As the Trump administration allows ordinary investors to move $5.6 trillion of 401(k) assets into private equity for the first time, one of the nation’s leading investment consultants published a paper arguing that pension funds’ and endowments’ forays into private equity have been duds. 

Richard Ennis co-founded EnnisKnupp investment consulting in 1981. By the time he sold it to benefits giant Aon Hewitt in 2010, the firm had $2 trillion in assets under advisement, making it one of the largest investment consulting firms in the world, providing advice to some of the nation’s leading pension funds and endowments. Ennis’s article, which was published in April in the Journal of Portfolio Management, argues that given performance data from the past decade, investing in private equity, hedge funds, and private real estate (“alternative investments”) hasn’t been worth the exorbitant fees paid to the industry. Fees for alternative investments are typically 30,000-60,000 percent higher than fees for index funds. 

Those same pension funds and endowments have been the anchor point for the $10 trillion alternative investment industry, composed of hedge funds, private equity, and private real estate. The industry has spawned some of the wealthiest and most powerful people on the planet: titans like Blackstone’s Stephen Schwarzman and Pete Peterson, KKR’s George Roberts and Henry Kravis, Apollo’s Leon Black, and the Carlyle Group’s David Rubenstein. To illustrate its influence, the top two donors to Democratic outside groups in 2020, Tom Steyer and Donald Sussman, come from alternative investments, as does the third-largest donor to GOP groups, the aforementioned Schwarzman, according to data collected by the Center for Responsive Politics. 

“Public pension funds underperformed passive investment by 1.0% a year over a recent decade; the annual shortfall of endowments is 1.6% a year,” Ennis finds. At $4 trillion in public pension fund assets, with 28 percent of assets invested in alternatives, the cost to cash-strapped state and local governments is $11 billion per year. For the $616 billion worth of endowment assets, with 58 percent of assets invested in alternatives, the cost is $6 billion annually. 

“All three areas of alternative investing have significantly underperformed for at least a decade,” Ennis notes. Despite the claims by pension funds that private equity, hedge funds, and private real estate provide “diversification,” Ennis finds that the returns of the industry are broadly correlated with the stock and bond markets, while having exponentially higher fees. 

In files released by the BlueLeaks hack, the FBI has raised concerns about private equity and hedge funds as vehicles for money laundering. The space has been characterized by a spate of scandals, with private equity and hedge fund bribery of pension fund officials resulting in prison terms for former New York State Comptroller Alan Hevesi and former CalPERS CEO Fred Buenrostro. 

Recent bankruptcies of private equity-owned companies include J.Crew and Chuck E. Cheese, and recent research finds that over half of companies that default on their bonds are owned by private equity firms. 

On June 3, the Department of Labor, headed by Secretary Eugene Scalia, the son of Antonin Scalia, allowed private equity into 401(k) plans for the first time. Prior to this only pension funds, endowments, or high net worth individuals could invest in private equity due to the risk involved. The new guidance “helps level the playing field for ordinary investors,” said Scalia. Given the performance issues with private equity for regular pension funds that invest at scale, the danger for high fees and poor performance in private equity for ordinary investors is acute, critics have argued

Just three weeks later, on June 24, the SEC released a “risk alert” that announced that the agency has recently “observed private fund advisers that did not provide adequate disclosure about conflicts relating to allocations of investments among clients,” and “failed to comply with contractual limits on certain expenses that could be charged to investors, such as legal fees or placement agent fees, thereby causing investors to overpay expenses,” among other violations.

Meanwhile, despite concerns raised by Ennis and others, pension funds globally have continued to invest more and more into alternative investments, growing from 6 percent in 1999 to 23 percent at the end of 2019. 

Ted Siedle, a former attorney with the SEC and pension fund forensic investigator, said that Ennis’s article encapsulates broader concerns with the industry.

“In my 35 years of experience I’ve never met a pension fund that has a full understanding of the extent of the fees, conflicts of interest, self-dealing, and performance calculation uncertainties related to these investments,” Siedle said. “Nobody understands how these things work. It’s well known that private equity has failed to deliver and the hidden, excessive, and illegal fees, conflicts of interest and self-dealing and performance chicanery is the reason. The significance is really that someone of Richard Ennis’s status validates what many people who have looked under the hood have concluded. … The truth is none of the investors in any of these funds have full knowledge of what the funds are doing.”

Eileen Appelbaum, the co-director of the Center for Economic and Policy Research, found that Ennis’s new research is the culmination of years of criticism at the industry from herself, her co-author Rosemary Batt, and Oxford University professor Ludovic Phalippou. 

“We’ve been writing about the fact that these private equity firms that pension funds are investing in have performed poorly for a long time.The reason why pension fund trustees don’t listen is because the top quartile funds do beat the market. They think they’re all in top quartile funds, but they’re not. The returns do not outperform a stock market fund which has much less risk. So why are you paying this?” said Appelbaum.  

When asked why alternative investments have continued to grow despite rising concerns about fees and performance, Ennis said, “I can’t begin to explain it. Things have reached a stage befitting inclusion in an update of Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds,” referencing the 1841 book on crowd psychology and economic bubbles. “Public pension funds in the U.S., which are both broke and broken, are contributing more than $40 billion a year to the asset management and brokerage industries, without benefit. One could say the rich are getting richer. They do so to the detriment of taxpayers and public employees, the funds’ stakeholders.”