US pension funds worth $1.5tn add risk through leverage

US public pension plans that manage hundreds of billions of dollars of assets are increasingly turning to risky leverage strategies as burgeoning private market holdings create cash flow strains.

At least eight very large US public pension funds are using borrowed cash or other leverage strategies, now that the board of Calstrs, one of the largest US retirement funds, this month voted to allow the fund to borrow as much as $30bn, or 10 per cent of its portfolio.

The strategy has risen in prominence as these giant funds have tied up a larger and larger share of their assets in illiquid investments such as private equity, infrastructure and real estate. Using borrowed money and derivatives can help boost returns, rebalance portfolios and give the funds access to cash without having to resort to fire sales of illiquid assets during times of market stress.

But use of leverage can backfire, as it did during the 2022 gilt markets crisis, when forced selling by UK pension funds led to an emergency intervention by the Bank of England. Global regulators have recently stepped up scrutiny of the practice as well as broader systemic risks posed by nonbank financial institutions.

“If you are borrowing money to help avoid fire sales then this is a risky strategy because the money still needs to be paid back,” said Alasdair Macdonald, head of investment strategy with WTW, a global professional services firm.

“There is still a risk that assets will have to be sold at low prices, to repay the borrowing, locking in losses.”

California’s Calpers as well as state funds in Wisconsin and Texas are among the large funds already using leverage as part of their strategies. Virginia Retirement System said they are adding the tactic in the near future. The eight US funds known to have embraced leverage together manage $1.5tn.

Many large pension funds currently have more money allocated to private equity than their targets, in part because a slowdown in deals and new listings mean…