Bain’s benefactors

Mitt Romney’s old firm puts spotlight on dubious funding practices of California’s big pension systems

Illustration by Jason Crosby

a freelance writer from the Bay Area

Mitt Romney’s run for the Republican presidential nomination has turned private equity into a topic of heated debate again. Romney’s former firm, Bain Capital, in which he still owns a significant stake, has been called a job destroyer by critics on both the left and right. Most recently, The New York Times revealed that a Bain fund in which Romney is personally invested stands to profit from the burgeoning Chinese market for surveillance cameras where there’s one buyer: the communist party.

Romney’s stake in the Bain Capital Asia fund—about $250,000—is very modest, however, compared to the California teachers pension system. According to the California State Teachers’ Retirement System’s most recent reports, the pension has committed $25 million to Bain Capital Asia, and has earned approximately $2.5 million on the investment since 2007. That makes CalSTRS one of Bain Capital Asia’s largest funders.

CalSTRS investments in Bain don’t end there. Since 2006, it has committed $1.28 billion to eight other Bain funds focusing on tech, real estate, consumer goods and credit. California’s teachers are therefore one of Bain’s largest sources of cash. CalSTRS stands to reap a much bigger profit than Romney from China’s thirst for spy cameras, among other questionable investments that pepper the firm’s investment portfolio.

Investments by CalSTRS in Bain’s controversial funds raise broad questions about the role of public pension funds in bankrolling private equity firms. Critics of private-equity point to the secrecy, heightened risks that fall ultimately on retirees and taxpayers, and the oftentimes socially destructive behaviors of private-equity firms, all of which are arguably multiplied by the addition of pension dollars. Now that the issue has been raised thanks to Romney’s presidential bid, and now that some pension executives are signaling they intend to increase their stakes in private equity, criticisms of Bain and other firms are all the more relevant.

The issue of secrecy clouds all other potential problems.

Joining CalSTRS as a major bankroller for Bain’s various investment vehicles is the University of California Retirement Plan, which has plunked more than $177 million in eight different Bain funds. According to recent disclosures filed with the secretary of state, the 300-pound gorilla of pensions, the California Public Employees Retirement System, is also mulling over whether to join in with a Bain investment of its own. CalSTRS, University of California and CalPERS have all been intensely lobbied by executives from Bain’s Palo Alto and Boston offices in recent months, signaling that the firm is recruiting to complete a new fund. A spokesperson for Bain confirmed that meetings are taking place, but declined to offer any further details.

A representative for CalSTRS likewise declined to comment on Bain’s recent communications with the fund except to explain that doing so, “may be counterproductive to our fiduciary role.” Like other pension systems, CalSTRS and CalPERS official policies are to keep the specifics of its dealings with private-equity firms a closely held secret. Current California law allows the pensions to shield the contents of their communications with private-equity firms from the public.

Private-equity firms have no obligation to disclose the contents of their portfolios, meaning that literally billions of pension dollars entrusted to private equity can be locked into unknown and risky investments, much of this overseas, often bankrolling ethically questionable activities, with years passing before a profit is turned, if at all.

This worries skeptics who question whether private equity actually delivers on its promised performance benchmarks. Some pension accounts with private equity have actually lost considerable money over the past decade, while others failed to meet the 7 to 12 percent return benchmark that most pension boards aim for.

Even those investments that do surpass 9 percent gross often fall far short of 9 percent net return after the private equity manager’s fees are subtracted, explains Edward Siedle. “Private equity-investing only guarantees that pensions will pay exponentially higher fees,” says Siedle, an analyst who runs Benchmark Financial Services and is widely consulted on pension issues. “The higher the fees, the more difficult it is to achieve superior net-investment performance.”

“Some say public-pension funds were the key enablers of the private equity boom,” says Ed Mendel, a veteran Capitol reporter who runs the influential Calpensions blog. “The funds do expect above-market returns from private equity.” Mendel, however, points to a recent New York Times analysis that cast doubt on private equity’s claim of securing higher returns. According to the Times: “[pensions] with a third to more than half of their money in private equity, hedge funds and real estate had returns that were more than a percentage point lower than returns of the funds that largely avoided those assets. They also paid nearly four times as much in fees.”

Notwithstanding these fees, CalPERS reported a negative 8-percent return on its portfolio of publicly traded stocks, but a 12.4-percent positive return on private equity over the last year, raw figures that justify the goals of pension managers who want to hand over more money to private equity.

Today UC’s retirement system is invested in 82 separate private equity funds. CalSTRS has money with upwards of 250 private equity funds, and CalPERS even more. The embrace of private-equity by big pensions has been swift. In 2002, pensions with at least $1 billion under management had only 3 percent of their total dollars committed to private-equity firms, according to a Wilshire Associates study completed for CalPERS this year. Today, that’s risen to 11 percent across the big pension funds.

Edward Zelinsky, a law professor at Yeshiva University, says the turn to private equity is due to unrealistic demands on investments such as the 9-percent growth benchmark. “In this low-return environment, public-defined benefit-pension plans generally assume that they can earn annual investment returns in the vicinity of 8 percent,” explains Zelinsky. “Such aggressive return assumptions allow governors and legislators to authorize smaller tax-financed contributions to such public pensions on the theory that anticipated investment gains will fund the retirement benefits promised to public employees.”

Ironically then, the public pensions hand billions over to private equity seeking these higher returns to benefit their unionized membership, and private equity turns around to fund corporate raids, offshoring of jobs, attacks on workers in other countries, and environmentally destructive activities. And it’s still unclear if, after fees and other costs are calculated, private equity pays. It’s all shrouded in secrecy.

“Public pensions can play a key role in leveraged buyouts,” explains Ed Mendel. “A private-equity firm puts up a token amount, gets a larger down payment from a pension fund or other limited partner, and borrows most of the money, using the takeover target’s assets as collateral.” The results of these leveraged buyout deals are mixed, but oftentimes the conquered company is forced to cut costs by laying off workers and selling assets, reinforcing private equity’s predatory reputation. Romney’s career (and fortune) at Bain Capital included more than a few of these kinds of deals, and recent press reports about the presidential contender’s role in various deals has brought the practice back to the foreground of political debate. “More than half of the CalPERS and CalSTRS private-equity holdings are in buyouts,” Mendel observes.

Criticisms of private equity as a job destroyer (and agent of other questionable pursuits) then are at the same time very much a criticism of the big California pensions as enablers, driven by their fiduciary obligations to public-sector employees. It all makes for a complicated problem that has yet to be acknowledged in the national debate about Bain Capital, and private equity in general, that has been engendered by Romney’s campaign.