NEW YORK (Bloomberg) - US pension funds contributed to the record $1.2 trillion that private-equity firms raised this decade. Three of the biggest investors, state pensions in California, Oregon and Washington, plunked down at least $53.8 billion. So far, they only have dwindling paper profits and a lot less cash to show the millions of policemen, teachers and other civil servants in their retirement plans.

The California Public Employees' Retirement System, the Washington State Investment Board and the Oregon Public Employees' Retirement Fund - among the few pension managers to disclose details of their investments - had recouped just $22.1 billion in cash by the end of 2008 from buyout funds started since 2000, according to data compiled by Bloomberg. That amounts to a shortfall of 59 percent. In total, they haven't reaped a paper gain from funds formed in the past seven years.

The wisdom of those investment decisions hangs on the remaining value private-equity firms assign to companies they snapped up in 2006 and 2007, during the peak of the buyout boom. For the California, Oregon and Washington plans, that figure totaled $15.8 billion at the beginning of the year.

While some investors say they are confident the private- equity industry's traditional practice of taking over companies will pay off, others have been shaken by a credit contraction that froze deal-making, eroded the value of the assets on private-equity firms' books and prevented them from cashing out in public share sales.

Now pension managers on both ends of the spectrum are looking skeptically at the so-called internal rate of return buyout firms calculate to gauge their results.

"I work for over 400,000 employees, and they can't eat IRRs," said Gary Bruebaker, the chief investment officer of the Washington State Investment Board. "At the end of the day, I care about how much do I give you, and how much money do I get back."

Private-equity firms pool money from so-called limited partners - pension funds, endowments, wealthy families and sovereign wealth funds - and use that cash, along with money borrowed from banks, for corporate takeovers. The buyout managers aim to boost profits through cost cuts, acquisitions or added lines of business, then reap a return for themselves and their investors in a public stock offering or a sale to another buyer.

The buyout firms also levy fees, typically two percent of the assets they oversee annually and 20 percent of profits from successful investments. That's helped make the titans of the industry into billionaires.

Stephen Schwarzman, the 62-year-old co-founder and chairman of Blackstone Group LP, the biggest private-equity firm, ranked 261st on the 2009 Forbes list of the world's richest people, with an estimated net worth of $2.5 billion. KKR & Co. LP co- founder Henry Kravis, 65, topped that with $3 billion, while Carlyle Group co-founder David Rubenstein, 60, weighed in at $1.4 billion.

Buyout managers, and some pension funds, downplay their cash returns so far this decade and counsel patience, saying that investments often look worse in the years immediately after they're made. Blackstone's Mr. Schwarzman told backers on an August 6 conference call he expected his New York-based firm to take some of its companies public in 2010. KKR, also in New York, sold shares in Avago Technologies Ltd. through an Initial Public Offering earlier this month, raising $648 million.

Pension funds also say that over time, private-equity returns compare favorably to the Standard & Poor's 500 Index, which declined 28 percent from the beginning of 2000 through the end of last year. Mr. Bruebaker says his Washington fund had an 8.2 percent average annual gain from its buyout investments in the past 10 years, compared with a 3.9 percent drop in the S&P.

While investors can sell publicly traded stocks as needed, buyout funds keep money tied up for years, said Steven Kaplan, a professor at the University of Chicago's Booth School of Business.

"With private equity, you're taking on a liquidity risk, which people did miscalculate," said Mr. Kaplan, who has studied takeover returns.

University endowments and philanthropic foundations hurt by the worst economic crisis since the Great Depression have struggled to sell their stakes in private-equity funds to raise cash. Investors including Harvard University, in Cambridge, Massachusetts, planned to raise more than $100 billion through so-called secondary sales of limited partnership interests, some at discounts of at least 50 percent, people familiar with the effort said last year.

Mr. Rubenstein, of Washington-based Carlyle, acknowledges that the buyout industry faces tough questions.

"People have a lot of money in the ground and today it's probably not worth what they had intended, but a turn-around in valuations is now beginning," Mr. Rubenstein said in an interview. "You'll probably see general partners and limited partners focused more on multiples of equity rather than just IRRs."

Representatives of Washington, Calpers and Oregon all said they remain committed to private equity, and pointed to the long-term nature of the investments.

"The market is in a trough," Oregon spokesman James Sinks said. "The picture would've looked different at the end of 2007." Calpers spokesman Clark McKinley noted that Calpers in June raised its target commitment to private equity to 14 percent of assets from 10 percent.

"That's an affirmation of our confidence in the asset class," he said.

Mr. Schwarzman and Mr. Kravis declined to comment for this article.

"We are hopefully toward the end of the absolute worst recession of our lifetimes," said Washington's Mr. Bruebaker. "If you take a snapshot right now, things might not look good. These are 10 to 12-year investments and we believe they'll be much better than what we see today."

Mr. Bruebaker's fund and the Oregon Public Employees' Retirement Fund warmed to buyouts during the 1980s, and Calpers joined in 1990. Today, among US pension plans, Calpers is the largest investor in private-equity funds, while Washington and Oregon are the third- and fourth-biggest, respectively, according to San Francisco-based consulting firm Probitas Partners Inc.

The three state funds, which serve more than two million people, collectively more than doubled their buyout commitments in 2005, to $8 billion from $3.1 billion.

They ramped up even more the next year, when commitments climbed to $18.7 billion, the data show.

All told, private-equity firms raked in $1.2 trillion from 2000 through 2008, according to London-based researcher Preqin Ltd. The influx of money, coupled with cheap debt-funding from Wall Street banks eager to collect fees, fuelled record-setting takeovers. Nine of the 10 biggest deals were announced from 2005 to mid-2007 as buyout firms acquired the likes of hotel operator Hilton Hotels Corp. and power producer TXU Corp.

The buyouts ground to a halt after the sub-prime-mortgage market collapsed in late-2007, extinguishing investor demand for high-yield, high-risk debt.

The dollar value of deals has dwindled to $42.2 billion so far this year from $212.2 billion in 2008, according to data compiled by Bloomberg.