Can Private Equity Really Save Sinking Pension Funds?

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In The Wall Street Journal, Jason Zweig tells the story of Calpers, the nation’s largest pension fund, and the nation’s growing investments in private equity. Like Calpers, many pensions are hoping to meet unrealistic return expectations (something I have written about many times, including here, here, here, and here) by investing in private equity. The problem is, it isn’t a sure bet that private equity will be able to produce the returns necessary. Zweig writes:

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Still, the future for private equity might not be as lucrative as the past, with money gushing in and with buyouts priced near their highest levels in the past decade and a half.

“Now, when everyone else is doing it and with [the prices of buyout deals] higher, expected returns look just okay,” says Steven Kaplan, a finance professor at the University of Chicago Booth School of Business.

Proponents say private equity’s outperformance comes from skilled managers who buy companies at attractive prices, improve operations, crank up returns with borrowed money and then sell at even more attractive prices.

Skeptics say the outperformance comes from using debt to invest in companies that are somewhat smaller and cheaper than average—which you could do yourself, at a fraction of the cost, by using borrowed money to buy an exchange-traded fund.

In a blog post last September, investment advisers Preston McSwain, managing partner of Fiduciary Wealth Partners in Boston, and Wesley Gray, founder of Alpha Architect in Broomall, Pa., posted a wager.

They offered to bet up to $1,000 that, over the next 15 years, a basket of the 10 largest private-equity funds of 2018 won’t outperform the stone-simple, dirt-cheap Vanguard Extended Market exchange-traded fund (purchased with 50% borrowed money).

So far, no takers.

E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.