Will Pension Funds Shun Private Equity?

BusinessWeek speculates that the attacks on Romney's work at Bain may cause pension funds to pull out of private equity deals:

With public scrutiny focused on private equity funds, pension funds are more reluctant to invest and may ask for more details on job creation and push for lower fees, according to officials and trustees at public pensions. "Pension funds have boards. They don't want to be giving money to an industry that has a taint," says Tony James, president of Blackstone Group (BX), the world's largest private equity firm. "Similarly, boards of directors don't want to sell their company to organizations they don't view as respectable. So it could be very damaging for the industry."

The debate comes as the industry is competing for a shrinking pool of investor dollars. Fundraising has fallen off sharply since the onset of the global financial crisis, staying below $100 billion each quarter, according to London-based researcher Preqin. In the second quarter of 2007, at the peak of the leveraged buyout boom, private equity firms raised almost $214 billion. In the fourth quarter of 2011, they raised $52.4 billion.

Public and private pension funds in the U.S. provide 42 percent of the capital for all private equity investments, according to the Private Equity Growth Capital Council in Washington.

If this happens, it will be good news.  For years now, pension funds have been trying to make up for contribution deficits by chasing higher returns in hedge funds and private equity--especially state and local funds, which have been chronically underfunded by politicians who like to promise goodies, but not the taxes needed to pay for them.

Those higher returns are not cost-free; they come attached to higher risk.  The last thing that you should be doing with someone's retirement is taking a high risk gamble in the hopes that you can compensate for undersaving.  (Side note to retirees panicking over today's low asset returns: this goes double when it's your retirement.)

But for that very reason, color me skeptical that this will actually happen.  Pension fund managers are trying to deal with underfunding in an environment where normal investments aren't offering much more return than stuffing the money inside your mattress.  If high-minded refusal to touch tainted deals means you have to go back to the principals and demand another 1% of salary in contributions, I'm betting that the investment committee will be brainstorming reasons to love private equity faster than you can say Adjusted Funding Target Attainment Percentage.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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