Unions Hate Private Equity, but They Love Its Profits

The Wall Street Journal reports that many of the same public-employee unions that have attacked Mitt Romney for his private equity career are increasingly pouring their own pension money into ... private equity. Awkward.

According to the Journal, large public pensions now have about $220 billion, or 11% or their total assets, invested with firms like Bain Capital, the private equity giant where Romney made his fortune. That's $50 billion more than a year ago. The chart below tracks the long term trend. 

Public employee unions have been pretty unsparing with Romney over his tenure at Bain, which they've accused of firing workers to wring more profits from the companies it's targeted in leveraged buyouts. The Service Employees International Union, for instance, has gone after him for having "a long and troubling track record of putting profits above workers." Meanwhile, the WSJ writes that the union's members have retirement savings in "numerous state and county pension plans" that have poured money into private equity. One SEIU member is a trustee on the Ohio Public Employees Retirement System, which has billions in private equity investments.  

It would be easy to play gotcha here. But that's less interesting than looking at what all this says about private equity's rising profile in the contemporary world of finance. Public pension funds are turning to these investments as they strain to hit their yearly return target of 8%. According to the WSJ, that's partly because during the last decade, private equity returns were more than twice as high as the S&P 500 stock index and Dow Jones Industrial Average. That's a great turn-around from private equity's early history, when funds didn't even match the S&P 500 after you subtracted management fees. As one source told the WSJ, today's pension-fund managers "would say you may be breaching your fiduciary duty if you avoid this asset class."

Translation: If these funds weren't investing in private equity, they wouldn't be doing their job. 

Update: January 27, 10:24 AM

The Economist is out with a new piece that takes a much dimmer view of private equity's returns. It argues that there's no conclusive evidence that buyout firms really outperform public stock indexes, citing recent research that analyzed multiple private equity databases to gauge funds' performance over time. It found that although it was "very likely" private equity did better than the S&P 500 after management fees were removed from the equation, the outcome changed radically depending on what database was used. And regardless of how funds have performed in the past, their profits may be about to get squeezed. Private equity firms have traditionally driven their returns higher by using large amounts of debt in their deals. But these days, banks aren't lending as much. Per the magazine: 

"Employees are going to make less money, and firms are going to make less money. Returns are going to be much more mundane," is the gloomy prediction of the boss of one of the largest private-equity firms.

Perhaps public pension funds are picking the wrong time to invest.