U.S. defined benefit (DB) pension plans are increasingly exposed to private credit and other risky alternative assets that could lead to funding troubles that ultimately strain government finances too, says Fitch Ratings.
In a report issued Monday, the rating agency said that in the wake of the global financial crisis, sponsors of public DB pensions took a variety of steps to improve the their plans’ solvency, such as increasing contribution rates, reducing benefits to new employees and adopting more conservative actuarial assumptions.
Even so, these plans generally remain underfunded and they’re also increasingly exposed to market risks. As other post-crisis trends, including higher allocations to alternative investments and steady demographic weakening “could amplify the effects of a market shock,” Fitch said.
The report noted that U.S. public pensions’ portfolio allocations to alternative assets had doubled since 2008 to 34% in 2024.
“Allocations to increasingly complex categories of alternatives can include leverage or variable rate strategies that expose investors, including pensions, to greater losses,” it warned.
In particular, private credit represents a “rapidly growing share of alternative investments, driven by [the sector’s] strong performance relative to traditional fixed income,” the report said — with many public pension funds increasing their exposure to private credit in an effort to drive higher returns.
For instance, California’s pension giant, CalPERS, recently raised its target allocation for private credit to 8%, up from 5%, “as part of a shift to 40% alternatives,” it noted.
Fitch also warned that the resilience of many of these alternative asset categories have not yet been tested in a downturn.
“The illiquidity of many alternative investments could also force plans with tighter cash flows to sell marketable assets at a loss to meet benefit or other obligations, such as capital calls,” it said.
As a result, negative market shocks could result in plans raising contribution requirements, it noted.
Additionally, Fitch said many plans’ demographics are weakening too — the ratio of active workers to retirees is declining, which “could exacerbate the effects of a market shock on pension contributions,” as the payout of benefits increasingly outpaces inflows from plan contributions.
Ultimately, this could add stress to government finances and their credit ratings.
“A major pension asset drawdown would depress portfolio values, raise unfunded liabilities, and lead to higher employer contributions, the report said. “This would take place just as governments would likely be grappling with economic and budgetary fallout from a downturn.”
While most governments should have the capacity to increase pension contributions, those with weaker balance sheets “could be most vulnerable due to budgetary pressure from increased pension contribution demands,” Fitch said.