The Rise of Private Credit in US Pension Plans

Explore the growing trend of US pension funds turning to private credit, with billions of dollars being allocated for higher investment returns.

US state and local retirement funds are increasingly turning to private credit as they seek higher returns on their investments. According to Equable, a bipartisan pension researcher, these systems are collectively allocating at least $100 billion of their roughly $5 trillion in assets into private debt. While this is currently only a small portion of their holdings, funds’ private credit positions have been steadily growing and are expected to continue to rise.

For nearly two decades, public pension funds have been diversifying their investments beyond traditional stocks and bonds, turning to alternatives to boost returns and fill funding shortfalls. In recent years, they have increased their exposure to private credit as the asset class has grown to $1.6 trillion globally. State pension funds, for example, may increase their private debt allocations to 6% over the next two years, up from 3.6% last year and 2.1% in 2017, according to investment adviser Cliffwater LLC.

The growth of private lending and the move towards alternative assets by state and local pensions can be traced back to the 2008 financial crisis. Regulators tightened rules on risky lending by banks, leading to a retreat from extending credit to some riskier corporate borrowers. This has created an opportunity for private credit to fill the void left by banks.

However, the shift into private credit is not without risks. Financial watchdogs have raised concerns about the lack of transparency and regulation in the sector, as well as the untested nature of private credit in a prolonged downturn. Despite these risks, proponents point to the benefits of private credit as an alternative investment, including senior-secured debt backed by company assets, attractive yields, and limited interest-rate risk.

The California Public Employees’ Retirement System (Calpers) and the Chicago Teachers’ Pension Fund are among the pension plans showing a keen interest in committing more to private credit. Calpers is targeting an allocation of 5% to private debt, while the Chicago Teachers’ Pension Fund is searching for asset managers to invest more than $300 million in private debt to boost its allocation from zero to 3% of assets.

While alternative investments overall have not been a panacea for retirement plans, the potential benefits of private credit are too significant for many funds to pass up. As a result, it is expected that US state pension assets invested in private credit will double in the next two years to about $200 billion.

The growing interest in private credit by US state and local retirement funds reflects a broader trend of diversification and pursuit of higher returns in the face of funding shortfalls. While the shift into private credit presents risks, the potential benefits are driving pension plans to increase their allocations to this booming sector of finance.