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

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

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)

Private Equity and Jobs Davis et al 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

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 ; half due to closings Especially evident in public-to-private transactions –In retail, employment falls by nearly 12% in targets relative to controls

PE and Jobs: Results from 2011 Study Firms –Continuers and deaths: “Summing these two components yields a two-year employment growth rate differential of 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 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 points …” p. 23

LP Returns Net of Fees Relative to S&P 500 Kaplan & Schoar 2005: Vintage –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 –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

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)

LP Returns Net of Fees Relative to S&P 500 Kaplan & Schoar 2005: Vintage –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 –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

Returns to PE/Returns to S&P 500 (Public Market Equivalent) Harris, Jenkinson and Kaplan 2011

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

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”