US pension funds’ private-equity investments swelled to an average 8.9% of holdings in 2021 after three years of straight growth, according to analytics company Preqin. That amounts to roughly $480 billion of state and local pension fund assets tracked by the Federal Reserve, up from about $300 billion in 2018.
Some of the growth comes from blockbuster 2021 returns—54% for private-equity funds tracked by the data analytics firm Burgiss, not including venture capital, for the year ended June 30.
But retirement officials are also moving more money into their private-equity portfolios. California’s public worker pension fund, the nation’s largest, voted in November to add another roughly $25 billion to its target allocation.
State and local government retirement funds are increasing their reliance on the costly and illiquid asset class despite a strong performance from public markets in recent years. Many funds project that future returns in public markets may wane.
Pension funds aren’t alone in their effort to supplement public market investments. They, alongside insurers, sovereign-wealth funds and endowments, are part of a growing wave of money washing into private equity.
Over the past two decades, retirement funds’ private-equity portfolios have swelled steadily as holdings of other alternative investments have fluctuated. Real estate and hedge funds make up about as much of the average pension portfolio as private equity, Preqin data shows. The portion of real-estate and hedge-fund investments, however, has been falling for the past three years as private equity has been rising. More recent additions to many pension portfolios, such as private debt, natural resources and infrastructure, still claim less than half of the portfolio share private equity does.
The $75 billion Los Angeles County Employees Retirement Association lifted its private-equity target to 17% of its portfolio in May from 10% while dialing back its target for stocks to 32% from 35%.
“We’re planning on being in an environment where portfolios have to work harder,” investment chief Jonathan Grabel said. “We thought that this was a prudent trade-off.” The pension fund has earned 16.6% on its private-equity portfolio from its inception in 1986 through Sept. 30, Mr. Grabel said.
State and local pension funds have hundreds of billions of dollars less than they need to cover promised future retirement benefits, after decades of underfunding, benefit overpromises, government austerity measures and three recessions. Courts have struck down retirement-benefit cuts. Workers and the government bodies that employ them have resisted paying a higher share. So over the past 20 years, retirement officials have increasingly turned to risky private markets.
Those alternative investments are looking more appealing than ever for many funds as they face lackluster public market projections for the coming decade.
Christopher Ailman, who has spent more than two decades as investment chief of California’s teacher pension fund, the nation’s second-largest, predicted last month that 2022 returns on the S&P 500 will be in the low single digits. Wilshire, which advises pensions, is expecting 10-year returns of 5% for U.S. stocks and 1.85% for core bonds. Private equity, the firm believes, will yield 8.4%.
Private-equity managers typically pool money into funds and use it to purchase companies, revamp them and then sell them or take them public, drawing down cash and then returning it to investors over a period of perhaps a decade. The industry has grown rapidly, swelling with cash from pensions, sovereign-wealth funds and other institutional investors. Private-equity firms announced more than $1 trillion worth of deals in the U.S. in 2021, including buyouts and exits, according to Dealogic.
But as the field has grown more crowded, the advantage over a low-maintenance stock portfolio has dwindled. For the three decades ended June 30, the Burgiss index, not including venture capital, yielded close to 14%, 3 percentage points more than the S&P 500. But its yield over the past 10 years was the same as the S&P 500, 14.8%.
Some of the costs and risks associated with private equity have grown over those decades. With rates low, private-equity firms are taking on record amounts of debt to retool the companies they are buying. In a November speech Securities and Exchange Commission Chair Gary Genslerquestioned whether institutions deciding whether to commit money to private-equity managers have “the consistent, comparable information they need to make informed investment decisions.”
Meanwhile, expenses associated with forming private-equity funds have more than doubled over the past decade, a recent trade group report found.
“Pricing is up pretty meaningfully,” said Todd Silverman, a managing principal at consultant Meketa Investment Group. “It’s being driven by private equity as a whole having more capital chasing more or less the same potential opportunities.”
Concerns about cost and risk have done little to tamp down demand from pension funds, however, leading to a tight competition for investment opportunities.
When directors of the $500 billion California Public Employees’ Retirement System voted this past fall to increase private equity to 13% from 8% of holdings, managing investment director Sterling Gunn told the board that finding private-equity opportunities that meet or exceed the fund’s expectations is a challenge.
Steve Foresti, chief investment officer at Wilshire, said he expects continued growth in pensions’ alternative asset portfolios, including private equity.
“In the next five to 10 years you’re going to see notably bigger private asset allocations across these institutions,” Mr. Foresti said.
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