Public Pension Funds May Be Feeling Political Pressure

March 1, 2005 ( - Public pension fund's home-state private equity investments tend to underperform, a sign that political pressure can lead some funds to make poor investment choices.

This is one of the findings from a new study from the Harvard Business School and the Massachusetts Institute of Technology that tried to discover why some investors fare better than others with their private equity holdings. According to the study, public pension funds are often forced through political pressure to invest in their own state’s private equity funds, a process that can lead to lower returns than they could receive if they were free of pressure to choose domestic firms.

The study also indicates that overall, endowments fare much better with their private equity investments, posting an average annual return of 20.5% on their 1991 to 2001 vintage venture and leveraged buy-out funds. Public pension funds were second, with an average return of 7.6%, followed by insurance companies (5.5%) and corporate pension funds (5.1%). The worst performers were banks and finance companies, which lost an average of 3.2%, followed by discretionary advisors, who lost on average 1.8%.

The more endowments in a fund, the better it does as well, according to the study. Oddly, the more banks in a fund, the worse it performs.

Why do endowments fare better? The answer, according to researchers Josh Lerner and Wan Wong, is complicated. They invest more capital in venture firms, the study found, and they have been in the arena for longer amounts of time, on average, two factors that possibly explain the higher average returns. They also note that endowments, more than any other investor group, have a knack for picking the right fund to re-open with. The funds they decide to reinvest do extremely well – an average of 31% returns – while funds they pass up on do not (7%).

The study also found that corporate pension funds and advisors – two of the lower-ranked investors by performance – tend to re-up their investment when past performance has been good. However, the study shows that this is not always the best way to do it.

“These findings suggest that endowments [and foundations] proactively use the information they gain as inside investors to improve their investment decisions, while other LPs seem less willing or able to use this information,” the authors write, according to the LBO Wire.