Should the Oregon Investment Council reduce its private equity?

That’s a vexing question on the minds of many investors right now. One of the leading scholars on the topic, the Sloan School of Management’s Antoinette Schoar, recently presented a paper at MIT’s Fiduciary Investors Symposium suggesting the asset class will continue to underperform because too much money is chasing too few promising private ventures. Bloated private equity funds with high fees are profiting off large investors’ memories of the days when these investments were portfolio leaders.

Oregon Treasury’s Chief Investment Officer John Skjervem was there too. His comments at this event prompted Susan Webber to suggest Skjervem is evidence public pension funds are the “dumb money” of the institutional investor world.

He did say something peculiar, suggesting the Oregon Treasury should lower the bar for evaluating private equity from its policy of 300 basis points above the Russell 3000. “We haven’t met our benchmark in at least five years, so we are starting to get questions about performance,” Skjervem said. “Is this a realistic benchmark? I would argue no, so then you get into the discussion about what the benchmark should be.

“I could argue Russell 3000 plus 10 basis points is worthwhile because 10 basis points on a $16 billion portfolio is real money. But plenty of people want a more significant figure over public markets to justify the illiquidity you are taking on.

“For a public plan, I could make a philosophical argument that even if we do nothing but match public market returns, there’s a place for private equity because of the appraisal-based accounting, which artificially smooths our total fund volatility, and there’s a genuine benefit to that.”

I don’t like his reasoning for lowering standards. This has less to do with noncorrelated asset classes diversifying a portfolio than a blatant exploitation of an accounting mirage. These are illiquid assets. As a result, they don’t appear as volatile as publicly traded equity only because we don’t have active markets discovering their real price. Of course the private equity fund managers’ “appraisal-based accounting” appears more stable, but they are in reality riskier!

There’s nothing actually smooth about an accounting gimmick. I find it disturbing that the man in charge of our PERS assets likes the way a scarcity of information about an asset class deceptively makes his portfolio appear more stable, even though in reality more exposure to these assets adds risk and recent evidence shows is a drag on the overall portfolio’s performance.

Private equity has been good to Oregon. The Oregon Investment Council pioneered these alternative assets 37 years ago when many state pension funds were just large bond funds, but we need to adapt to a different market. Oregon has been cutting its private equity exposure from 25% to 17.5%. That still seems like a rather large allocation, given the results of Antoinette Schoar’s research. There may be good arguments for having that size of a position, but admiring the stability of estimated valuations should not be one of them.

Eric Shierman lives in Salem and is the author of A Brief History of Political Cultural Change.