Just before Thanksgiving, to much fanfare, CalPERS released its long-awaited report on the $3.4 billion in performance fees it paid to private equity firms over the last 25 years, including $1.1 billion in the last fiscal year.
To the relief of the industry, CalPERS reported stellar returns from its investments; an industry publication labeled the report a public relations coup. The report, however, omitted the most important information that California taxpayers and public employees need to know to judge whether the performance fees were justified – whether the returns were high enough to outweigh the risks of private equity investments.
The staff of the California Public Employees’ Retirement System omitted any information on the risk-adjusted returns and failed to tell the public the unfortunate truth: Investments in private equity have underperformed the pension fund’s risk-adjusted stock market benchmark over the last three, five and 10 years. Over the last 10 years, CalPERS would have had exactly the same return if it had simply invested in the stock market index – without the added risks of private equity and without paying exorbitant performance bonuses.
Not wishing to be embarrassed in the future, CalPERS staff will ask the board at its meeting Monday to vote to eliminate any benchmark. This would effectively eliminate the risk adjustment for private equity investments.
No doubt a football team that can’t get the ball over the goal line wishes it could just remove the end zone, but that’s not how the game is played.
Earlier, CalPERS staff further tried to obscure the mediocre private equity returns by comparing them with the dismal returns from its actual investments in the stock market, rather than with its risk-adjusted market benchmark. The pension fund’s private equity returns look good compared with the poor performance of its stock market investments. But that is cold comfort to the workers and retirees who rely on CalPERS to invest their retirement savings wisely.
CalPERS policy states that it will invest in top-performing private equity funds. The top 25 percent of them do beat the stock market by a sufficient margin to make these investments worthwhile.
But CalPERS has not been able to meet its policy. This is not surprising. Since 2000, it has not been possible to use a private equity firm’s track record to predict how its subsequent funds will perform.
A recent study found that a firm with a top-performing fund had only a 22 percent chance that a subsequent fund would do well, while a firm with a low-performing fund had an almost identical 21 percent chance that its next fund would be a top performer.
If the benchmark is eliminated as the CalPERS staff proposes, private equity firms will be able to continue to collect outrageously high fees from the retirement savings of public workers without being judged on whether their performance warrants these bonuses. Taxpayers and workers will be the losers.
Eileen Appelbaum is an economist at the Center for Economic and Policy Research in Washington, D.C., and can be contacted at firstname.lastname@example.org. Rosemary Batt is a professor in the Industrial and Labor Relations School at Cornell University and can be contacted at email@example.com.