Look for the union label and you will find it in some unlikely places these days. One case in point: After years of shunning the alternative investment sector, labor union pension plans are trying to embrace private equity funds.
At first glance, the timing seems off. Private equity funds - both venture capital and leveraged buyout operations - delivered handsome returns for most of the late 1990s, returning an average annual 17.9 percent for the five years through September 30, according to research firm Venture Economics. But the past two years brought a sobering morning after. The sector declined 11.3 percent in value for the 12 months through September 30. Now with excess capital chasing a limited number of promising investments, future gains could be hard to come by.
Despite the pitfalls, though, labor unions are taking a chance on the leveraged buyout and venture capital funds that make up the sector. Like other pension plans, foundations and endowments that have boosted their allocation to the asset class over the past decade, unions are looking to diversify their portfolios and gain a measure of noncorrelated returns. On average, union pension funds allocate 50 percent of portfolios to stock, 40 percent to bonds and 10 percent to real estate and other asset classes.
No one precisely tracks their moves, but James Manley, a veteran Taft-Hartley investment consultant, estimates that in the past two years the nation’s 3,200 Taft-Hartley pension funds (multiemployer plans, jointly administered by labor and management), have committed to private equity upwards of $2 billion of their $400 billion in pension assets. Although most Taft-Hartley funds seem to prefer venture capital to leveraged buyout funds, there are at least a handful that are looking at both. Labor unions probably now keep close to 1 percent of their assets in private equity. That’s a drop in the lunch bucket, but quite an increase from the estimated one third of 1 percent they had invested in the asset class in 1999. But unions still lag well behind the pension, foundation and endowment industry average of 7.5 percent, according to a recent report by Goldman, Sachs & Co. and Frank Russell Co.
“There has been an explosion of interest in private equity,” says Jack Marco, chairman of Marco Consulting Group, a leading investment consulting firm for union pension funds. “Two years ago my clients had no money invested in the asset class. Now, they’ve got about $400 million in the sector.”
“Certainly, there’s an increasing momentum among Taft-Hartley funds to invest in private equity,” says Enos Throop Jr., director of investments at the $6.2 billion United Mine Workers of America Health & Retirement Funds. A pioneer in the area, UMWA began investing in private equity in 1993 and now has 5 percent of its assets in the sector. Although the private equity portfolio has suffered during the past 18 months, Throop says that over the past five years, it has produced average annual returns of more than 15 percent.
In what has since become the most visible and controversial case of a union investment in private equity, Ullico, the union-owned insurance holding company, plowed $7.6 million into a start-up called Atlantic Crossing in March 1997. That stake soared to more than $1.6 billion on paper after the company, by then known as Global Crossing, went public in 1998. Ullico sold Global Crossing shares in 1999 and 2000, earning some $335 million after taxes. But that triumph has been blighted. Global Crossing is now in Chapter 11, and its stock trades for pennies. Ullico won’t disclose how many shares it still owns, but insurance rating agency A.M. Best Co. downgraded a Ullico subsidiary in January in part because of a “significant” decline in Ullico’s Global Crossing investment. And last month reports emerged that the U.S. Attorney’s office in Washington is investigating whether Ullico executives engaged in wrongdoing by indirectly profiting off their Global Crossing investment (see story below).
However the Ullico saga plays out, unions will almost certainly keep pushing into private equity. At the end of last year, for example, the 1199 National Benefit & Pension Funds, part of New York’s Health and Human Services Union, decided to boost private equity from roughly 2 percent of its $6 billion portfolio to about 10 percent over the next five years. “This is an area we’ve been discussing for quite some time,” says Lorraine Monchak, chief investment officer at the fund. “There’s certainly a learning curve for Taft-Hartleys when it comes to private equity.”
On a smaller scale, Local 555 of the United Food and Commercial Workers in Tigard, Oregon, decided in November to invest $30 million of its $600 million portfolio in a private equity fund-of-funds; its umbrella organization, the United Food and Commercial Workers Union, earmarked $150 million for the asset class, $20 million of which has been invested.
The longtime institutional investor in the asset class, the $147 billion California Public Employees’ Retirement System, the nation’s largest public pension plan, wants to encourage a greater union presence in private equity. In February it teamed up with a Los Angeles-based private equity investor, Yucaipa Cos., to create Yucaipa American Funds, designed as an investment vehicle for unions looking to take private equity stakes. It hopes to raise more than $1.5 billion. CalPERS will invest $35 million for a minority interest in YAF’s money management arm and has also committed $250 million to the funds. “The investments will focus on industries and companies that maintain strong corporate governance practices and are sensitive to the interests of their employees,” according to a CalPERS statement. The new funds will be managed by Yucaipa’s Ron Burkle (Institutional Investor, May 1998), a onetime supermarket magnate who is also a former member of the United Food and Commercial Workers.
“There has been an awakening,” says investment consultant Manley. “Labor is coming to a realization that putting some of their money to work in private equity will be good for their funds in the long run.”
Although unions are naturally hunting for stronger returns on their pension fund portfolios, there are those who say they are not just in it for the money. Many want to target their capital infusions to worker-friendly companies, and they certainly want to steer clear of antiunion employers or buyout shops that cut costs through downsizing.
“Unions don’t want to be embarrassed by their investments,” says Bruce Raynor, president of the Union of Needletrades, Industrial and Textile Employees, or Unite, which began investing in private equity in 1999 and now keeps 5 percent of its $4 billion in assets in the area. “They don’t want to own companies that are shutting down plants and moving jobs to poverty-stricken countries to exploit cheap labor.”
The AFL-CIO tries to identify good private equity funds for unions through its investment products review program. The labor organization scrutinizes LBO shops and venture capital firms for a track record of investing in companies with healthy collective bargaining relationships and worker-friendly management teams. Says Bill Patterson, director of the AFL-CIO’s Office of Investment: “We want to provide pension trustees with some way of evaluating claims by managers that they are worker-friendly.” Adds his colleague Michael Garland, the office’s corporate transaction coordinator, “The reality is, there aren’t a lot of worker-friendly funds out there.”
Currently, only eight make the AFL-CIO list, including Separate Account P, a private equity fund run by Ullico, and KPS Special Situations Fund, which specializes in corporate turnarounds.
Once they have targeted pro-labor funds for a capital injection, union investors are finding that many private equity firms have considerable excess cash but a dearth of suitable places to invest it. According to the Goldman Sachs-Frank Russell report, just 63 percent of the money committed to private equity has been drawn upon by fund managers.
“It’s not necessarily an easy time for a new investor to be placing his bets,” says Colin Blaydon, a business professor at Dartmouth’s Tuck School of Business and director of its John H. Foster Center for Private Equity. “There is an enormous overhang of committed capital out there.”
In addition, valuing private equity is never simple - or transparent - since the stakes are so illiquid; many funds are required to report the value of their holdings just once a year. “There’s a risk with private equity,” says Michael Calabrese, former pension counsel at the AFL-CIO and an advocate of Taft-Hartley investments in private equity. “You just don’t always know what you’re getting.”
Half of all private equity investments by tax-exempt organizations like foundations and pensions go into leveraged buyout funds, according to Goldman Sachs and Frank Russell, but the specter of LBO-induced layoffs will probably restrain any mass move by unions into the asset class. “Leveraged buyout funds are the biggest chunk of the private equity market, and they aren’t perceived as being union-friendly,” says Dale Meyer, who raised private equity at J.P. Morgan Chase & Co. before leaving the firm in February to work as a partner for money manager Probitas Partners, a private placement agent.
Still, not all Taft-Hartley funds insist on worker-friendly investments in their private equity deals. Some are just looking for the highest return they can get.
“I don’t believe in restrictions,” says Unite’s Raynor, who would like to double the private equity allocation to 10 percent over the next several years. “We put returns first and foremost.”
Created by the Taft-Hartley Labor Act of 1947, union pension funds have traditionally been among the most cautious of investors, in no small part because of the historically uneasy relationship between management and labor representatives on pension boards. “There are still different points of view between the union and employer trustees, which tends to make the funds more conservative,” says Raynor. “We all agree on equities; we all agree that we should be in bonds. We can’t agree on a whole lot else.”
The AFL-CIO planted the seeds for private equity investments in 1965, when it created its Mortgage Investment Trust, a Securities and Exchange Commission-registered money manager that now invests for some 420 Taft-Hartley and public pension plans. The labor umbrella organization wanted to diversify from a portfolio largely invested in bonds, and it also wanted to make investments that would create union jobs by financing new housing construction. The trust, which now oversees $4 billion in assets, served as a kind of blueprint for private equity investing for Taft-Hartleys.
For much of the 1980s, though, private equity remained anathema to labor organizations. Union members saw one LBO fund after another streamline their acquisitions by laying off thousands of workers and raiding the target company’s pension fund. By the early 1990s, though, a few union investors, including the UMWA and Ullico, recognized the appeal of selectively diversifying into the asset class, especially as they saw the venture capital explosion creating vast wealth and thousands of jobs.
Even before its Global Crossing foray, Ullico had tried to leverage its private equity expertise by attracting other investors to its deals. In 1995 its money management arm, Trust Fund Advisors, set up Separate Account P, which the AFL-CIO in 1999 rated “excellent” for the collateral benefits it produced for workers. It attracted such early investors as the $1 billion pension fund of the Service Employees International Union, which committed $10 million. From 1995 to 1999 Separate Account P produced average annual returns of 19.36 percent. It will not provide more recent performance numbers.
The only other fund to receive an “excellent” rating from the AFL-CIO was $210 million-in-assets KPS Special Situations Fund, sponsored by Keilin and Co., a boutique investment bank that invests in troubled unionized companies. The firm often uses employee stock ownership plans to refinance debt and recapitalize companies. In May 1999, for example, KPS helped workers at Asheville, North Carolina-based Champion International Corp. buy seven of the company’s paper and packaging plants after Champion failed to find a buyer. KPS provided $35 million for a 55 percent stake in a newly formed company called Blue Ridge Paper Products. Senior management took a 5 percent interest, and employees got 40 percent in exchange for a 15 percent cut in wages and benefits. The acquisition helped save 2,200 jobs. (Because it is in the midst of raising money for a second fund, KPS declined to provide performance numbers for its first fund.)
More modestly, Pittsburgh-based Heartland Labor Capital Network, a nonprofit consortium backed by the United Steelworkers of America, has spent the past several years encouraging private equity investments by Taft-Hartleys in struggling small to midsize U.S. manufacturing companies that might otherwise shift operations offshore. Heartland is working with Simsbury, Connecticut-based Landmark Partners, which specializes in buying private equity stakes from other investors. Landmark has raised $70 million for a fund that will invest in small-cap private equity and ambitiously aims to have $250 million by the end of the year. Eight union plans have committed $55 million to the fund since it began seeking investors two years ago.
“The first test is quality of management,” says Landmark fund manager Patrick Flanagan, a Harvard MBA whose father worked as a telephone linesman. “One of the key ways in which we will assess that is how they value their most important asset: their workforce.”
Companies that are genuinely worker-friendly won’t be easy to find, but enthusiasts in the crowd project that within five years the average union fund allocation to private equity could jump to 5 percent.
“It’s not going to happen overnight, but I think we’ll get there,” says Flanagan.
Tangling wires with Global Crossing
Looking for first-round investors in Atlantic Crossing, his wireless start-up, Gary Winnick turned to some familiar faces in 1997, individuals who had joined his deals in the past. Among them: Michael Steed and Terry McAuliffe, respectively, the former executive director and the current chairman of the Democratic National Committee.
McAuliffe invested $100,000 in Winnick’s venture that year and later sold shares of what is now called Global Crossing worth $18 million. Steed, who was then senior vice president for investments at Ullico, persuaded the union-owned life insurer to invest $7.6 million.
For Ullico the deal held out a double benefit. It was a promising venture investment, and the insurer was able to extract promises that Winnick’s operation would use only union workers on its rigs; Steed subsequently joined Winnick’s board. The investment, which represented less than 1 percent of Ullico’s $2.9 billion portfolio, was a bid to share in New Economy wealth by a labor organization that traces its roots back to 1925.
Ullico’s wild card went public in 1998 as Global Crossing, and its stock soared, then later sank in a now-familiar cautionary tale of speculative excess and market revenge. Three months ago Global Crossing filed for bankruptcy protection, and its shares now trade for pennies, down from a May 1999 high of $61.375. Although Winnick, the CEO and founder, managed to unload stock worth $734 million, not many investors shared his good fortune. Ullico was one of the few. It reportedly sold half its stake of 33 million Global Crossing shares in 1999 and 2000, earning about $335 million after taxes.
But Ullico’s success may not be unalloyed. The Securities and Exchange Commission and the Federal Bureau of Investigation have been probing Global Crossing’s financial reporting. What Ullico once heralded as a “worker-friendly” enterprise has laid off thousands of employees as it struggles to regain its footing. And now - according to a published report in BusinessWeek - a Washington, D.C., grand jury is investigating charges that Robert Georgine, Ullico’s chief executive, and some other board members improperly reaped huge profits by buying and selling Ullico stock in transactions with the company. These deals were reportedly unavailable to other shareholders of Ullico, a privately owned company that doesn’t trade on the open market. Stockholders can only sell their shares back to Ullico, which prices them once a year based on the size of its surplus - the difference between the assets and liabilities on its balance sheet.
Last month BusinessWeek reported that Ullico insiders knew that the company would reprice its stock at $146 at the end of 1999 because the Global Crossing investment vastly inflated the surplus. The company offered to sell its directors 4,000 shares each at the 1998 price of $54, according to BusinessWeek. For instance, Georgine’s Ullico holdings rose from 8,800 shares in 1998 to 52,800 shares in 1999, and he sold his shares back to Ullico at $146, according to the magazine, which says it is unclear why he got so many shares. The AFL-CIO is conducting its own investigation; Ullico declines to comment.
In January a subsidiary of the union-owned insurer got hit with a downgrade in its A.M. Best Co. rating, from B++ to B+. According to an A.M. Best report, the sharp decline in the value of the Global Crossing investment had reduced Ullico’s ability to help Union Labor Life Insurance Co. bolster its capital base, which had suffered declines because of losses in one of its business lines. In recent years Ullico had buoyed Union Labor Life with cash infusions, funneling $15 million into the subsidiary in 1999 alone. A.M. Best concluded that the decline in value of the Global Crossing holdings means that Ullico won’t be able to offer similar assistance going forward.
And in an entirely separate episode, last month the Department of Labor sued Ullico, alleging that the insurer broke pension laws by investing $10 million in retirement funds in a shaky Las Vegas real estate venture. - J.D.
