By Som Priestley, CFA®, Christopher Tarui, Ryan Wagner, CFA

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Optimizing Opportunities: Public Pension Plans Reassess Allocations Amid Higher Fixed Income Yields

February 2025

Key Insights

Public defined benefit plans have become overweight risk assets in an effort to achieve return targets.
We believe higher capital market assumptions have created additional pathways for plans to pursue their return targets.
Plans have the opportunity to reassess their asset allocations as we believe that plans may be able to reduce overall risk while maintaining their expected return.

The Crisil Coalition Greenwich 2024 Public Pension Defined Benefit Study sponsored by T. Rowe Price confirmed our expectations that defined benefit (DB) plans became overweight risk assets and have maintained this positioning despite broadly higher capital market assumptions (CMAs). Our Solutions team analyzed the effects of historical CMAs and expected return on assets (EROAs) to understand how each could be impacting asset allocations now and how these allocations could evolve going forward. Our analysis indicates that plans could be in a position to meet their EROAs while lowering overall portfolio risk.

Potential asset allocation imbalances have emerged in public pensions

Our mid-2024 Crisil Coalition Greenwich survey revealed that the average defined benefit plan had significant exposure to risk assets, with average allocations to equity, both public and private, of 56%. Figure 1 highlights that many respondents were overweight their own equity targets.

This finding was not surprising—over a decade of zero or near-zero interest rates hampering fixed income return potential contributed to this dynamic. What was somewhat surprising given the notable increase in available yields in recent years is that many allocations have remained overweight risk assets and underweight public fixed income.

Figure 2 illustrates the period of near-zero interest rates that forced plans to increase equity allocations in an effort to achieve their targeted return goals. The sharp increase in interest rates in recent years has reversed this dynamic, yet many plans remain overweight equity and could consider reevaluating this positioning.

Higher CMAs: New possibilities

Central bank rate hikes of 2022–2023 have led to higher-yielding fixed income assets, and CMAs have risen in many asset classes, notably in public fixed income sectors. With our survey indicating that the majority of plans intended to hold EROAs steady, we evaluated how impactful increased CMAs could be to asset allocation possibilities.

We simulated thousands of portfolio weights and constructed portfolios using 2020 and 2025 return assumptions to understand the impact that different return environments would have had on portfolios.

"With significantly more portfolios potentially achieving targeted results, investors have more options for how they allocate their assets."
– Christopher Tarui
Head of U.S. Consultant Relations

Source: Crisil Coalition Greenwich 2024 Public Pension Defined Benefit Study. Figures inparentheses ( ) indicate number of respondents.

Analysis is for illustrative purposes only and are not indicative of future results.
Graphic displays the required expected equity return to representative pension plan portfolio returnassumption (allowing for leverage). Expected nominal equity returns constructed using the ShillerCyclically Adjusted S&P Price to Earnings Ratio (1/CAPE) and the University of Michigan 5-yearinflation expectations survey; returns adjusted so that the U.S. equity expected returns matchedthe realized returns (3.3% gap adjustment). Fixed income expected returns are represented withthe Bloomberg U.S. Aggregate Bond Index yield-to-worst, and cash is represented by the yield onthe 3-month U.S. Treasury constant maturity index.Given expected return for bonds and equity, we calculate the required equity allocation (or weight)to meet a 7% return target. In cases where meeting the return target was not feasible by mereequity and bonds, we allow for leverage using cash returns. Calculations based on 12-month rollingreturns.
Sources: Haver Analytics, Federal Reserve Bank of St. Louis. Public Plans Data. 2002–2022.Center for Retirement Research at Boston College, Mission Square Research Institute, NationalAssociation of State Retirement Administrators, and Government Finance Officers Association.
Data for 2023 assumed as data for 2022. Please see Additional Disclosures page for relevant indexdata provider legal notices and disclaimers for this Bloomberg Index Services Limited sourcinginformation.

As shown in Figure 3, approximately 2% of all the potential portfolios would have achieved the average pension EROA of 7%¹ when using 2020 CMAs. This figure increases dramatically—to nearly 20% of all potential portfolios meeting the EROA target—when using 2025 CMAs that have risen as higher cash rates have increased fixed income yields across sectors.

We estimate that revised asset allocations that increase exposure to fixed income can potentially reduce overall portfolio risk by nearly 20% while still achieving an ex-ante return profile that aligns with typical public plan EROAs. Using the 2025 CMAs, the average current allocation would generate an expected five-year return of 7%, which is in the middle of the stated range. To estimate the reduction in volatility, we targeted the same return value while minimizing risk, within some constraints:

No more than 5% allocation to fixed income subsectors
U.S./non-U.S. equity split remains aligned with MSCI All Country World Index
Cap of 5% on private credit and 10% on real estate

This simulation analysis for illustrative purposes only and is not indicative of any product, strategy, or client account.
Results based on 100,000 simulated portfolio weights using 2020 and 2025 CMA assumptions for returns, variances and covariances of global equity, emerging market (EM) equity, Global Aggregate ex U.S. (Hedged), U.S. Cash, U.S. Aggregate, U.S. High Yield, U.S. Bank Loans, EM Sovereign, Hedge Funds, and Private Equity.Source: Cambridge Associates LLC. Please see Additional Disclosures page for a representative list of indexes and relevant index data provider legal notices & disclaimers for this Bloomberg Index Services Limited, FTSE/Russell, HFR, J.P. Morgan Chase and Co., Morningstar, and MSCI sourcing information and other important information.Information presented consists of blends of various market indices using historical performance data and allocations named in the T. Rowe Price Capital Market Assumptions. The sample portfolios do not reflect the impact that material economic, market, or other factors may have on weighting decisions. If the weightings change, results would be different. Analysis by T. Rowe Price. Using 2020 and 2025 T. Rowe Price CMAs.

In achieving the volatility reduction, increased allocations to plus-sector fixed income (bank-loans, securitized, distressed debt) would offset reductions in private equity, cash, and hedge funds.

Opportunities to reduce risk asset allocations and add fixed income

The results of our public defined benefit plan survey confirm that plans remain overweight risk assets; however, the current environment creates opportunities to reassess asset allocations, as there are more portfolio construction options that can deliver against return targets while lowering overall risk.

"We believe there is an opportunity for pension plans to seek similar returns while lowering risk. It may be time for some investors to look to opportunities in fixed income."
– Som Priestley
Regional Head of Multi-Asset Solutions

Forecasts are for illustrative purposes only and are not indicative of future results.
This information is not intended to be investment advice or a recommendation to take any particular investment action. Forecasts are based on subjective estimates about market environments that may never occur. See page 7 for Important Information on T. Rowe Price Capital Market Assumptions. For full CMA methodology, request a copy of the Capital Market Assumptions Methodology document.Source: Cambridge Associates LLC.
Please see Additional Disclosures page for relevant index data provider legal notices & disclaimers for this Bloomberg Index Services Limited, FTSE/Russell, HFR, J. P. Morgan Chase & Co., Morningstar, MSCI, Standard & Poor’s sourcing information.

Som Priestley, CFA® Regional Head of Multi-Asset Solutions

Som Priestley is head of Multi-Asset Solutions, North America and a portfolio manager in the Multi-Asset Division. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.

Christopher Tarui Head of Global Institutional Alternatives Distribution, U.S. Consultant Relations, and OCIO

Chris Tarui is the head of U.S. Consultant Relations with the Americas division of T. Rowe Price, the organization responsible for the firm's institutional business in North America. In the Americas division, his responsibilities include OCIO and global alternatives distribution. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.

Ryan Wagner, CFA Institutional Client Service Executive

Ryan Wagner is an institutional client service executive in the Americas division, the organization responsible for the firm's institutional business in North America. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price Associates, Inc.

¹ The 7% EROA target was informed by historic pension plan EROAs. Source: Center for Retirement Research at Boston College, Mission Square Research Institute, National Association of State Retirement Administrators, and Government Finance Officers Association.

Additional Disclosures

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Source for Morningstar data and index data: © 2025 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

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Source for Standard & Poor’s index data: The S&P Indices are a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). This presentation is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P Indices.

Important Information

T. Rowe Price Capital Market Assumptions: The information presented herein is shown for illustrative, informational purposes only. Forecasts are based on subjective estimates about market environments that may never occur. This material does not reflect the actual returns of any portfolio/ strategy and is not indicative of future results. The historical returns used as a basis for this analysis are based on information gathered by T. Rowe Price and from third-party sources and have not been independently verified. The asset classes referenced in our capital market assumptions are represented by broad-based indices, which have been selected because they are well known and are easily recognizable by investors. Indices have limitations due to materially different characteristics from an actual investment portfolio in terms of security holdings, sector weightings, volatility, and asset allocation. Therefore, returns and volatility of a portfolio may differ from those of the index. Management fees, transaction costs, taxes, and potential expenses are not considered and would reduce returns. Expected returns for each asset class can be conditional on economic scenarios; in the event a particular scenario comes to pass, actual returns could be significantly higher or lower than forecast.

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202412-4082874

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