Pension funds have paid huge fees to private equity companies in the last decade in order to increase the returns on their funds. But a look at their returns shows that it would be very hard to justify the fees that they have paid.
Private equity firms made a lot of money when the market was good. But pension funds have not even got half of the returns that had been promised by these companies. Alternative investments such as venture capital, real estate, private equity and hedge funds were supposed to help public pension funds, but their portfolios have still seen significant declines in value.
Ironically, one of the main reasons for poor returns is the huge fees given to private equity companies. Private equity managers often make profits because of the fees instead of the returns that they are able to deliver. These funds typically take around 20% of the profits that the investor gets on the investments, but they also take a cut from the money that they were given to manage.
The justification given by private equity fund managers for exorbitant fees is that they enable the investors to get market-beating returns on their investments because of the skills of the managers. However, most private equity funds have failed to generate enough profits to compensate for the fees.
In fact, statistics show that the returns that public pension funds have been getting have been falling with time. The private equity industry has clearly failed in its promise of beating the stock market returns. Most of the funds perform worse than the stock market after their fees are accounted for.
The private equity industry has grown largely because of the high level of contributions made by public pension funds. And now there is increasing criticism of the industry, especially because it failed to protect its investors during the recession.
Although the returns have somewhat improved in the last year, pension funds now realize that private equity is not immune to an economic downturn. Pension fund managers are now much more selective when they invest in private equity, and this could be bad news for the smaller companies in the industry.
Unless private equity companies are able to restore the faith of the investors, the industry could go through a huge transformation with one of the biggest sources of capital drying up.