Private Equity is Destroying Public Pensions

Underfunded and Undervalued: The Truth About Teacher Pensions

I'm a public school teacher in Massachusetts, and I think I may have some information relating to your final set of questions as to why public pensions have been underperforming basic 401K portfolios despite spending 100s of millions on external managers. I recently sent to my own retirement system, MTRS, an open letter outlining eight key concerns raised by regulators, researchers, and reporters regarding MassPRIM’s investment strategy. The letter includes detailed fact patterns, internal PRIM documents, and recordings of PRIM executives and board members that highlight potential mismanagement and systemic risks within the MTRS fund—one of the worst-funded pensions in the nation. Long story short, Private Equity! I've attached each question from the open letter below:

Dear MTRS Board,

My name is Matthew Scheffler. I am a public school teacher in Framingham, MA, and an active MTRS member. I was hoping to attend this upcoming January 31st board meeting to ask the following questions; however, I am unable to do so as it is scheduled during the school day. Therefore, please answer the following questions as the fiduciaries of my retirement savings during this upcoming board meeting or in writing about why MTRS is one of the worst-funded teacher retirement systems in the nation, as highlighted recently in the Boston Globe. This is despite public markets being at all-time highs and pension contributions per pupil in Massachusetts rising by 109 percent since 2015.

Furthermore, since 2001, teacher pension debt has grown exponentially, causing retirement costs to triple as a share of state and local education budgets. This leaves less money to support classrooms, teachers, and students and causes an undue financial burden on school budgets, most evident in the recent North Shore Teacher Strikes.

Question I. Why has MassPRIM elected to invest tens of billions of our public retirement savings into the same investment strategy—LBOs and Private Equity—that bankrupted thousands of S&L banks in the 1980s? Public pensions were overfunded by $7 billion in 2000 yet would become $1.37 trillion underfunded by 2020 despite public markets continually achieving all-time highs. Research finds that underperforming investment decisions are the largest contributor to unfunded liabilities, and the only material change that could explain such a seismic shift of fortunes was MassPRIM's systematic retreat from low-cost regulated public markets, again at all-time highs to high-cost unregulated private markets, presently experiencing their worst financial crisis since 2008.

Question II. Can you explain in greater detail how MassPRIM assigns private equity the highest expected return while evaluating it as one of the lowest risk factors for the PRIT fund? The first principle of finance is that risk and return are directly related. MassPRIM says private equity is its best-performing asset class, blessing it with a 10-year expected rate of return of 9.4%, its highest assumed rate, while miraculously claiming private equity contributes one of the lowest risks to the PRIT fund at 5.3%. The New York State Attorney General reports that rule one of investing is that “risk and return go hand-in-hand. Higher returns mean greater risk, while lower returns promise greater safety”. The FBI warns that "investment or business fraud schemes will try to lure you in with the promise of low- or no-risk investments.”

Question III. Why should teacher retirement savings and Massachusetts taxpayers pay a minimum of $550 million a year in management fees to subsidize the underperformance and failed investments of MassPRIM's 180 external fund managers, 97 of whom are private equity managers? The 2023 Annual Comprehensive Financial Report acknowledges that MassPRIM's management has achieved 0% of added value since inception. This affirms the recent research findings by the Center for Retirement Research at Boston College that public pensions have failed to outperform a simple 60/40 index over various periods from 2000 to 2023.

Question IV. Why should we trust MassPRIM's due diligence process, given its historical investments into ENRON, Bernie Maddoff, and FTX with our retirement savings?

(Sources: Independent State Auditor's Report on Certain Activities of the Pension Reserve Investment Management Board; Reuters: Two U.S. pension funds see $52 mln hit from Madoff; NBC Boston: Losses Pile Up at $89B Mass. Pension Fund)

Questions V. Can you present evidence supporting Michael Trotsky and Dennis Naughton's prior public statements that private equity's IRRs are realized cash-on-cash returns? In November 2023, Michael Trotsky claimed at MTRS's Annual Constituent Forum that private equity had realized 20+% cash-on-cash returns annually for the last five and ten-year periods, which was echoed by MassPRIM board members Bob Brousseau and Dennis Naughton in a separate presentation to the Massachusetts Teacher Association (MTA).

This is in direct contrast to all research and public reporting showing that "private capital firms have taken more money from investors than they’ve distributed back to them in gains for six straight years, for a total gap of $1.56tn over that period”

(source: FT- Private Capital has raised more capital than it returned).

Questions VI. What is MassPRIM's formal response as to why top regulators, legislators, and central banks worldwide are concerned about systematic risk involving the valuations of private assets that Michael Trotsky previously dismissed as a common myth? Over 40% of the PRIT fund is committed to alternative investments, amongst the highest in the nation. MassPRIM COO Anthony Falzone says private fund managers earn $207+ million in annual fees because of their performance. Yet, in the past 12 months, financial regulators and credit agencies around the world have raised serious questions about that performance and the potential of systematic risk hidden within the private markets, according to the International Organization of Securities Commissions (IOSCO), Financial Conduct Authority (FCA), Financial Stability Oversight Council (FSOC), SEC, IMF, Moody’s Credit Rating, and S&P Global. Furthermore, Massachusetts’ U.S. Senator Elizabeth Warren is proposing the Stop the Wall Street Looting Act, citing peer-reviewed academic research from Oxford titled An Inconvenient Fact: Private Equity Returns & The Billionaire Factory.

(Sources: Equable: State of Pensions 2023 & BBG: Private Credit Valuations Worry World’s Financial Watchdogs)

Question VII. What independent research supports MassPRIM's high confidence in these private alternative investments despite this growing shadow of doubt from independent regulators and experts and MassPRIM’s historical underperformance? Private equity's abuse and mismanagement of public pensions is such an open secret that Warren Buffet and Charles Munger publicly called out these private fund managers for dishonest performance metrics with public pensions in 2019; the CFA published a series of articles titled the "Myths of Private Equity Performance" in 2020; and just last month a well-respected Wall Street analyst published a report titled: The Next Big Short: Hidden Risks Behind Private Equity's $8 Trillion Market. MassPRIM appears to disagree with these findings, given your $3 Billion Earmark for Private Equity in 2023 (source: WSJ). Yet, private equity has only received more scrutiny from financial regulators and the press as time passes.

Bloomberg: Why Private Equity May Be Due for a Reckoning (July 9, 2024) | Bloomberg: The Private Equity Bubble Is About to Deflate | WSJ: Pensions Piled Into Private Equity. Now They Can’t Get Out (Sources: Berkshire Hathaway Annual Meeting 2019; CFA Institute: The Myth of Private Equity Performance; The Next Big Short: Hidden Risks Behind Private Equity's $8 Trillion Market)

Question VIII. What measures do MTRS and MassPRIM take to address the growing number of horror stories involving private equity investments, especially those directly involving our private fund managers who have financed criminal activity? Research and reporting have found that MassPRIM’s private equity managers have financed the wrongful deaths of newborns’ mothers through the asset-stripping of hospitals (Apollo), the maiming of children illegally hired to clean slaughterhouses (Charlesbank Capital Partner & Blackstone), the sexual assaults, torture, and deaths of at-risk youth in private behavior schools and foster care companies (Centerbridge Capital Partners & Bain Capital); the exploitation of inmates via price-gouging of prison-phone lines and their deaths from the denial of lifesaving medical care (American Securities and H.I.G. Captial), and the abuse and premature deaths of tens of thousands of elderly residents in nursing homes and hospice care (KKR). Research shows that 67% of private equity capital is sourced directly from public pensions, with MassPRIM being among the highest allocators in the nation with our retirement savings.

(Sources: Boston Globe: Steward Hospitals, NBC News: Labor practices at private-equity-owned firms may endanger retirement income for teachers, says report; The New Yorker: When Private Equity Takes Over a Nursing Home)

Please let me know if you have any questions about the attached sources, links, or research. All research and articles are from reputable independent sources and provide invaluable insight into the dire state of our pension.

Sincerely, Matthew Scheffler