Finance blog Naked Capitalism has published a long interview with Eileen Appelbaum and Rosemary Batt, authors of Private Equity at Work, a book that dives into the inner-workings of the PE industry.
Part of the Naked Capitalism interview, conducted by Andrew Dittmer, covers the relationship between limited partners (pension funds) and general partners (PE firms). Here’s that portion of the interview:
Andrew Dittmer: In general, LPs seem to have a pretty submissive attitude toward GPs. Where do you think this attitude comes from?
Rosemary Batt: One cause is the difference in information and power. Many pension funds don’t have the resources to hire managers who are sophisticated in their knowledge of private equity firms. They don’t have the resources to do due diligence to the extent they would like to, so they need to rely on the PE fund, essentially deferring to them in what they say.
Eileen Appelbaum: I think that there is a reluctance to question this information or to share it with other knowledgeable people – they are afraid that if they do, they will not be allowed to invest in the fund because the general partners will turn them away.
I attended a lunchtime lecture recently, the title of which was “How is it that private equity is the only industry in which 70% of the firms are top-quartile?”The general partners have found ways to persuade their investors that they are the top-quartile funds, that “you will make out best if you invest with us,”and “we’re very particular – if you can’t protect our secret sauce, we aren’t going to do business with you.”
The other side of it is that some of the pension funds have their own in-house experts, and some of them believe they’re smarter than the average bear – there’s a certain pride in their ability to get the best possible deal, better than other LPs can get.
It’s the lack of transparency. With more transparency we’d have a lot less of these problems.
Rosemary Batt: Another issue is yield – often they’re thinking, “We need to be investing in private equity or alternative investment funds because this is the only way to get higher yields.” There’s a kind of halo effect, if you will, around the private equity model – many people think it really does produce higher returns without really having the knowledge. In some cases, there are political battles that have to be fought to get legislators to make a decision not to invest in these funds.
Eileen Appelbaum: Often the person who is appointed to make the decisions about private equity investments comes from Wall Street, maybe even from a PE background.
[…]
Eileen Appelbaum: Rose and I did a briefing at the AFL for the investment group. We had investment people from both union confederations who are concerned about the fact pension funds are putting so much money into private equity. They told us that they had never been able to see a limited partner agreement until Yves Smith published them. The pension fund people are so afraid of losing the opportunity to invest in PE. Some general partner could cut them off for having shared the limited partner agreement. Unbelievable.
This is the only section of the interview that deals explicitly with pension funds, but the whole interview is worth reading. You can read it here.