US public pension funds are divided over whether to increase their exposure to alternative assets such as private credit, amid concerns about the sector’s rapid growth and vulnerability to market volatility, according to Fitch Ratings.

A report from the ratings agency found that some US public pension funds are ramping up their exposure to alternative assets, with private credit representing a “rapidly growing” share of these investments.

Data from the Public Plan Database show that alternatives outside of traditional equity, fixed income and cash made up 34 per cent of pension portfolios in the 2024 fiscal year, double the level in 2008.

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CalPERS, the $589.8bn (£451.7bn) California pension system, recently increased its target allocation to private credit from five to eight per cent, as part of a broader move to allocate 40 per cent of its portfolio to alternatives. Fitch said the push towards private credit reflects its appeal for funds seeking to “drive returns and address still-substantial liabilities”.

However, some US pension funds remain wary, pulling back their exposure due to “unease” about the sector’s rapid growth amid macroeconomic and credit quality concerns, Fitch noted.

Overall, US pension funds remain underfunded and exposed to market volatility, said Fitch, with higher allocations to alternative investments potentially amplifying the effects of a economic shock.

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Fitch’s main concern around alternatives was that the assets are yet to be tested in a downturn.

Overall, a significant market shock could increase the burden of state and local pension liabilities and drive contribution requirements higher, the agency warned.

While Fitch said most governments retain flexibility to raise pension contributions,  supported by mechanisms such as asset smoothing, which phases in losses over time, it cautioned that those with weaker liability metrics and high debt servicing costs could face the greatest rating pressure.

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