In the past few weeks, some of the largest pension funds in the U.S. have reported exceptional returns for the past fiscal year. And this is good news for members of the pension funds because after several years of dismal performance, a good year is welcome news indeed.
According to press reports, California’s two giant pensions had tremendous years with post-fiscal-year returns that each topped 20 percent. The $154.3 billion California State Teachers’ Retirement System (CalSTRS), said its 23.1 percent return was “remarkable,” adding that it was its best performance in 25 years. Meanwhile, the $237.5 billion California Public Employees Retirement System (CalPERS) posted a 20.7 percent return, the best since 1997.
In addition, New York’s Common Retirement Fund (NYCRF) has grown to $146.5 billion, “its highest point since markets crashed in 2008,” state Comptroller Tom DiNapoli said. The fund, which provides benefits for more than a million state and municipal and retirees – generated a 14.6 percent rate of return for the 2010-11 fiscal year, which ended March 30. The fund grew about $6 billion since the end of 2010.
Private Equity’s Role
What really is remarkable about this news though is the key role that private equity played in the growth of each fund in the past fiscal year.
According to PE Hub, CalPERS’ private equity holdings, which account for 13.8 percent of its portfolio, returned 25.3 percent for the year. Private equity, which makes up 14.3 percent of its portfolio, returned 22.5 percent for the year for CalSTRS. And for the NYCRF private equity investments saw an 18.9 percent return in the past fiscal year.
Of course these three leading pension funds are well off their peak years in 2007. However, their recovery is compelling and private equity is playing a key role in it. Many of you may be surprised to learn what a large percentage private equity makes up in the portfolios of these hefty pension funds. Given that these funds are under incredible pressure right now to earn more than adequate returns for their members, many of you probably assume that to play it safe, most, if not all, of their investments would be in relatively secure vehicles such as public equities, even more so with the dramatic impact that the real estate portions of their investments had on these funds beginning in 2007.
However, the really smart folks running these funds realize that solid and relatively safe returns can be found with equity funds. This is especially the case now where the days of the highly leveraged, mega billion-dollar buyouts are in the past; more and more equity funds are moving downstream into the middle and lower-to make investments. As these equity funds now begin to “cash out” of their longer-term holdings by selling them or taking them public, pension funds are beginning to realize some substantial returns on their PE investments. This will only lead them to re-invest in this asset class going forward.
PE Funds and the Middle Market
Ultimately, all of this is great news for owners of middle-market companies. As we have discussed before, the middle-market is the niche that equity funds largely target for companies to invest in. With the recent returns by their PE investments in their last fiscal years, pension funds will only encourage more of this by continuing to expand the portion of their funds placed in equity firms. This will in turn require equity fund managers to become even more aggressive in identifying good middle-market companies to invest in.
Now, more than ever before, it is vital that owners of privately held businesses begin to position their companies as attractive to equity firms. Keep in mind that these professional buyers look at hundreds of acquisition opportunities before settling on one target. If you want your company to stand out in this crowd, consider partnering with an M&A advisory firm that has experience selling middle-market companies to all buyer types. This will ensure that you are ready for the next wave of equity buyouts coming ashore in the next 12 to 18 months.
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