Looting Worker Pensions
Are equity hedge funds beneficial or harmful?
Harvard economists Bebchuk, Brav and Jiang conclude in a 2015 study that all the criticisms levelled at the predatory tactics of equity/hedge funds are unfounded. Bechuk calls them ‘activist hedge funds’ and claims their tactics do not have a detrimental effect on long-term profitability for shareholders.
You will easily find the pro hedge fund Bebchuk study by searching about hedge fund effectiveness. It has been reproduced on several academic and business sites — usually with high praise. The search results listing for this report will fill the first two or three pages. Yet, there is a serious flaw in its fundamental hypothesis.
No harm to wealthy shareholders, yes — but what about workers?
In 2017, another study pointed out the flaw in the Bebchuk work. This study you will not find easily on a search. It hasn’t been reproduced or praised on academic or business sites. If you find it at all, it will be on the third search result page or later. These economists agree with all of the upticks cited in the Bebchuk study, but — a very big BUT — as the equity/hedge fund shareholders won, somebody lost.
Economists Anup Agrawal and Yuri Lim noticed something Bebchuk overlooked: as the hedge fund returns to shareholders increased, employee pension funding decreased. It wasn’t superior business management that produced much of the profits for their members, but the ability to underfund worker pensions.
“Shareholder gains from activism appear to partly come from raiding deferred compensation promised to workers, and from taxpayers via PBGC [ Pension Benefit Guarantee Corporation] guarantee”.
The researchers find this is a common tactic in the hedge fund playbook:
“We find that targeted firms reduce employer contributions to the pension fund, which they justify by increasing the assumed rates of returns on plan investments. They also tilt plan investments toward riskier assets, in a failed effort to boost plan returns”.
Additionally, these authors point out that if the government pension fund reserve for that plan cannot cover the claim, the taxpayers may have to kick in.
According to Joshua Gotbaum, a former head of Pension Benefit Guaranty Corporation (PBGC) warns overlooking the harm to pension funds is a glaring oversight. In a 2013 review by him, companies controlled by hedge funds and private-equity firms have used bankruptcy to avoid more than $650 million of pension obligations. That leaves the government’s pension insurer-and often the taxpayers-to pick up the tab.
How Government Pension Fund Managers Help Private Equity Harm Workers
According to Wolf Richter writing in his Wolf Street blog. “Among the biggest investors in PE (Private Equity)firms are public pension funds. They provide about 20% of the $3 trillion in assets managed by PE firms”.
Richter gives the example of the three PE firms: KKK, Bain Capital and Vornado Realty, that combined to acquire Toys “R” Us with the usual leveraged buyout. The firms put Toys “R” Us into bankruptcy with an underfunded worker pension, which resulted in workers having to claim against government pension funds,
Continuing this example, Richter points out that The Washington State Investment Board (WSIB), which manages retirement and public funds for a number of state government employees, had been investing in KKK for over 30 years. Richter says that according to the Wall Street Journal the WSIB invested in 23 KKK funds including 1.5 billion in the Toys “R” Us investment.
The WSIB makes no secret that it invests heavily in PE firms as its website declares: “The Investment team is composed of investment professionals who manage WSIB’s major asset classes, including public equity, private equity, real estate, tangible assets, and fixed income”.
Private Equity Funds Prove to be Poor Investments
While pension funds have paid billions in fees to PE managers, the PE returns have been no better than if the funds had been invested in minimum fee index funds. That according to research by Oxford professor Ludovic Phalippou in a paper entitled An Inconvenient Fact: Private Equity Returns & The Billionaire Factory.
From 2006 to 2015, the private equity industry raked in $230 billion in incentive fees or carried interest [which are also a type of fee], according to the research.
Further the report showed employee pension funds are minting billionaires to the detriment of the employees’ pensions, “This money went from companies and pensions to private equity fund managers. In 2005, there were three billionaires on Forbes’ list from the private equity industry. Last year [2019], there were 17 private equity billionaires”.
Why Private Equity Firms Are Poor Investments
This requires a little side journey into what an index fund is, and why its fees are so low. It does not require any active management, that is reading financial statements on a current basis, and such. The theory is that the stock market in general usually goes up. Some stocks go up, some go down, but overall, the value increases.
If you try to pick a stock, you could lose. So, rather than doing that, take a sample of all the stocks in an index like the S&P 500. That sample is taken once at the beginning. Investors can buy into this fund as a type of mutual fund called an Exchange Traded Fund (ETF). Because there’s no active management, the fees are bare minimum.
Warren Buffett made a famous challenge to all money managers world wide claiming they could not beat the return of an index fund over a ten-year period ending in 2017. Only one dared to take up his challenge- and lost.
What Can Be Done
* Fire the investment advisors for all pension funds and require these funds invest only in ETFs for the equity portion of their portfolio
* Alternatively, set the investment advisors’ commissions so that they are calculated on how much their gain, less their fees, beat the results of an ETF fund
The result of the Buffet challenge has been known since 2017. So why are both private and public pension fund managers still investing in private equity and other investments and not just low fee ETFs for the equity part of the portfolio? It must be that employees don’t know what’s happening. If you know of an employee contributing to a pension fund, send them this article.
Originally published at https://jandweir.substack.com.
