2025 Investment Themes for Public Funds

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• On: 02/13/2025 12:03:10
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By: Katie Comstock and Julie Becker, Aon 

With a new market vantage point entering 2025, opportunities exist for public pension plans to reevaluate fixed income portfolio construction, assess liquidity, reconsider private market allocations, and evaluate their governance processes. 

This is an excerpt from NCPERS Winter 2025 issue of PERSist.

The market environment entering 2025, with higher interest rates, normalizing inflation, resilient economic growth, and heightened geopolitical concerns, is offering a new vantage point for investment decision-making. We anticipate these new and interesting dynamics to offer four major investment themes for public funds in the upcoming year.  

1. Fixed Income Portfolio Construction 

Typically, liquid core fixed income mandates are heavily anchored to the Bloomberg Aggregate Index. This benchmark's profile has evolved over the past several years and now offers roughly 80% government-related risk and represents less than half of the publicly traded fixed income universe, as shown in the following exhibit.  
 


There are potential advantages for investors to branch out beyond the Aggregate Index. Other areas that are attractive include private corporate credit, asset-based finance/securitized credit, specialty finance, and opportunistic credit. Opportunities span investment grade and high yield, as well as public and private markets. These types of securities can offer greater yield premiums for illiquidity, complexity, and simply being outside major indices. We believe these opportunities can benefit a range of investors, spanning fixed income portfolios with conservative goals to those with return-focused objectives.  

2. Assess Liquidity 

A key reason liquidity is important is that it affects the opportunity set of investments that public funds can consider. For plans already stretched on liquidity, there may not be significant ability to expand investments in illiquid assets without creating unwanted risks. Whereas public plans with capacity to invest in more illiquid assets have greater ability to consider increasing existing allocations and/or adding new allocations to illiquid assets. 

Public funds have been increasing their allocations to alternative investments (many of which are considered illiquid investments) for decades, as shown in the following exhibit. 



As we enter 2025, many public funds are at or above their target allocations for illiquid assets, while many opportunities for alternative investments look attractive. As a result, many plan sponsors are evaluating their capacity to increase target allocations to illiquid assets. This requires careful analysis of each fund's unique circumstances, and importantly, specific cash flow expectations under a range of potential economic scenarios. 

3. Reevaluate Opportunities in Private Markets 

Our third theme for 2025 is reevaluating opportunities across private markets. As noted in Theme 2 of assessing liquidity, it is crucial to understand the capacity for illiquidity when determining whether to delve further into private markets. Changing market conditions reshuffles the attractiveness of various strategies across private markets, making many investors reevaluate their allocations. Most notably, the interest rate environment today impacts the relative attractiveness of many types of private assets where the returns are tied to interest rates (e.g., direct lending), where leverage is used (e.g., core real estate), or where performance is influenced by cash returns (e.g., some hedge funds using derivatives). 

The growth in private markets has been significant and there is a myriad of potential roles these strategies play, such as return enhancement, diversification¹, inflation hedging, and impact investing, to name a few.  We anticipate private market allocations to continue to increase through 2025, with particular focus on aligning exposure with areas deemed most attractive, such as various forms of private credit and real assets. 

4. Evaluate Governance 

Governance is primarily about having the processes in place to successfully determine and execute the investment views. We see an increased focus on governance by entities of all sizes, which is necessary as markets and investment solutions are getting increasingly complex. Strong governance is the foundation of a successful pension system. 

Some specific aspects of governance getting more attention from public funds recently include: 

• articulating investment objectives and beliefs (including on topics related to responsible investing and diverse manager initiatives) 
• addressing debates about ESG, risk management processes (operational due diligence has been getting greater focus) 
• processes for vetting new investments (to make sure there are sufficient controls, without limiting flexibility too much) 
• setting actuarial parameters like the assumed long-term return on assets.