Public Pension Plans and Private Equity

 Reporter Michael Corkery paints a grim picture of what lies ahead for government workers. In “Pension Crisis Looms Despite Cuts by Nearly Every State” (Wall Street Journal, September 22-23, 2012), steps taken to reduce costs “have fallen well short of bridging a nearly $1 trillion funding gap.” Besides reduced benefits for new hires, increased contributions required of both new and existing workers, suspended cost-of-living adjustments and lower benefits for current workers, governments are starting to implement defined contribution plans such as 401(k) arrangements. No doubt the debate about constitutionality will rage on but the fact remains that the status quo is nearly impossible to maintain.

For some plans, a solution is to alter assets and invest more in alternatives such as private equity and hedge funds. According to the Private Equity Growth Capital Counsel, private equity and some pension funds have done well by each other. Its map of state-by-state performance shows positive returns for public pension funds such as the California State Teachers’ Retirement System. Whether the relationship between the two groups will continue is uncertain. As Kate D. Mitchell, Managing Director with Scale Venture Partners and a speaker at the 2012 Dow Jones Private Equity Analyst Conference observed, a shift from defined benefit plans to defined contribution plans for countless state and local employers will likely mean fewer dollars for the private equity industry. What happens then will depend on whether new monies will be available from other sources or instead cause a contraction in long-term deployment of assets by general partners ("GP").

In addition, political pressures are a reality, especially with respect to how capital gains are currently taxed. Should rates increase at the same time that fewer dollars are available from public pension plan coffers, the private equity industry could find itself under pressure in terms of growth potential and profitability. Other speakers at the Dow Jones Private Equity Analyst Conference were extremely upbeat about the outlook for uber growth in certain geographic sectors and industries. If they are right, investors in private equity will want to look carefully at the make-up of a GP's portfolio.

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