US pension funds were below their median target allocation to private debt in August, a reflection of the challenges in analyzing the growing number of private debt participants.

The median target allocation across 117 US pension funds was $188 million, while the median actual allocation was $112 million, according to S&P Global Market Intelligence data.

This suggests that pension funds had a $76 million median net underallocation to private debt as of Aug. 21.

The majority of pension funds analyzed failed to meet their targets. Of the 117 pension funds, 75 underallocated, 31 overallocated and 11 matched their respective targets.

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The underallocation to private debt, which promises relatively high returns and low volatility while offering diversification to pension funds, is likely linked to the increasing number of lenders, said Joseph Weissglass, managing director at investment bank Configure Partners LLC.

The number of private debt fund managers increased to 1,210 in 2023 from 389 in 2008, according to data from Preqin. Approximately 2,184 private debt funds are currently in the market seeking capital, Market Intelligence data shows.

"Private credit as an asset class has developed relatively quickly over the last five years to what is now a very scaled asset class. It has been challenging for allocators to track the managers that are successful and look at the different strategies within private credit," Weissglass said.

Private debt has grown rapidly since the 2008 global financial crisis and is now taking share from bank lending and public markets. Assets and undeployed capital commitments grew to about $2.1 trillion globally in 2023 as banks have become less willing to provide financing to middle-market firms with riskier profiles in the US and Europe, according to the International Monetary Fund's global financial stability report for April.

Under and over

The California Public Employees' Retirement System (CalPERS) recorded the highest underallocation to private debt among US pension funds. The fund had an actual allocation of $14.30 billion, falling $26.55 billion short of its target of $40.84 billion.

In a 2023 annual review of CalPERS, investment advisory firm Wilshire Advisors LLC wrote that the pension fund's five-person private debt team is experienced but under-resourced.

"Additional resources, on both the personnel and technological fronts, will be critical to sustain the success of the program, especially given the increased long-term target to private debt," the review said.

As of March 31, CalPERS' private debt portfolio comprised 42 investments totaling about $33 billion in commitments.

The United Parcel Service of America Pension Plan came in second, with an actual allocation of $948 million versus its target of $7.44 billion.

The South Carolina Retirement System Investment Commission had the largest overallocation to private debt. The fund recorded an actual allocation of $3.73 billion, $1.06 billion higher than its target. As of March 31, private debt represented 8.5% of the pension fund's total asset allocation, above its 7% policy target, according to a quarterly report by the pension fund.

The Texas County & District Retirement System ranked second with $13.10 billion in actual allocation, almost $1 billion above its target of $12.13 billion.

Top allocators

The Virginia Retirement System had the largest private debt allocation, at $16.12 billion, followed by CalPERS with $14.30 billion.

Of the 117 US pension funds, the Platte River Power Authority Pension Plan, Texas Abilene Firemen's Relief & Retirement Fund, West Virginia Natural Resources Police Officers Retirement System and IBEW Local 150 Supplemental Pension Fund recorded the lowest allocation to private debt at $1 million each.

Outlook

The widely anticipated rate cut by the Federal Reserve is expected to boost M&A activity, which will likely be a net positive for private debt.

"M&A is a primary driver of origination volumes and opportunities in private credit. And so a rate cut, all else equal, will benefit private credit as far as deploying the assets that they've raised, deploying the dry powder that they've raised," Weissglass said.

"A potential other side of the coin is that rate cuts could bring banks and/or probably syndicated markets back into the fold as deeper competition for private credit. But on the net, there are more tailwinds than headwinds."