Callan consultants tell Lexington pension committee portfolio can be modestly de-risked while adding private credit; follow-up meeting set

Callan investment consultants told members of the Lexington City Pension Board subcommittee that the city’s current asset mix is projected to meet the plan’s 7% actuarial return target over a 10-year horizon but that the board can modestly increase defensive allocations without sacrificing expected return.

The presentation, led by John Perron, senior vice president in Callan’s capital markets group, laid out two main paths: (1) incrementally increase the allocation to core fixed income (the consultants suggested around a 5 percentage-point increase funded from public equities) to reduce portfolio volatility while still targeting 7% long-term returns and (2) consider introducing alternative assets — specifically private credit, private equity and infrastructure — with private credit shown as the most diversifying of the three in Callan’s “straw-man” mixes.

Callan presented baseline numbers to illustrate the tradeoffs. “The current allocation has a projected 10 year return of about 7.12%,” Perron said during his slides. He and other Callan staff noted that core fixed income forecasts have risen since the prior asset-liability study, with expected 10-year returns for high-quality fixed income roughly in the mid-to-high 4 percent range (around 4.75–5.0%), improving the case for modestly stronger allocations to bonds.

Why it matters: Callan showed that because the spread between expected equity and fixed-income returns has narrowed relative to several years ago, moving a small slice of the portfolio into investment-grade fixed income can materially reduce downside volatility without dropping below the actuarial return assumption. As Perron summarized, an incremental 5% shift into core fixed income (funded from public equity) would still leave the plan with an expected return near the 7% target while lowering the portfolio’s standard deviation.

On alternatives, Callan presented private credit as a relative hybrid: it offers yields comparable to publicly traded high-yield bonds but with a liquidity premium and a degree of structural covenant protection. In Callan’s modeling, adding 5% to a private credit allocation (funded roughly 3% from U.S. equity and 2% from international equity in the firm’s straw-man) produced an improved Sharpe ratio and modestly lower standard deviation compared with pure equity exposure. Callan cautioned private credit and private equity carry longer lockups and different operational requirements: private credit looked like a multi-year investment (roughly 3–5 year effective liquidity in typical vehicles), while private equity typically involves a longer illiquidity profile (around 10 years in closed-end structures).

Committee reaction and next steps: Several board members signaled informal agreement with a modest move toward fixed income and interest in examining private credit more closely. Board member Aaron said he was “comfortable with … moderately adjusting U.S. and global together” and called private credit “probably my preference.” Another board member, Tommy, said he could be persuaded to add private credit but preferred modest steps.

The committee agreed, by general consent, to schedule a follow-up subcommittee meeting for more detailed modeling and to consider operational implications (vehicles, liquidity, fee and administrative structure). The group set a virtual meeting for 10:30 a.m. on June 25 to review more detailed asset-liability modeling and to dig deeper on private credit and the non-U.S. structure. Callan said it would deliver more detailed modeling at that session.

Discussion-only items and constraints: Callan emphasized that nothing in the current asset mix was “broken” and that the proposals are intended as incremental, not radical, changes. The consultants repeatedly framed choices as trade-offs between expected return and risk (standard deviation) and highlighted that private credit and private equity carry liquidity and implementation differences that will require investment-policy or operational adjustments if the board pursues them.

Ending

Staff and the consultant will return to the subcommittee with modeled mixes that show the effect of (a) adding roughly 5 percentage points to core fixed income funded from public equities and (b) alternatives mixes that add 5 percentage points to private credit (funding sources shown as a mix of U.S. and global ex‑U.S. equity). The board also requested modeling that tests a modest home‑country bias (reducing international equity by about 4%) and the operational steps needed to permit private-credit allocations within the plan’s investment policy.