Private Equity and Pension Funds

1. Private Equity and Pension Funds Eileen Appelbaum AFL-CIO and Change to Win Union Pension Fund Trustees Conference April 1, 2012 Omni Shoreham Hotel Washington, DC

2. Outline • Does the private equity industry create or destroy jobs? • Private equity returns to limited partners: What does the academic research show?

3. PE and Job Creation/Destruction • PE likes to portray itself as buying up failing firms and turning them around • Evidence suggests this is a very small part of what private equity actually does • Between 1 and 2% of PE investments in any year are in distressed companies (Kaplan and Strömberg 2009) • Landmark study of effect of PE on jobs found that employment in companies in which PE invested was growing on average 2% faster than at comparable companies in which there was no PE investment (Davis et al. 2011)

4. Private Equity and JobsDavis et al. 2011 • Compares employment dynamics in “targets” acquired by PE in LBO 1/1980 – 12/2005 with “controls” • Study examines both firms and establishments at those firms • Claim that they find that: “employment grows a tad more slowly in PE than in non-PE owned companies” • Examining their results shows this is not true • Hint: Acquiring a company and its employees does not count as job creation

5. PE and Jobs: Results from 2011 Study Establishments • “However, there is a clear pattern of slower growth at targets post buyout, with growth differentials ranging from 0.5% to 2% per year. These differentials cumulate to 3.2% of employment in the first two years post buyout and 6.4% over five years.” p. 17 • “Slower employment growth at PE targets post buyout entirely reflects a greater pace of job destruction” pp. 17-18; half due to closings • Especially evident in public-to-private transactions • In retail, employment falls by nearly 12% in targets relative to controls

6. PE and Jobs: Results from 2011 Study Firms • Continuers and deaths: “Summing these two components yields a two-year employment growth rate differential of -5.49 percentage points for targets, a large difference” p. 23 • Adding in greater job growth for targets than controls at greenfield establishments (+1.87)” yields a differential of -3.62 percentage points for targets” p. 23 • Only when acquisitions are included does the employment growth differential shrink to less than 1% • “Finally, bringing in the role of acquisitions and divestitures reduces this differential to -0.81 points …” p. 23

7. LP Returns Net of Fees Relative to S&P 500 • Kaplan & Schoar 2005: Vintage 1984-1997 • Uses VE data from voluntary reporting by LPs and GPs • Sample includes only funds that are liquidated • Inflows are actual cash flows to LPs, not subjective estimates • Harris, Jenkinson & Kaplan 2011: Vintage 1984-2008 • Uses Burgiss data from LPs that use Burgiss system • Sample includes funds that have not exited all investments • Returns calculated using estimated value of unrealized investments in portfolio • 2002 fund, 55% estimate; 2003 fund, 71% ; after 2003, > 80% • Unknowable (self) selection bias in both data sets

8. Public Market Equivalent • Method used to compare PE returns to the S&P 500 • PME compares LP return net of fees to equivalent investment in S&P 500 • PME is “sensible measure for LPs as it reflects the return to private equity investments relative to public equities” (Kaplan & Schoar 2005: 1797)

9. LP Returns Net of Fees Relative to S&P 500 • Kaplan & Schoar 2005: Vintage 1984-1997 • On average, investing in S&P 500 beats PE • Only top quarter of PE funds beats market on average • Equal weighted: Median = 0.80, Av = 0.97, 25%ile = 0.63, 75%ile = 1.12 • Size weighted: Median = 0.83, Av = 0.93, 25%ile = 0.72, 75%ile = 1.03 • Harris, Jenkinson &Kaplan 2011: Vintage 1984-2008 • On average, PE beats investing in S&P 500 • Includes estimates of returns for companies still in portfolio • Equal weighted: Median = 1.16, Average = 1.22 • Size weighted: Average = 1.27

10. Returns to PE/Returns to S&P 500(Public Market Equivalent) Harris, Jenkinsonand Kaplan 2011

11. Management Fees and Investor Returns(Metrick & Yasuda 2009) • PE firm collects management fees on all committed capital* • Annual charge is 2% first 5 years, may decrease after • Median is 13-14% of committed capital over life of fund • Accounts for two-thirds of GP earnings • Have incentive to raise larger and larger funds – later funds larger • Revenue per $ of committed funds decreases as funds grow in size, but larger funds => higher management fees and earnings for GP *Plus transaction fee (buying/selling), fee for monitoring portfolio firm – collected from portfolio firm, shared with LPs; plus ‘establishment fee’ of up to $1 million from LPs

12. Pension Fund Returns (Andanov, , Bauer, & Cremers 2011) • Examined effect of management fees and carry on returns to pension funds – found strong negative effect • Larger pension funds have access to best investment opportunities, can negotiate lower fees • Returns to pension funds highly variable • PE had spectacular run in 1990s, but returns fell to an average of 4.5% in last 10 years • Cremers: “If I had to summarize it in a nutshell, pension funds got similar returns to what they would have gotten had they invested in passive equities”