Transcript Private Equity and Pension Funds

Private Equity and Pension Funds
Eileen Appelbaum
AFL-CIO and Change to Win
Union Pension Fund Trustees Conference
April 1, 2012
Omni Shoreham Hotel
Washington, DC
Outline
• Does the private equity industry create or
destroy jobs?
• Private equity returns to limited partners:
What does the academic research show?
PE and Job Creation/Destruction
• PE likes to portray itself as buying up failing
firms and turning them around
• Evidence suggests this is a very small part of what
private equity actually does
– Between 1 and 2% of PE investments in any year are in
distressed companies (Kaplan and Strömberg 2009)
– Landmark study of effect of PE on jobs found that
employment in companies in which PE invested was
growing on average 2% faster than at comparable
companies in which there was no PE investment (Davis
et al. 2011)
Private Equity and Jobs
Davis et al. 2011
• Compares employment dynamics in “targets” acquired
by PE in LBO 1/1980 – 12/2005 with “controls”
– Study examines both firms and establishments at those firms
• Claim that they find that: “employment grows a tad
more slowly in PE than in non-PE owned companies”
• Examining their results shows this is not true
• Hint: Acquiring a company and its employees does not
count as job creation
PE and Jobs: Results from 2011 Study
Establishments
– “However, there is a clear pattern of slower growth at targets post
buyout, with growth differentials ranging from 0.5% to 2% per
year. These differentials cumulate to 3.2% of employment in the
first two years post buyout and 6.4% over five years.” p. 17
– “Slower employment growth at PE targets post buyout entirely
reflects a greater pace of job destruction” pp. 17-18; half due to
closings
• Especially evident in public-to-private transactions
– In retail, employment falls by nearly 12% in targets relative to
controls
PE and Jobs: Results from 2011 Study
Firms
– Continuers and deaths: “Summing these two components yields a
two-year employment growth rate differential of -5.49 percentage
points for targets, a large difference” p. 23
– Adding in greater job growth for targets than controls at greenfield
establishments (+1.87)” yields a differential of -3.62 percentage
points for targets” p. 23
– Only when acquisitions are included does the employment growth
differential shrink to less than 1%
– “Finally, bringing in the role of acquisitions and divestitures
reduces this differential to -0.81 points …” p. 23
LP Returns Net of Fees Relative to S&P 500
• Kaplan & Schoar 2005: Vintage 1984-1997
– Uses VE data from voluntary reporting by LPs and GPs
– Sample includes only funds that are liquidated
– Inflows are actual cash flows to LPs, not subjective estimates
• Harris, Jenkinson & Kaplan 2011: Vintage 1984-2008
– Uses Burgiss data from LPs that use Burgiss system
– Sample includes funds that have not exited all investments
– Returns calculated using estimated value of unrealized
investments in portfolio
– 2002 fund, 55% estimate; 2003 fund, 71% ; after 2003, > 80%
• Unknowable (self) selection bias in both data sets
Public Market Equivalent
• Method used to compare PE returns to the S&P
500
• PME compares LP return net of fees to equivalent
investment in S&P 500
• PME is “sensible measure for LPs as it reflects the
return to private equity investments relative to
public equities” (Kaplan & Schoar 2005: 1797)
LP Returns Net of Fees Relative to S&P 500
• Kaplan & Schoar 2005: Vintage 1984-1997
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On average, investing in S&P 500 beats PE
Only top quarter of PE funds beats market on average
Equal weighted: Median = 0.80, Av = 0.97, 25%ile = 0.63, 75%ile = 1.12
Size weighted: Median = 0.83, Av = 0.93, 25%ile = 0.72, 75%ile = 1.03
• Harris, Jenkinson & Kaplan 2011: Vintage 1984-2008
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On average, PE beats investing in S&P 500
Includes estimates of returns for companies still in portfolio
Equal weighted: Median = 1.16, Average = 1.22
Size weighted: Average = 1.27
Returns to PE/Returns to S&P 500
(Public Market Equivalent)
Harris, Jenkinson and Kaplan 2011
Management Fees and Investor Returns
(Metrick & Yasuda 2009)
• PE firm collects management fees on all committed capital*
– Annual charge is 2% first 5 years, may decrease after
• Median is 13-14% of committed capital over life of fund
• Accounts for two-thirds of GP earnings
– Have incentive to raise larger and larger funds – later funds larger
– Revenue per $ of committed funds decreases as funds grow in size,
but larger funds => higher management fees and earnings for GP
*Plus transaction fee (buying/selling), fee for monitoring portfolio firm – collected from
portfolio firm, shared with LPs; plus ‘establishment fee’ of up to $1 million from LPs
Pension Fund Returns
(Andanov, , Bauer, & Cremers 2011)
• Examined effect of management fees and carry on returns
to pension funds – found strong negative effect
• Larger pension funds have access to best investment
opportunities, can negotiate lower fees
• Returns to pension funds highly variable
• PE had spectacular run in 1990s, but returns fell to an
average of 4.5% in last 10 years
• Cremers: “If I had to summarize it in a nutshell, pension
funds got similar returns to what they would have gotten
had they invested in passive equities”