data provider Preqin Ltd. Those funds have an average alternatives allocation of 21%.

Obviously I understand the logic behind it and the need too chase returns for the sake of returns but at some point people will need to sit up and realize this just isn't going to work.

It baffles me that, although alternative investments certainly will get the job done, stewards of massive quantities of public money are eschewing preservation for the sake of return.

How do you fix this? I guess this prompts me to more of a question of what the future of retirement funds will look like going forward. Obviously most of the generations on here are not going to be relying on social security or a defined benefits fund. What then? Where are retirement products going? Do we simply have massive asset management and 401k plans? It seems to me that the current generations who are looking at retiring in 40 or 50 years are probably slightly more risk adverse and have the issue of needing to put away even more money than before because of the lack of secondary or tertiary funding sources. Can someone make me feel better about this?

 
Amphipathic:
What is funny is that organized labor attacks PE (and Romney) for sending jobs overseas while also enabling them to do so by providing boatloads of money.

Not only does organized labor attack PE for sending jobs overseas, but that they make too much money by striping down companies... funny thing is, their own retirement is on the line. Its a love/hate relationship.

Pensions need the returns, but criticize PE's methods of getting the returns they desperately need. Round and round we go...

 
Best Response

So what's the problem? Pensions and endowments will always invest in alternative asset classes such as real estate, private equity, and hedge funds (I believe an average to alternatives is around 20-30% of a portfolio). They have huge obligations that they are trying to cover, and simply buying equities and investment-grade fixed income wont cover them. Many of these pensions are underfunded so they need to find that return somewhere.

'In the meantime, educators like Vella Pallette, a retired elementary-schoolteacher from the tiny Central Texas town of May, are in limbo. The 78-year-old's $2,000 monthly pension check is her sole source of income. "A little more money," she says, "sure would help."'

Well, if you want a little more yield, you're going to have to take a little more risk.

Super Nintendo, Sega Genesis - when I was dead broke man I couldn't picture this
 
idragmazda:
Well, if you want a little more yield, you're going to have to take a little more risk.
Return, not yield.

Yields are down everywhere. Leverage is cheap; equally so for lenders and borrowers.

So, if you have to hit a 7.5% target (or 8.0%, like Texas Teachers) and 10/30 T-bonds are 1.95%/3.13%, you have a few options (non-exclusive list follows): (1) Be a lender and make next to nothing. GE is sitting on $100BB in cash but still borrowing more because why the hell not issue for three years at 85bps. Want to loan them more? (2) Be a borrower, or at least invest in companies that use debt, while debt is insanely cheap. (3) Put on a spread play. Borrow at your insanely low state/muni rate and use that as leverage to try to ratchet up a 6% junk bond yield.

What was the biggest problem for investors in 2005? Chase for yield. Subprime was, in large part, a symptom. What is the biggest problem for investors now? Chase for yield.

There's something scary about joking around with your buy-side colleagues about the risk curve. When, over and over, you hear guys you basically respect effectively say, "Hey, if I take all the risk in the world I can get 200-225 bps" and then they go out and keep buying, it's time to show up at the debt market without the "Lender" badge.

It's not my fault.
 

Don't worry, these are a sharp bunch of guys, but it IS risky. I'm thinking this is about as far as you can push it without becoming reckless, or maybe they are? On a side note:

Addinator:
stewards of massive quantities of public money are eschewing preservation for the sake of return.
....the real reason why privatising social security terrifies people.

The problem with the government is that there's no downside to fucking up. In China, if you make a bad policy, you can expect the gov't to find some crime to charge you with to punish you. If not, some guys kill themselves to maintain honor.

Here it's just a smash and grab.

Get busy living
 
George87:
A lot of pension funds are starting to co-invest or direct invest and skip the PE fees and headaches altogether. Not sure how they actively manage their investments in certain companies or assets but I read this in an FT articlea few days ago...

Yes. A lot of the major Canadian funds/managers (OTPP, OMERS, AIMCO) are heading this way.

 

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