The pitfalls of private equity

April 24, 2024
Holding a magnifying glass over documents.
Private equity investments have grown in popularity, but they are also being met with more scrutiny and criticism, sometimes for good reason.

Asked what he thought of pension plans getting involved in private equity, renowned investor Warren Buffett said he’d “seen a number of proposals from private equity funds where the returns are really not calculated in a manner that I would regard as honest. If I were running a pension fund, I would be very careful about what was being offered to me.” 

Every year, pension plans release annual reports that include a breakdown of what they own, which most of us understand: infrastructure, real estate and public equity such as stocks. But private equity (PE) is a mystery to many. It represents a third (33 per cent) of the Canada Pension Plan Investment Board’s (CPPIB) asset portfolio and $37.2 billion of PSP Investments’ assets, but what does it mean? 

In simple terms, it’s an investment in a company not listed publicly. These investments can be done by a PE firm (such as Blackrock, KKR or Apollo) or by direct purchase. Ideally, an underperforming company would be acquired, overhauled and then sold at a profit. They are usually long-term investments that are not easily liquidated, which is fine for pension plans that have longer investment horizons. 

PE has several benefits, including a record of reasonable and stable returns. As such, these investments are increasingly popular — more money has been raised in private markets than public markets over the past 10 years. But those changes have resulted in more scrutiny and criticism. 

Deals or agreements with PE firms often lack transparency. The terms of agreements are rarely disclosed. Seldom disclosed management and performance fees paid to PE firms are also often exorbitant. 

Further, valuations on these assets also seem unrealistic — staying stable even in times when public equities take massive dives. 

It’s a reason pension managers like them, but it’s raised suspicions. Some experts such as Jeffrey C. Hooke, professor at the Johns Hopkins Carey Business School, point out that PE funds report the values of their own investments with little third-party oversight. Volatility is understated and returns are “smoothed.” An overestimated valuation could mean unexpected losses when it comes time to sell. Meanwhile, PE firms have fought tooth and nail against regulators’ efforts to make their dealings more transparent. 

PE firms have also been accused of lacking ethics, particularly because of how they acquire companies. Commonly, they will use a leveraged buyout to purchase a company. It will invest say 10 per cent of the value of the company and then take out a loan on or leverage the rest of the cost. But the firm isn’t taking on the risk itself; it’s saddling the company it’s purchased with that debt. It then cuts costs to deal with debt, pays itself consultant fees and sells the companies at a profit, often at the expense of its clients and employees. This can become a life-and-death situation, for example, when PE firms purchase long-term care homes. 

It’s no surprise that PE firms have appeared in housing headlines recently. Business Insider reported that 44 per cent of single-home purchases in the U.S. in 2023 were made by PE, which set its sights on Canada. 

Blackrock, a firm that works with the CPPIB, already owns $14 billion in Canadian real estate. This means your pension’s investments could be making it harder for you or your kids to buy or keep a home. 

There’s much going on in the PE sphere at the moment — CPPIB and Caisse de dépôt et placement du Québec, for example, each sold about $2 billion worth in November, perhaps because the whole market is slowing down. Ultimately, PE is a dark market whose actual returns and practices are largely hidden. Although we can’t change that, we can at least monitor it and be aware of it.


This article appeared in the spring 2023 issue of Sage magazine as part of our “From the Pension Desk” series, which offers answers to our members’ most common questions about their pensions. While you’re here, why not download the full issue and peruse our back issues too?