Tuning Out ‘Short-Term Noise,’ Public Pensions Stay Nimble Amid Private Credit Risks

When you’re the nation’s largest public pension fund, any move you make is inevitably scrutinized by the market, especially when it seems to be “going against the current thinking,” said Marcie Frost, CEO of the California Public Employees’ Retirement System, or CalPERs, during a board meeting on April 14.

Frost was referring to the fund’s entanglement with private credit, including its involvement with Blue Owl’s recent $1.4 billion sale of loans to pay back investors because of elevated redemption pressures. CalPERs allocates 4% of its $600 billion in assets to private credit, although at one point the target was 8% under the newly adopted total portfolio approach, Frost said.

CalPERs is among the public pension funds with some of the largest private credit allocations in size, according to Barclays Research. Others include the State Teachers Retirement System of Ohio, or STRS Ohio, and the Arizona State Retirement System, or ASRS, which hold approximately 9.5% and 13.6% of their portfolios in private credit, respectively.

The municipal market is not fully immune to headline risks around private credit, although such challenges are not systemic, market participants say. Private credit presents “a potential second order macro overlay, but the transmission into munis is slow, selective and most visible first in higher education and parts of healthcare, not credit wide beta expansion,” said James Pruskowski, managing director at Hennion & Walsh.

When zeroing in on the impact on public pensions, deterioration in a particular asset’s performance tends to materialize in gradual increases in required contributions “rather than abrupt fiscal stress,” Pruskowski explained. This is because most large public pension funds operate “under actuarial and political contribution frameworks, not market-to-market funding triggers,” he said.

Barclays analysts echoed this sentiment, saying that one of the most direct linkages, in their view, is through direct holdings of private credit by pension funds and endowments that have been “aggressively expanding” into this asset class, albeit to a lesser degree. The perks of this shift include higher yields and diversification benefits given private credit’s “lower correlations with fixed income and equity,” they said.

But as private credit alarm bells continue ringing, certain pension funds have swiftly adjusted their positions. The Illinois Municipal Retirement Fund, or IMRF, lowered its private credit target to 3.5% from 4%, and the East Bay Municipal Utility District Employees’ Retirement System in California canceled a planned $140 million allocation to private credit in March, according to a report by PitchBook. On the other hand, funds such as the Kentucky Employees Retirement System continue to find private credit attractive, noting in a November 2025 meeting that the asset class remains appealing compared with others such as private equity.

Headline volatility often reflects market sentiment, but “it doesn’t change the fundamental math of our approach,” said Timothy Reese, CEO and chief investment officer of Pennsylvania Municipal Retirement System, or PMRS, noting that most recent headline risk stems from liquidity requests in retail-heavy BDC structures. “Conversely, PMRS is focused on the lower and middle Market segments, which are predominantly institutional investors with long-term horizons,” he said. Viewing private credit as a durable, long-term component of our portfolio, PMRS is not “reacting to short-term noise,” Reese added.

As more funds turn to private credit as an alternative investment, tracking private credit allocation has not been straightforward as the asset class may be viewed differently within each portfolio. STRS Ohio, for instance, recently categorized private credit as a stand-alone asset class after a 2025 asset liability study, perhaps signaling a potential risk differentiation between the asset and the rest of its opportunistic counterparts. Throughout fiscal 2025, private credit was held within the former opportunistic/diversified asset class.

Whether private credit belongs to the “opportunistic” category or its own bucket, the inherent difference “lies in the predictability of returns and the specific protections found in private contracts compared to public fixed income,” said Reese. For a public pension fund, the goal is to match long-term liabilities, and private credit provides a specialized tool to achieve that without the same level of volatility found in the public markets, he explained.

Larger allocations to alternative investments, such as private credit, could be partly attributed to the Great Recession, after which many pension funds found themselves underfunded and “were forced to make up lost ground by trying to invest in riskier assets,” according to Barclays analysts.

The relationship between funded level and private credit allocation “isn’t linear,” however, said Pruskowski.

Better funded plans tend to have more flexibility to allocate to illiquids like private credit as a diversification tool. Meanwhile, lower funded status can push plans toward higher return seeking behavior, but “governance, liquidity needs and contribution pressure often matter just as much as the funding gap,” he explained, emphasizing that the equation comprises several components like funding level, cash flow profile and governance bandwidth – rather than a single variable.

Octus compiled data on the funded levels of 30 pension funds against their private credit allocation, showing the most aggressive allocations in terms of percentage in Arizona, Virginia and Kentucky, as shown below:
 

Representatives from IMRF,the California’s East Bay Municipal Utility District, STRS Ohio and the Kentucky Public Pension Authority did not respond to requests for comment. ASRS declined to comment.