Sunday, May 03, 2015
Buying a pig in a poke
The pension funds that are left in this country are constantly seeking new investments to maintain their necessary rate of return and many have embraced private equity funds to do so. One of the hazards of doing so for the pension funds is the lack of understanding of just how much it costs them. In the world of BSD investing, the investor is as much a source of revenue as the investments made.
Partnership agreements outlining private equity firms’ practices are as closely guarded as the recipe for Coca-Cola.And the less the investor knows, the more the PE crew can skim from them. Nice work if you can get it.
Indeed, when it comes to secrecy, few industries do it better than private equity. To outsiders, the lucrative business of borrowing money, buying companies and hoping to sell them later at a profit is as impenetrable as a lockbox. Rates of return and hidden costs are difficult to identify, even for investors in these deals.
While top-line fees associated with these funds are well known — management typically charges investors 1 to 2 percent of assets and about 20 percent of portfolio gains — many charges are hidden from view. These include transaction fees, legal costs, taxes, monitoring or oversight fees, and other expenses charged to the portfolio companies held in a fund.
Those undisclosed charges are a meaningful drag on returns.
How meaningful? Very, according to a recent report by CEM Benchmarking, a Toronto-based consulting firm specializing in pension fund performance analysis.
It estimated that more than half of private equity costs charged to United States pension funds were not being disclosed.
CEM concluded that the difference between what funds reported as expenses and what they actually charged investors averaged at least two percentage points a year. For a $3 billion private equity portfolio, that would add up to $61 million.
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