1. Private Equity, Hedge Funds and Sovereign
Wealth Funds: an analysis on Investment funds,
corporate governance, and labour outcomes
Dr. Peter Wilke
5 July 2010
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2. Introduction
One feature of the global economy in recent years has been the fast growing
number of new investments funds (PE, HF, and SWF) and the dramatically
increased amount of money controlled by these funds.
This increase was accompanied by fundamental changes in financial markets
and a sometimes heated debate on the impact of these funds on employment,
work, industrial relations, and restructuring practices.
Fund managers have claimed that they play a valuable role in rejuvenating
under-performing companies, thereby contributing to long-term employment
growth.
Employee representatives and those on the political left have argued that these
new forms of investment secure returns at the expense of labour.
However, the evidence base for assessing the effects of these funds on labour
outcomes remains limited and controversial.
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3. Central questions
Activities of new investment funds are very central to corporate governance –
what does this mean for capital, managers, workers?
Highly controversial within Europe – is there a transfer of value from taxpayers
and workers to private investors?
Current discussions in EU institutions concerning AIFM-Directive regulating
these funds.
For labour outcomes three dimensions of work and employment may be affected
Employment levels
Work organisation
Industrial relations
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4. Studies and Evidence
Evidence based on 3 studies:
For DG Empolyment in 2009: The impacts of PE, HF and SWF investors on
industrial restructuring in Europe as illustrated by case studies
For the European Economic and Social Committee (EESC) in 2009: Data
collection study on the impact of PE, HF, and SWF on industrial change in
Europe.
For Eurofound in 2010: The impact of investment funds on restructuring
practices and employment levels.
In these 3 studies we have examined in total 30 cases in 10 European countries.
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5. The PE model
PE investment funds typically invite subscriptions from wealthy individuals and
institutional investors, usually for a set period of time – the lifetime of the fund.
These investors become limited partners in the fund.
This pooling of capital is used to acquire existing companies with a view to
restructuring their operations prior to a resale or stock-market flotation some 3 /
5 years later (though sometimes longer).
Acquisition typically financed at least partly by debt, secured against
assets/income stream of target company
Debt burden imposes discipline on management of target firm. Limits ‘free cash
flow’
Targets include firms with strong cash flow, under-performing firms but with good
growth prospects. Often firms in mature and traditional industries. Aim is to
restructure to generate greater returns.
Listed companies often taken private.
As debt repaid, value of the firm increases. Aim is to exit within a defined time
usually either by IPO or trade sale.
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6. The PE model
Top 20 PE firms by Capital raised over the last five years (by 2008)
Fund Name Country Capital raised over the last five years
(1 January 2003 – 15 April 2008, billion USD)
The Carlyle Group US $52,00
Goldman Sachs Principal Investment Area US 49,05
Texas Pacific Group US 48,75
Kohlberg Kravis Roberts (KKR) US 39,67
CVC Capital Partners UK 36,84
Apollo Management US 32,82
Bain Capital US 31,71
Permira UK 25,43
Apax Partners UK 25,23
The Blackstone Group US 23,30
Warburg Pincus UK 23,00
3i Group UK 22,98
Advent International US 18,32
Terra Firma Capital Partners UK 17,00
American Capital US 17,00
Providence Equity Partners US 16,36
Silver Lake US 15,60
Cerberus Capital Management US 14,90
AIG Investments US 14,22
Fortress Investment Group US 14,00
Source: PE International`s Magazine. http://www.peimedia.com/resources/PEI50/PEI-50_executivesummary.pdf
In 2008 PE funds around the world had approximately $2,500 billion of funds
under management. This is relatively small compared with other institutional
investors (about 3%) but, until the recent financial crash, the volume and
importance of PE investment was growing.
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7. The PE model: where does the profit come from?
1. There may be genuine improvements in the performance of investee funds
arising from better management, new strategies, and improvements in methods
i.e. value creation.
2. There may be value transfers from government and taxpayers arising from
financial engineering: the use of debt limiting corporation tax, capital gains rather
than income tax, and also the transfer of profits abroad.
3. There may be transfers from other capitalists i.e. acquiring companies at
good prices, selling them at inflated prices, and thereby exploiting investors in
the PE fund. Furthermore value transfers from debt holders may also take place
as the probability of bankruptcy typically increases with increasing leverage and
the value of existing debt decreases.
4. There may be value transfers from workers.
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8. The PE model: impact on labour?
Initial restructuring of target companies may involve asset sales and closures.
But can also enhance the companies performance. Impact on employment?
New managers installed. Breach of ‘implicit contracts’ with labour?
Managers tightly controlled by interventionist owners and incentivised by
incentive contracts.
High leverage and ‘financial engineering’ imposes strong discipline on managers
through control of ‘free cash flow’. Diversion of cash flow from insiders to
owners?
Reduction of wages and benefits?
Reduction of employee voice?
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9. The HF model
Privately organised investment vehicles which operate outside many national
securities regulations. Limited disclosure.
Variety of investment strategies, including currency and commodities. Our focus
is equity and activist HFs.
Pressure on managers to increase returns to investors through increased
dividends, share buybacks, and to re-orientate business strategy, often divesting
marginal, poor-performing activities.
Usually take minority stake. Hold for shorter time period – 5 to 10 months.
Involvement in takeover battles leads to increase price premium. This can lead
to strong pressures to reduce employment post-takeover.
Diversion of cash-flow to investors limits resources available for employment,
wages, benefits.
Leads to strategy changes, involving potentially reductions in employment.
Expect that employment effects less marked than PE because interventions are
not so ‘deep’.
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10. The HF model
The number of HFs worldwide was just under 7,000 in 2009, having declined
somewhat from a peak of over 7,500 in 2007 (Charles Rivers Associates).
Global assets under management was just under $ 2000 billion in 2008.
Top 20 HF by Assets under Management in 2009
Firm Capital $ millions
1 Bridgewater Associates (Westport, CT) $38,600
2 JPMorgan Asset Management (New York, NY) 32,893
3 Paulson & Co. (New York, NY) 29,000
4 D.E. Shaw & Co. (New York, NY) 28,600
5 Brevan Howard Asset Mgmt (London, U.K.)* 26,840
6 Man Investments (London, U.K.) 24,400
7 Och-Ziff Capital Mgmt Group (New York, NY) 22,100
8 Soros Fund Mgmt (New York, NY)** 21,000
9 Goldman Sachs Asset Mgmt (New York, NY)** 20,585
10 Farallon Capital Mgmt (San Francisco, CA)*** 20,000
10 Renaissance Technologies Corp. (East Setauket, NY)*** 20,000
12 Barclays Global Investors (London, U.K.) **** 17,000
13 Baupost Group (Boston, MA) 16,800
14 BlueBay Asset Mgmt (London, U.K.) 16,700
15 Moore Capital Mgmt (New York, NY) 16,500
16 Avenue Capital Group (New York, NY)** 16,204
17 King Street Capital Mgmt (New York, NY) 15,900
18 Angelo, Gordon & Co. (New York, NY) 14,000
19 Fortress Investment Group (New York, NY) 13,661
20 BlueCrest Capital Mgmt (London, U.K) 13,273
Source: Alpha Magazines Hedge Fund 100 (2009)
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11. The SWF model
Investment funds operated by governments or their agencies where ‘excess’
foreign reserves exist (Gulf States, China, Singapore, Norway).
Take substantial, sometimes controlling, stakes in target companies.
But, ‘softly, softly’ approach because of political sensitivities and long-term
investment approach.
Therefore traditionally tend to be passive investors, seeking few changes in
target companies.
But, becoming increasingly involved in PE and HF, and taking larger stakes.
Predict less impact on labour - due to passive investment approach
But maybe some pressure to restructure, which may have consequences for
employment, voice
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12. The SWF model
The largest SWFs are based in UAE, Norway, Saudi Arabia, China, and
Singapore. The estimated investing activity of SWFs in 2007 was approximately
$33.3 billion. Overall, assets under management by SWF increased from under
$1,000 billion in 1999 to $3,800 billion in 2009 (IFSL 2010).
Fund Name Country Assets under Origin
Managemen
t
(billion USD)
Abu Dhabi Investment Authority UAE – Abu $627 Oil
Dhabi
Government Pension Fund – Global Norway $445 Oil
SAMA Foreign Holdings Saudi Arabia $431 Oil
SAFE Investment Company China $347.1 Non-
1
(estimate) Commodity
China Investment Corporation China $288.8 Non-
Commodity
Government of Singapore Investment Corporation Singapore $247.5 Non-
Commodity
Kuwait Investment Authority Kuwait $202.8 Oil
National Welfare Fund Russia $168 Oil
National Social Security Fund China $146.5 Non-
Commodity
Hong Kong Monetary Authority Investment China $139.7 Non-
Portfolio Commodity
Temasek Holdings Singapore $122 Non-
Commodity
Libyan Investment Authority Libya $70 Oil
Qatar Investment Authority Qatar $65 Oil
Australian Future Fund Australia $49.3 Non-
Commodity
Revenue Regulation Fund Algeria $47.0 Oil
Kazakhstan National Fund Kazakhstan $38 Oil
National Pensions Reserve Fund Ireland $30.6 Non-
Commodity
Brunei Investment Agency Brunei $30 Oil
Strategic Investment Fund France $28 Non-
Commodity
Korea Investment Corporation Korea $27 Non-
Commodity
Source: SWF Institute, March 2010
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13. Comparing the funds
The main difference between the funds is in the size of the ownership stake. PE
investments are usually substantial and often a majority of the ownership.
Activist HFs usually hold smaller stakes. SWF traditionally held small
investments to keep below legal disclosure limits, but there is evidence of a
tendency towards taking larger, strategic ownership stakes.
PE and HF adopt activist approaches to monitoring their investments whilst
SWFs for the most part are passive. PE has a strong influence on the strategic
direction of portfolio companies via majority ownership. Activist HFs rely more on
a range of tactics e.g. proxy voting.
It is arguable that the governance strategy of PE tends to focus at least in part
on value creation whereas activist HF are mainly concerned with value transfer.
The time horizons for returns tend to differ between the three types of fund. PE
typically aims to hold its portfolio companies for some years. Activist HFs
typically have a shorter time horizon, aiming to secure returns from activism
within a year. SWF have the longest time horizons, emanating from their
generally passive approach to their investments.
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14. Mechanisms linking funds and labour outcomes
Effect on time horizons. HFs tend to have short-term, PE medium-term, and
SWF long-term time horizons. Short-term horizons may lead to higher pay-back
demand and a disinclination to invest in longer-term, intangible assets, such as
human resources. In practice, this may affect job security and preparedness to
invest in human capital.
Effect on corporate strategies. The acquisition of shares may induce firms to
expand or contract, to acquire or divest, to pursue greater product market share
or financial maximisation. Such strategies will have implications for job security,
for promotion prospects, and for pay and benefits.
Effect performance management. May shift the balance between devices based
on traditional commitments and ones based on monetary rewards. It may also
shift the balance between performance targets based on production and service
quality and targets based on financial returns.
Effect on balance in employee voice systems. May affect the balance between
direct participation as opposed to collective participation in the firm. Works
councils and trade unions may be either favoured or disfavoured.
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15. What is the evidence from case studies? PE
Most of the evidence on the impact of PE relates to job growth and contraction.
There have been several large-scale studies using quantitative data from
company accounts etc. There are some examples that show that industries with
PE ownership have higher growth in employment and employment costs. These
results are consistent with the idea that PE stimulates growth and value creation
in the sectors in which they operate.
However, case study evidence tends to show that restructuring following PE
takeovers has led to reductions in employment and reductions in wages and
benefits. However, the representativeness of case studies is an issue, especially
as there could be a tendency for cases to be selected that exhibit more dramatic
change.
The influence on work organization and industrial relation is less clear. Contrary
to the public debate there is at least no clear negative influence.
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16. What is the evidence from case studies? HF
As yet there are not many studies of the impact of activist HFs on employment
relations, work relations, and industrial relations.
There are a modest number of case studies on labour effects of HF activism.
These case studies show how activist HF forces a comparatively fast
restructuring process, leading to a massive divestment program but also to an
increased profitability of the company.
Any effects of HF activism on labour may well be indirect. Activist HF objectives
tend to focus on shareholder returns and governance reform: whilst these may
have implications for labour and employment, they are not obviously about
reforming this area of corporate activity.
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17. What is the evidence from case studies? SWF
There is very little empirical evidence that we know of relating to the effects of
SWFs on labour and employment.
Two cases in DG Employment report – Cegelec and P&O.
Given the passive investment strategies generally pursued by SWFs it is likely
that the impact on labour has been minimal.
Where they have substantial ownership rights, this passivity may well have
benefited labour in the sense that company insiders will have had considerable
discretion in the management of the firm.
The ownership and control strategies of SWFs appear to be changing in the
direction of greater activism. As the objectives and effects of this greater
activism are not entirely clear, it is difficult to predict any labour or employment
effects.
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18. Summary of findings
There is an impact of the different investment funds on employment, working
conditions and industrial relations. In all case there were effects on employment,
especially job numbers – some losses, but more transfers
Impact on labour may vary between type of fund. PE most interventionist,
followed by HF, then SWF.
This impact will be moderated by the strategy of fund.
It will also be moderated by presence of labour regulation concerning employee
voice and protection
Little effect on work organisation, small effect on industrial relations, but
industrial relations also works as a moderator
Finally: it is not possible to label investment funds either positively or negatively
– as "angels or demons”.
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