Key Takeaways
- • Michael Markov, head of financial technology firm MPI, estimates public pension funds carry risks at least 20 percent greater than they report, largely because private equity holdings are not properly accounted for, according to The New York Times.
- • The Oregon Public Employees Retirement Fund's reported statistics understate its volatility by more than 40 percent, Markov said.
- • Private equity returns appear smooth because they rely on infrequent appraisals of private companies, creating stale pricing that masks true risk.
- • Public pensions have increased allocations to illiquid, opaque private equity funds in pursuit of returns above what stocks and bonds deliver, often using debt-fueled buyout strategies.
Summary
A New York Times analysis published August 4, 2023 examines how public pension funds may be underreporting their risk exposure, particularly in private equity. The Oregon Public Employees Retirement Fund, which publishes monthly reports that the Times describes as more timely than most state and local government pension disclosures, serves as the central example. Like many public plans, Oregon's fund has sought returns higher than it expects from traditional stocks and bonds alone, and has accordingly increased its commitments to private equity funds that are illiquid and opaque.
The Times reports that these private equity funds engage in debt-fueled takeovers of companies and promise investors high returns, but carry hidden risks that are not widely understood or clearly reported. New research from Michael Markov, a mathematician who heads MPI, a financial technology company, argues that reporting by Oregon and other public pension funds routinely understates these risks. Markov, who previously warned about the consistent returns in Bernard L. Madoff's Ponzi scheme, estimates that on average public pension risks are at least 20 percent greater than reported. He says Oregon's pension fund is more than 40 percent more volatile than its own reported statistics indicate.
The core mechanism, according to Markov, is stale pricing. Private equity returns appear low in volatility because they are based on infrequent appraisals of private companies rather than market prices. "When you adjust for the stale pricing in private equity funds, the risks are much greater," he said in a telephone conversation with the Times. Publisher context notes the broader trend: between 2001 and 2021, allocations to alternative assets rose from 14 percent to 39 percent of public pensions' risky investments, and public pension alternative investment use has more than doubled over the past 15 years.
The Times reports that these private equity funds engage in debt-fueled takeovers of companies and promise investors high returns, but carry hidden risks that are not widely understood or clearly reported. New research from Michael Markov, a mathematician who heads MPI, a financial technology company, argues that reporting by Oregon and other public pension funds routinely understates these risks. Markov, who previously warned about the consistent returns in Bernard L. Madoff's Ponzi scheme, estimates that on average public pension risks are at least 20 percent greater than reported. He says Oregon's pension fund is more than 40 percent more volatile than its own reported statistics indicate.
The core mechanism, according to Markov, is stale pricing. Private equity returns appear low in volatility because they are based on infrequent appraisals of private companies rather than market prices. "When you adjust for the stale pricing in private equity funds, the risks are much greater," he said in a telephone conversation with the Times. Publisher context notes the broader trend: between 2001 and 2021, allocations to alternative assets rose from 14 percent to 39 percent of public pensions' risky investments, and public pension alternative investment use has more than doubled over the past 15 years.
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