There is a fascinating piece by Gretchen Morgenson in today’s New York Times about the large investments public pensions have made in private equity funds. The focus is on the secrecy of these deals, but the question also comes up as to whether these investments are proper given the fiduciary role that pension fund managers are supposed to play.
One thought that occurs to me is this: pension funds by their nature should position themselves overall toward relatively lower risk portfolios. Yet pension funds pay a management fee to private equity firms, and then the first 20% or so of investment profits go to private equity as well. For these fixed costs pension investors receive rights to the residual returns, which may be positive or, as in the case that leads the article, negative. Present and future pensioners are paying for the opportunity to play a lottery.
It should really be the other way around. General partners like private equity funds should pay pension funds an initial percent on investment for access to capital along with returns up to some specified level. The private equity folks, being more risk-loving (in theory) would then grab what’s left. In this way the risk would be allocated according to levels of fiduciary responsibility. Why should wealthy speculators load the risk onto working class retirees?