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

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Balancing Risk and Return: Public Pension Plan Allocations in a New Fixed Income Environment

Public pension plans may be accepting more volatility than is needed to meet return targets.

November 2025, From the Field

Key Insights

The investment environment has changed since the U.S. Federal Reserve began its last tightening cycle in 2022. Fixed income yields have risen substantially.
Our latest five-year capital market assumptions include expected bond returns that are considerably higher than the levels seen over the past decade.
We observe U.S. public defined benefit plans may be accepting more volatility in their portfolios than is needed to achieve their expected return targets.

In the first quarter of 2025, we published a white paper entitled, “Optimizing Opportunities: Public Pension Plans Reassess Allocations Amid Higher Fixed Income Yields.”¹ The paper explored both the results and the implications of applying current capital market assumptions (CMAs) with the average asset allocations of U.S. public defined benefit (DB) plans.

The background to our earlier paper was the Federal Reserve’s decision to begin raising interest rates in 2022, which ended the prolonged period of zero or near-zero cash rates that followed the 2008-2009 global financial crisis (GFC). In that environment, the average public pension plan was forced to adopt a more aggressive asset allocation in order to meet its expected return on assets (EROA).

Like many investment firms, T. Rowe Price constructs its CMAs using the building block methodology, in which riskier asset classes are assumed to pay a premium over the cash rate to compensate investors for their higher expected volatility.² Logically, then, after the Federal Reserve began tightening, the expected returns in our CMAs rose to levels not seen in the prior decade. This was particularly true for many fixed income asset categories (Figure 1).

Expected returns in T. Rowe Price’s CMAs have risen substantially since 2022

(Fig. 1) Annualized five-year expected returns in U.S. dollars, 2022 CMAs vs. 2025 CMAs

Column chart comparing expected returns in our 2022 and 2025 Capital Market Assumptions.

This analysis is for illustrative purposes only and is not indicative of any product, strategy, or client account.
T. Rowe Price CMAs are as of February 2022 and February 2025.
Please see the Appendix for a list of the reference indexes used to represent the asset classes included in T. Rowe Price’s Capital Market Assumptions.
Sources: Bloomberg Finance L.P., FTSE/Russell, and MSCI. Visit troweprice.com/marketdata for additional legal notices and disclaimers. All data analysis by T. Rowe Price.

Meanwhile, our return assumptions for U.S. large-cap stocks are somewhat higher than in our 2022 CMAs but far lower than the outsized gains realized in recent years.

Given these trends, we found that applying our 2025 CMAs to the post-GFC asset allocations of over 200 U.S. public DB plans produced an expected level of portfolio volatility that was higher than what we believe will be necessary to achieve the average expected return on assets (EROA) target of approximately 6.8%.³

Our key takeaway from those calculations was that the current capital market environment offers an opportunity for public DB plans—and, indeed, for any investor—to revisit their strategic asset allocation (SAA) and potentially reduce expected volatility without sacrificing the ability to meet their required return targets.

Opportunities Revisited

As a follow-up to our original paper, we re-tested our hypothesis using data from the public pension fiscal year that closed on June 30, 2025. We reviewed performance for U.S. public DB plans with more than $1 billion in total assets.

As reported by Pensions & Investments, the median performance across the 74 plans that had published their results as of October 8, 2025, was 10.6% (versus 9.9% for the 2024 plan year and 7.6% in fiscal 2023).⁴

While this strong outperformance was a welcome result, it underscored the fact that the average public DB plan still may be taking more risk than necessary to achieve an average EROA of 6.8%.

Reassessing the average plan allocation

To illustrate our thesis, we compared the current average SAA for U.S. public DB plans against an alternative SAA that was rebalanced to seek a 7% expected return while minimizing volatility (Figure 2).

Our analysis found that while the average plan’s SAA currently targets a 7% expected return, it has a projected volatility of 12.3% (Figure 3). Based on our five-year estimated CMAs and assuming a normal distribution of returns, this implies that the average U.S. public DB plan faces a 28.5% probability of experiencing a negative return in any given year.⁵

In contrast, our alternative SAA targeted the same 7% expected return but, as shown in Figure 3, had the potential to achieve that result with an expected portfolio volatility of just 9.1%. In our analysis, this represented a potential risk reduction of more than 25% and lowered the probability of a negative annual return to 22.1%. Although allocating 50% of a public DB plan portfolio to publicly traded fixed income assets might not be practical (or prudent, depending upon the implementation), we believe our updated analysis continues to demonstrate an existing opportunity for plans to reassess their asset allocations.

Conclusion

The post-GFC era was marked by extraordinarily low interest rates, which drove investors toward risk assets. Although monetary policy and market expectations have changed considerably since then, many plans continue to maintain allocations that reflect the previous environment and so may be overlooking a potential opportunity to achieve their return targets with less risk.

U.S. public DB plans may want to consider rebalancing their strategic asset allocations

(Fig. 2) Average public plan strategic allocation vs. a rebalanced SAA targeting lower risk¹

Donut chart comparing the average public DB plan allocation mix with a rebalanced alternative.

This analysis is for illustrative purposes only and is not indicative of any product, strategy, or client account.
¹Rebalanced SAA was optimized based on the expected asset class returns and volatilities shown in T. Rowe Price’s 2025 Capital Market Assumptions. The rebalanced SAA was determined by fixing the desired rate of return while minimizing the expected volatility subject to diversification constraints within the alternatives and public fixed income allocations. The rebalanced SAA portfolio maintained the same allocation to alternatives and allowed no more than a 5% allocation to each fixed income subsector. The rebalanced SAA does not reflect the impact that material economic, market, or other factors might have on weighting decisions. If the weightings were changed, results would be different.
Public Equity = MSCI ACWI Index. Public Fixed Income = Bloomberg Global Aggregate (Hedged USD) Index. Please see the Appendix for a list of the other reference indexes used to represent the asset classes shown above and for the return, volatility, and correlation estimates in T. Rowe Price’s 2025 Capital Market Assumptions.
Bloomberg Finance L.P., Cambridge Associates LLC, Cliffwater, FTSE Russell, MSCI, NAREIT/FTSE, and HFR. Visit troweprice.com/marketdata for additional legal notices and disclaimers. All data analysis by T. Rowe Price.

Current CMAs indicate a potential opportunity to meet return targets with less risk

(Fig. 3) T. Rowe Price CMA estimates vs. five-year historical performance

	Five-Year Historical	CMA Estimates
	Five-Year Historical	Average Public DB SAA	Rebalanced SAA
Total Portfolio Expected Return	10.2%	7.0%	7.0%
Total Portfolio Expected Volatility	9.6%	12.3%	9.1%

This analysis is for illustrative purposes only and is not indicative of any product, strategy, or client account.
T. Rowe Price CMAs are as of February 2025. Historical performance for the five-year period ended June 30, 2025. Returns are in U.S. dollars.
Source: Data analysis by T. Rowe Price. Please see the Appendix for a list of the reference indexes used to represent the asset classes included in T. Rowe Price’s Capital Market Assumptions.

2025 Five-Year Capital Market Assumptions

Forecasts are for illustrative purposes only and are not indicative of future results.
Sources: Bloomberg Index Services Limited, Cambridge Associates LLC, Cliffwater, FTSE/Russell, HFR, J.P. Morgan Chase, Morningstar, MSCI, NCREIF, and S&P. Visit troweprice.com/marketdata for additional legal notices & disclaimers. All data analysis by T. Rowe Price.
Please see Reference Indexes for a list of the indexes used to represent the asset categories included in T. Rowe Price’s Capital Market Assumptions.
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 byT. 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. For full CMA methodology, request a copy of the Capital Market Assumptions Methodology document.

Reference Indexes

	Asset Class	Reference Index
Equity	Global Equity	MSCI ACWI Index
	DM Equity	MSCI World Index
	DM ex-U.S. Equity	MSCI World ex-USA Index
	U.S. Equity	Russell 3000 Index
	U.S. Large-Cap Equity	Russell 1000 Index
	U.S. Small-Cap Equity	Russell 2000 Index
	EM Equity	MSCI Emerging Markets Index
	Real Asset Equity	S&P Real Assets Index
Fixed Income	Global Aggregate	Bloomberg Global Aggregate Bond Index
	Global Aggregate ex-U.S. (Hdg)	Bloomberg Global Aggregate ex-U.S. (USD Hedged) Index
	Global High Yield	Bloomberg Corporate High Yield Bond Index
	U.S. Cash	Bloomberg 1–3 Month Treasury Bills Index
	U.S. Treasury	Bloomberg U.S. Treasury Bond Index
	U.S. IG Corporate	Bloomberg U.S. Aggregate Corporate Bond Index
	U.S. Aggregate	Bloomberg U.S. Aggregate Bond Index
	U.S. High Yield	Bloomberg U.S. Corporate High Yield Bond Index
	U.S. Bank Loans	Morningstar LSTA Leveraged Performing Loan Index
	U.S. Securitized	Bloomberg U.S. Securitized Index
	U.S. TIPS	Bloomberg Global Inflation-Linked U.S. TIPS Index
	EM Sovereign	JP Morgan EMBI Global Diversified
	EM Corporate	JP Morgan CEMBI
Alternatives	Commodities	Bloomberg Commodity Index
	REITs	FTSE EPRA/NAREIT Developed Index
	Hedge Funds	HFRI Fund of Funds Composite Index
	Private Equity	Cambridge Associates LLC Global Private Equity Index
	Private Credit	Cliffwater Direct Lending Index

Hdg = Hedged currency exposure. EM = Emerging Markets. DM = Developed Markets.
Sources: Bloomberg Index Services Limited, Cambridge Associates LLC, Cliffwater, FTSE/Russell, HFR, J.P. Morgan Chase, Morningstar, MSCI, NCREIF, and S&P. Visit troweprice.com/marketdata for additional legal notices and disclaimers.

U.S. public DB plans may want to consider rebalancing their strategic asset allocations

(Fig. 2) Average public plan strategic allocation vs. a rebalanced SAA targeting lower risk¹

This analysis is for illustrative purposes only and is not indicative of any product, strategy, or client account.
¹Rebalanced SSA was optimized based on the expected asset class returns and volatilities shown in T. Rowe Price’s 2025 Capital Market Assumptions. The rebalanced SAA was determined by fixing the desired rate of return while minimizing the expected volatility subject to diversification constraints within the alternatives and public fixed income allocations. The rebalanced SAA portfolio maintained the same allocation to alternatives and allowed no more than a 5% allocation to each fixed income subsector. The rebalanced SSA does not reflect the impact that material economic, market, or other factors might have on weighting decisions. If the weightings were changed, results would be different.
Public Equity = MSCI ACWI Index. Public Fixed Income = Bloomberg Global Aggregate (Hedged USD) Index. Please see the Appendix for a list of the other reference indexes used to represent the asset classes shown above and for the return, volatility, and correlation estimates in T. Rowe Price’s 2025 Capital Market Assumptions.
Bloomberg Finance L.P., Cambridge Associates LLC, Cliffwater, FTSE Russell, MSCI, NAREIT/FTSE, and HFR. Visit troweprice.com/marketdata for additional legal notices and disclaimers. All data analysis by T. Rowe Price.

Current CMAs indicate a potential opportunity to meet return targets with less risk

(Fig. 3) T. Rowe Price CMA estimates vs. five-year historical performance

	Five-Year Historical	CMA Estimates
	Five-Year Historical	Average Public DB SAA	Rebalanced SAA
Total Portfolio Expected Return	10.2%	7.0%	7.0%
Total Portfolio Expected Volatility	9.6%	12.3%	9.1%

2025 Five-Year Capital Market Assumptions

Forecasts are for illustrative purposes only and are not indicative of future results.
Sources: Bloomberg Index Services Limited, Cambridge Associates LLC, Cliffwater, FTSE/Russell, HFR, J.P. Morgan Chase & Co, Morningstar, MSCI, NCREIF, and S&P. Visit troweprice.com/marketdata for additional legal notices & disclaimers. All data analysis by T. Rowe Price.
Please see Reference Indexes for a list of the indexes used to represent the asset categories included in T. Rowe Price’s Capital Market Assumptions.
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. For full CMA methodology, request a copy of the Capital Market Assumptions Methodology document.

Reference Indexes

	Asset Class	Reference Index
Equity	Global Equity	MSCI ACWI Index
	DM Equity	MSCI World Index
	DM ex-U.S. Equity	MSCI World ex-USA Index
	U.S. Equity	Russell 3000 Index
	U.S. Large-Cap Equity	Russell 1000 Index
	U.S. Small-Cap Equity	Russell 2000 Index
	EM Equity	MSCI Emerging Markets Index
	Real Asset Equity	S&P Real Assets Index
Fixed Income	Global Aggregate	Bloomberg Global Aggregate Bond Index
	Global Aggregate ex-U.S. (Hdg)	Bloomberg Global Aggregate ex-U.S. (USD Hedged) Index
	Global High Yield	Bloomberg Corporate High Yield Bond Index
	U.S. Cash	Bloomberg 1–3 Month Treasury Bills Index
	U.S. Treasury	Bloomberg U.S. Treasury Bond Index
	U.S. IG Corporate	Bloomberg U.S. Aggregate Corporate Bond Index
	U.S. Aggregate	Bloomberg U.S. Aggregate Bond Index
	U.S. High Yield	Bloomberg U.S. Corporate High Yield Bond Index
	U.S. Bank Loans	S&P/LSTA Leveraged Performing Loan Index
	U.S. Securitized	Bloomberg U.S. Securitized Index
	U.S. TIPS	Bloomberg Global Inflation-Linked U.S. TIPS Index
	EM Sovereign	JP Morgan EMBI Global Diversified
	EM Corporate	JP Morgan CEMBI
Alternatives	Commodities	Bloomberg Commodity Index
	REITs	FTSE EPRA/NAREIT Developed Index
	Hedge Funds	HFRI Fund of Funds Composite Index
	Private Equity	Cambridge Associates LLC Global Private Equity Index
	Private Credit	Cliffwater Direct Lending Index

Som Priestley, CFA Head, Global Investment Solutions

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

Ryan Wagner, CFA Institutional Client Service Executive

Public Pensions

We offer clients a full spectrum of investment options, leveraging our proprietary fundamental research platform, as well as client-driven solutions to address your plan’s unique challenges and goals.

¹On the web at https://www.troweprice.com/institutional/us/en/insights/articles/2025/q1/optimizing-opportunities-public-pension-plans-reassess-na.html.

²For our full CMA methodology, request a copy of the Capital Market Assumptions Methodology document.

³ The 6.8% EROA target was informed by historic pension plan EROAs. Sources: Center for Retirement Research at Boston College, Mission Square Research Institute, National Association of State Retirement Administrators, and Government Finance Officers Association.

⁴ “Another banner year for pension funds as public equities push returns higher,” Pensions & Investments, October 8, 2025.

⁵For the probability of loss calculations, our analysis used the estimated portfolio return and standard deviation for the average U.S. public DB plan, based on the average plan asset allocation mix and our 2025 CMAs, to estimate the probability of a negative return. Results should be interpreted with caution, as capital market assumptions may not fully capture future risks, and variance alone may not fully describe non-normality or tail risks in asset returns.

Important Information

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial, and tax advice before making any investment decision. T. Rowe Price group of companies, including T. Rowe Price Associates, Inc., and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or a solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction. Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of October 2025 and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price. The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

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Canada — Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to non-individual Accredited Investors and non-individual Permitted Clients as defined under National Instrument 45-106 and National Instrument 31-103, respectively. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

© 2025 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design and related indicators (see troweprice.com/ip) are trademarks of T. Rowe Price Group, Inc. All other trademarks are the property of their respective owners.

202511-4945353

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Balancing Risk and Return: Public Pension Plan Allocations in a New Fixed Income Environment

Expected returns in T. Rowe Price’s CMAs have risen substantially since 2022

Opportunities Revisited

Reassessing the average plan allocation

Conclusion

U.S. public DB plans may want to consider rebalancing their strategic asset allocations

Current CMAs indicate a potential opportunity to meet return targets with less risk

2025 Five-Year Capital Market Assumptions

Reference Indexes

U.S. public DB plans may want to consider rebalancing their strategic asset allocations

Current CMAs indicate a potential opportunity to meet return targets with less risk

2025 Five-Year Capital Market Assumptions

Reference Indexes

Public Pensions

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