Guest Post: Private equity benefits Californians

Now that the California Public Employees’ Retirement System (CalPERS) has disclosed its private equity profits, the success of its private equity partnerships is clear. The data show that its private equity program has delivered $24.2 billion to the people of California since 1990.

With this number, there is no question that the asset class has helped secure pension benefits for California’s 1.7 million current and future retirees. And, in so doing, private equity has also benefited every taxpayer in California.

Yet, long before the data release, critics of the private equity industry were drumming up controversy over the profit sharing arrangement, known as carried interest. But the critics missed the point.

Contrary to the political rhetoric, carried interest is not a fee paid by investors. Rather, carried interest is a profits interest – typically 20 percent – to which private equity general partners are entitled as profits are generated, and which CalPERS and other limited partner investors agree upon upfront. Carried interest aligns the interests of pensions and private equity, so that pensions receive their share of their private equity partnerships’ profits, and then the private equity general partners receive their share – in that order.

CalPERS’ multiple private equity general partners collectively realized $3.4 billion in carried interest profits since 1990, meaning that CalPERS received over five times the amount of profits generated through its private equity partnerships. This is not just a good thing for California; it’s great.

These profits support the retirement benefits of 1.7 million people who have dedicated their lives to supporting their fellow Californians: Teachers educating the next generation of leaders, firefighters aiding our families during emergencies, law enforcement officers creating safe communities, judges and staff ensuring justice in California courts, and many other state and county employees.

Strong returns also mean fewer taxpayer dollars are needed to fund pension benefits. Pensions are jointly funded by employer (the state) and employee contributions, which are invested so that pension fund dollars grow over time. According to CalPERS, the majority of spending – that is, 65 cents of every dollar – on public employee pensions over the last 20 years has come from investment earnings.

Private equity is but one asset class in which CalPERS invests, but as chief investment officer Ted Eliopoulos pointed out last month, the asset class has had the highest net returns in their portfolio and is an integral part of their investment strategy.  Over the last decade, private equity has returned 11.9 percent, after fees and after carried interest, for CalPERS.

This consistent investment performance comes from working side by side with invested companies. Private equity partners use capital to purchase companies, improve them over the long-term, and sell them at a profit. Private equity ownership generates value through operational and managerial improvements, as well as capital investment.

Pension plans invest in private equity because research shows that it is less volatile than public equities, and as CalPERS notes, private equity outperforms all other investments for pension funds. It’s never the largest asset class in the portfolio, but it almost always provides the best returns.

Indeed, in its annual ranking of large public pension funds, the Private Equity Growth Capital Council found that private equity delivered a 12.1 percent annualized return to the median public pension over the last 10 years, more than any other asset class.

With strong performance year after year, the partnership between pension plans and private equity is worth acclaim. Private equity consistently supports the needs of its investment partners and thus the people of California. Investors such as CalPERS will continue to yield high returns well into the future.

Jason Mulvihill is General Counsel for the Private Equity Growth Capital Council, a Washington D.C.-based trade association.

Photo courtesy of PEGCC