The state's investment arm has a formal goal of earning 7.5% per year for pension plans. Thankfully, it has invested a big chunk of pension money in private equity.

The private-equity slice of the big fund managed by the Minnesota State Board of Investment (SBI) had returns of better than 12% for the past three years and five years, and generated about 13.5% over the past 10 years, according to the board's June report.

That's terrific, as the Minnesota Center for Fiscal Excellence just pointed out in a recent analysis. Mark Haveman, the center's executive director, only hopes the SBI can keep it up. He doesn't expect that result, but even if SBI manages to, it wouldn't be enough to solve the state's chronic pension-plan problem.

Haveman said in a follow-up conversation that he wrote the private-equity article in part to make sure he really understood the SBI investments and the big role they play in Minnesota's pension plans for public employees.

The center routinely publishes insightful analysis of state government, tax policy and public finances. In his recent look at private equity and state pensions, Haveman gave away his thinking by titling the analysis "Banking on 'A Superior Form of Capitalism.' "

Superior capitalism appeared in quotes because Haveman isn't the kind of person who would say something like that. The head of Yale University's endowment, though, seems to be exactly the kind of person who would (and did).

Like a lot of informed people in Minnesota, Haveman has a lot of respect for the SBI.

This little outpost of state government has more than one job, but its biggest pool to oversee is the $71 billion (as of June) in funds for the big public pension plans. Roughly $11 billion in market value of the funds' value was invested in what SBI termed private markets — and most of that was in private equity.

Private is as it sounds, meaning there's no public trading of the assets. That means no quick and low-cost way to sell them and no real-time price for what they are worth. In exchange for giving all that up, the investor in private assets, at least in theory, should earn higher returns.

Private equity includes what is usually called venture capital, plus firms that buy controlling stakes in businesses. Whatever the investment approach, one key idea is that private equity managers rarely remain passive observers of the businesses they have put money into. Instead, they are hands-on to improve financial performance.

The state itself does not exactly invest in private-equity deals. Instead it commits money to investment funds created by private-equity firms.

As a group, these fund managers have as bad a PR problem as any legal business in America.

For one thing, they have a form of partnership business model that's created a heads-I-win, tails-you-lose fee structure. The equity managers get a sweetheart tax treatment on most of their compensation, too, taxed at lower capital gains rates rather than as ordinary income.

These include firms whose reputation comes from becoming known for selling off assets and financing their companies with too much debt, putting workers' jobs at risk in the name of capital efficiency. Plus, it's hard to argue that this whole process of financing and refinancing creates much of genuine value.

But whatever you want to believe about how private-equity firms do their work, the returns have been solid. Picking the right fund manager seems to really matter, though — and it helps to be lucky, too, like picking a fund that made most of its investments at a good time in the deal cycle.

Of course, the classic problem in business applies here: As a market attracts more capital, firms maintaining their success gets a lot harder. The money has flooded in — from pension funds, endowments, life insurance companies and others. Last year, new commitments to private-equity funds hit another new record, at more than $300 billion.

Private-equity funds globally have a record $1.45 trillion in undeployed capital.

As the Economist magazine suggested earlier this year, the time to jump into private equity might not be when everybody else thinks it is a can't-miss way to generate superior returns.

With all that money in the market, the price of businesses these firms like to buy has increased every year of the past decade, according to a report earlier this year from consultant firm McKinsey & Co. Usually explained as multiple of cash earnings, purchase price values last year were the highest in 15 years. Investors in 2019 would have had to pay 35% more than in 2010, McKinsey said, to acquire the same company.

Cheap and readily available debt financed these steeply priced buyouts, with the total average buyout debt last year — again expressed as multiple of cash earnings — climbing to levels not even seen in 2007, the last year of an easy money era that preceded the financial crisis of 2008.

Haveman is cautious in his outlook on future returns in private equity. He also is curious why state policymakers don't seem to grasp that continued all-star performances by SBI in private equity won't fix the pension gap.

Since fiscal 2002, Haveman wrote, falling short on contributions has alone added about $7 billion to state pension plans' unfunded liabilities.

Haveman argues that the gap is caused by a systemic problem, not necessarily by poor decisions alone. There's a requirement to balance the budget, but no such requirement to fill an off-the-balance-sheet financial hole.

"Given the condition and current design of our plans," he said, "there is no escaping the need to put more money in."