By GRETCHEN MORGENSON
The New York Times
July 1, 2016
It began last year as a promising push by a few states to require private equity firms that invest on behalf of public pension funds and university endowments to be more forthcoming. But the effort has hit a wall as bills in California and Kentucky intended to shed light on fees and practices at these powerful firms have been either killed or watered down.
One of the bills proposed in California would have required only modest disclosures: the publication of a handful of pages from confidential limited partnership agreements. It was shot down.
Even worse, another private equity transparency bill in the state was recently amended to eliminate disclosures about related-party transactions between private equity firms and the portfolio companies they oversee. Fees paid by portfolio companies to private equity funds ultimately come out of the pockets of fund investors, so more sunlight in this area would have been beneficial.
“The net effect is that a California public fund would receive much less than a full picture of the related-party transactions,” said Michael Flaherman, a former board member of the California Public Employees’ Retirement System and chairman of its investment committee, who is now a visiting scholar at the Goldman School of Public Policy at the University of California, Berkeley. “The missing part of the picture would be the portion of the fees that the private equity firms get to pocket in full.”
Not to be outdone, some lawmakers in the nation’s capital are trying to roll back newer regulations that have given the Securities and Exchange Commission a window onto private equity practices.
This fight against transparency, it’s worth noting, coincides with a series of S.E.C. enforcement actions against private equity firms. Stated simply, these cases prove that investors need more, not less, information about what their managers are up to.
“Just when they lift the hood on private equity and find some mechanical problems, they want to slam it shut again,” said Jennifer Taub, a professor at Vermont Law School. “Having a whole big pot of money in the shadows is not a good idea if you’re trying to prevent systemic risk.”
The attempts to keep private equity practices under wraps also coincide with a decline in the industry’s investment returns. An analysis published in late June by the Center for Economic and Policy Research notes that private equity’s performance in recent years is about even with that of the overall stock market. That means investors are not receiving appropriate rewards for the additional risks they take in these funds.
The research also identified another crucial shift: Past returns by a private equity manager are no longer as reliable a predictor of that manager’s future performance.
The report “Are Lower Private Equity Returns the New Normal?” was written by Eileen Appelbaum, a senior economist at the center, and Rosemary Batt, a professor at the Cornell University School of Industrial and Labor Relations. It examines the most recent academic research on private equity returns during both boom times and busts.
For years, private equity funds beat the overall stock market by a fairly wide margin. Since 2006, however, this has not been the case.
One 2015 academic study cited in the report found that during the 1990s the median private equity fund exceeded the returns of the Standard & Poor’s 500-stock index by 1.75 percent annually. Since 2006, however, the median fund has basically been in line with the performance of the S.&P.
Another study highlighted in the report drew the same conclusion. It calculated returns as of 2014 for funds of different vintages and compared their performance with that of earlier funds. This study considered funds with start dates ranging from the 1990s to 2009.