Zombies Haunt Minnesota State Pension
Minnesota's pensions are loaded with private funds that have extended their troubled lives, milking management fees for mediocre and over-leveraged assets for years.
It’s Halloween. What better time to talk about Zombies!
(The Zombie funds discussion below is from our recently completed forensic investigation of the Minnesota state pension system, commissioned by thousands of concerned state teachers. Click to download the entire investigative findings.)
Following the wreckage of the 2009 global financial crisis (GFC), many private equity managers (unable to raise new capital because of poor performance) extended the lives of their troubled funds, milking management fees from investors for mediocre and over-leveraged assets for years.
These funds were referred to as “Zombie Funds” by the financial press.
Said Forbes:
Though it’s hard to put numbers on how many once thriving private equity managers joined the ranks of the walking dead as a result of the GFC, Triago estimates that there were some 1,100 zombie funds in 2019; that is fee-collecting funds more than 10 years old with assets still in their portfolios, yet run by managers unable to raise a new fund (using a yardstick of 10 years). Funds that began investing in 2008 held $220 billion in unrealized investments in their portfolios ten years later, more than any other private equity vintage has ever held at that stage …
The life cycle of a private equity fund can be broadly divided into four distinct stages. Fundraising is the first stage of the private equity life cycle and involves raising capital from investors. Private equity firms will seek to raise capital from accredited investors such as high-net-worth individuals, pension funds, and institutional investors. These investors provide the capital required to invest in private companies and generate returns for the fund. The investment stage is the second stage of the private equity life cycle, and it involves identifying and acquiring companies with the potential for growth and profitability. Portfolio management stage is the third stage of the private equity life cycle, and it involves working closely with the companies in which the private equity firm has invested. Finally, the exit stage is crucial to the success of the private equity fund, as it is how investors receive their returns. Private equity firms will have a target return on investment that they aim to achieve, and the exit stage is where they can realize this return. These firms can exit their investment via an IPO, sale to another company, or even another private equity firm.
According to the 2023 financial statements of the Minnesota Teachers Retirement Association:
The typical liquidation period for alternative investments ranges from 3 to 12 years. The majority of the distribution is received during the liquidation period, however, it is not uncommon for a minimal amount of the fund to remain open while awaiting final close. As of June 30, 2023, the alternative investments are not expected to be sold at an amount different from the NAV value of the SBI’s ownership interest in partner’s capital.
The above disclosure, in our opinion, is inadequate in that it may minimize the risks related to extended liquidations in the TRA portfolio. When alternative investments fail to fully liquidate within the stated term of the fund, numerous concerns arise, including whether some or all investment fees will continue to be charged, as well as whether the valuation of portfolio investments and performance reporting has been accurate over the life of the fund.
When alternative investments fail to fully liquidate within the stated term of the fund, numerous concerns arise, including whether some or all investment fees will continue to be charged, as well as whether the valuation of portfolio investments and performance reporting has been accurate over the life of the fund.
Major public pensions have been found to be at risk from Zombie funds:
Even in 2023 some major investors still seem to be suffering from the 2009 Global Financial Crisis-generated spike in zombie funds. In a survey of 10 major public retirement systems in September, Bloomberg found that on average 4 percent of their private equity holdings were still locked in funds that began investing prior to 2009, with one group’s concentration - the North Carolina state pension fund - hitting 11 percent.
Zombie funds and managers can be a serious drag on private equity performance.
A new class of Zombie funds is reportedly emerging today due to the sharp rise in interest rates:
With the world’s most influential benchmark for the cost of debt, the U.S. federal funds rate, rising to 5.25-to-5.50 percent from a floor of zero over the 16 months through July - the fastest sustained hike in 40 years - the $9 trillion-in-assets private equity world must brace for a sharp rise in poorly performing portfolios and the emergence of a new class of the walking dead among private equity managers.
According to TRA’s financial statements, there are 45 out of 193 Private Equity funds owned by SBI that are over the 12-year liquidation and represent 6% of the Private Equity NAV value. There are 8 out of 35 Real Estate funds owned by SBI that are over the 12-year liquidation and represent 1.2% of the Real Estate NAV value. There are 12 out of 32 Real Assets funds owned by SBI that are over the 12-year liquidation and represent 13.2% of the Real Assets NAV value. There are 13 out of 42 Private Credit funds owned by SBI that are over the 12-year liquidation and represent 7.1% of the Private Credit NAV value.
As noted recently in Institutional Investor:
In recent years, the returns of many top private equity leveraged buyout funds have barely beaten the stock market as some funds can’t sell huge chunks of their portfolio, according to a new academic analysis.
For funds between seven and nine years old, “half of the stated asset value consists of unsold deals that are ‘marked to market’ by the private equity managers,” according to a study by Jeffrey Hooke, a senior finance lecturer at Johns Hopkins Carey Business School who focuses on the alternative asset class.
What’s particularly striking in Hooke’s analysis is how long it is taking private equity funds to sell off their portfolio companies, which is making them even less competitive with, say, an S&P 500 index fund.
In conclusion, Minnesota state pension alternative investments subject to extended liquidations should be examined more fully. There is ample reason to believe, in the opinion of experts, that the delayed liquidations may be “red flags” for abusive practices, including, but not limited to, fraudulent valuations.