Four of the largest publicly-traded private equity funds recently reported their largest quarterly increase in total assets under management in four years. Much of that increase is due to insurance funds, pension funds, and others pouring money into private equity funds in a bid for better returns on investment. That doesn’t bode well for retirees hoping to benefit from pensions, as the volatility inherent in private equity and the conservatism that should be inherent to pension funds could lead to a catastrophic mismatch.
What is Private Equity?
Private equity firms are firms that raise pools of money from various sources in a bid to make more money through various investments. One of the private equity strategies with which many people are familiar is that of the buyout. The private equity firm identifies a company that is underperforming but that has potential to perform better, raises capital from investors or through loans to purchase that company, then makes changes to management or business processes to improve the company’s performance. After a certain period of time, often a few years, the acquired company will then be sold again, hopefully for a profit, and investors will then be repaid from those profits.
Investing in private equity funds is fundamentally riskier than investing in other more conventional manners such as purchases of stocks or bonds because it relies on the private equity firm’s ability to assess a company’s future performance within its industry and within the economy. If the firm’s predictions don’t come to fruition or the company it acquires performs poorly then investors will lose much of their money. That makes it very risky for pension funds to invest in private equity.
Why Are Pension Funds Investing in Private Equity?
Pension funds are obligated to pay out benefits to retirees. Many pension funds are beginning to feel under the gun because they are not fully funded. And with the current low-interest rate environment there are very few investment options available to make up for the gains that pension funds should have been making over the past decade in order to fully pay for retirees’ pensions. That’s why many pension funds have begun to invest in private equity funds, in a bid to raise their returns on investments and ensure that they meet their fiduciary obligations to retirees.
Future of Pension Funds
If pension fund managers invest in funds that start to perform poorly, however, the result could be that they dig themselves deeper into a hole. The fact that pension funds think it necessary to start chasing returns is a worrying sign. It’s not quite as troubling as if they were to invest in junk bonds, but that may only be a short step away.
Retirees who expect to benefit from a pension from their company, or from a school district or government agency, should keep a watchful on their pension funds’ investment decisions. If you see that your fund managers are starting to make riskier and riskier investments in a bid for return, that might mean that your pension fund is not in the best fiscal health. That makes it all the more important for you to make sure that you have your own retirement savings set aside just in case.