Op-Ed: Public pensions bet underfunded retirements on private credit's riskiest corner
Regional News
Audio By Carbonatix
12:18 PM on Monday, August 17
Equable Institute reported on July 23 that America's state and local pension systems have reached their best-funded status since 2009. Trustees will read that as vindication for a decade of reaching into private credit for extra yield.
I spent years underwriting exactly this kind of loan before Wall Street gave it a retail-friendly name, and vindication is not the word I would use. Unfunded liabilities still total $1.13 trillion. A system can improve every year for a decade and still owe more than a trillion dollars it does not have, and several of the pension systems chasing that improvement now sit with allocations to the same private credit funds that spent the first half of 2026 capping investor withdrawals, a built-in limit meant to stop a manager from dumping illiquid loans into a falling market, well below what was requested.
The reach happened fast. Pensions & Investments' annual survey found that defined-benefit funds among the 200 largest U.S. retirement plans held $198.4 billion in private credit as of Sept. 30, 2024, up 57.2% from $126.2 billion a year earlier and roughly 7.6 times what they held five years before. That is not a gradual reallocation. It is a stampede into a still-maturing corner of credit markets, timed almost exactly with the retail boom in the same funds now facing redemption pressure.
California's teacher pension fund is the clearest case. CalSTRS, a $402 billion system, holds private credit funds managed by Blue Owl Capital and is, according to Reuters, citing LSEG data, the largest investor in Blue Owl Capital Corp, one of the manager's publicly traded business development companies.
A CalSTRS spokesperson told Reuters the system remains committed to its long-term strategy, including investing in private credit. Arizona's Public Safety Personnel Retirement System has built its allocation toward a 20% target, reporting 14.9% as of March 31. Kentucky's Employees' Retirement System carries the same 20% target, telling its investment committee this past November that private credit remains attractive relative to private equity. None of these systems built these positions quietly. Trustees approved every target in a public meeting, and none of them fully disclose which specific funds sit underneath.
Public pension reporting shows commitments to managers and broad asset-class targets. It does not routinely show a fund-by-fund map of exposure to Blackstone's BCRED, Blue Owl's OCIC and OTIC, or Apollo's Debt Solutions BDC, the specific vehicles that spent the first half of 2026 capping withdrawals well below investor demand. A beneficiary in Kentucky or Arizona cannot look up whether the system's private credit manager holds a stake in a fund gating retail investors on the other side of the same balance sheet.
The mechanism is not theoretical. Morgan Stanley's credit team has projected direct lending default rates could climb to 8%, concentrated in the roughly 26% of exposure sitting in software borrowers now pressured by artificial intelligence. Howard Marks, whose credit judgment I have trusted for decades, warned in an April memo that some direct lending managers accepted too much capital too quickly and underwrote to standards that would not hold. A retail investor who cannot redeem from a fund experiences an inconvenience. A pension system that cannot redeem or has to mark down a position it believed was performing widens the exact funding gap it took the position to close. The shortfall does not vanish. It moves to whichever taxpayer or future contribution rate closes it instead.
None of this means public pensions should abandon private credit. Diversified, conservatively underwritten direct lending has earned its place in an institutional portfolio for decades, and systems disciplined about manager selection will likely be rewarded once this cycle clears. It means pension boards should require, as a matter of ordinary fiduciary duty, fund-level transparency into which private credit vehicles their managers hold, and stress testing against the redemption pressure that already hit five major funds this year.
A trustee who cannot answer whether the system's book overlaps with a gated fund is not exercising oversight. They are hoping on the public's dime. For public money already short by $1.13 trillion, hope is not a fiduciary standard, and it should not be the one we accept.
