Confidentiality of limited partnership agreements is paramount

Recent calls for public pension funds to disclose the terms that govern their investments in private equity funds ignore the substantial benefits that this very confidentiality provides the pension and its beneficiaries.

Confidentiality is paramount for a simple reason: Private equity is one of the most competitive corners of the financial marketplace. Thousands of private equity firms compete every day for a finite pool of talent, investment capital and businesses which have unrealized potential.

This is good news for fund investors and for the companies in which private equity funds invest because competition breeds better performance at a lower cost.

It’s the same market force that consumers benefit from when Coke and Pepsi compete for their business.

The argument that limited partnership agreements (LPAs) should be accessible to the public is akin to demanding that Coca-Cola publish its famous (and secret) soda recipe.

Like Coke’s secret recipe, LPAs contain proprietary and commercially sensitive trade secret information that, if disclosed, could undermine a private equity fund’s ability to invest and generate high returns for its limited partners.

Overnight, competitors would have access to sensitive information, like the fund’s investment strategy, investment limitations, and key personnel that competitors could use to outbid the fund on a deal or otherwise disadvantage it in competitive negotiations.

This could pose a real problem for public pensions, many of which are underfunded and have struggled to meet their return targets, because private equity has consistently been a top performing asset class for them.

Over the past 10 years, the median investment return, net of fees, delivered by private equity was 12.3 percent, well above the returns of fixed income, public equities and real estate.

This is one of the reasons that public pensions themselves agree and prefer to sign confidential agreements.

Those calling for disclosure also ignore other key factors.

First, public pensions are not the only investors in a fund. Many organizations, like charitable foundations or college endowments, make investments with the understanding that their agreements will be kept confidential. That promise will be broken the minute a single LPA is released publicly.

Second, LPAs are highly negotiated agreements between sophisticated parties and, in the case of public pensions, are entered into by individuals who have a fiduciary duty to act in the best interests of beneficiaries. So it goes beyond reason to believe that they would enter into any agreement that would violate that duty. It is also in the long-term interest of private equity firms to produce a track record of superior returns, net of fees.

We can all agree that, generally speaking, transparency in financial markets is essential. In the case of LPAs, there is total transparency between the investor (the pension plan) and the fund. But we should also acknowledge that maintaining confidentiality among rival private equity firms is required to maintain competition and foster innovation.

There are valid and well-established reasons for preserving confidentiality that protect both the private equity fund and its limited partners. This confidentiality should be preserved.

Steve Judge is the president and chief executive officer of the Private Equity Growth Capital Council (PEGCC), based in Washington, D.C.

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