Unlocking Value: Pension Fund Strategies in Private Equity Amid Liquidity Challenges

In the evolving landscape of global pension fund management, private equity has emerged as both a cornerstone and a conundrum. Over the past two decades, pension funds have increasingly allocated capital to private equity, driven by the allure of diversification and risk-adjusted returns. However, as of Q1 2025, more than half of pension funds globally exceeded their target allocations to private equity, with the median actual allocation surpassing the median target by $23.5 million across 298 fundsPension funds record overallocation to private equity in Q1 2025^[1]. This overallocation, fueled by prolonged holding periods, slow exit activity, and the denominator effect—where public market corrections inflate the relative value of private assets—has created a liquidity bottleneckPrivate Equity Trends in 2025 - With Intelligence^[2].

The Overallocation Dilemma

The scale of overallocation is stark. California State Teachers' Retirement System (CalSTRS) alone reported a $7.49 billion overallocation, while the Public Sector Pension Investment Board in Montreal faced a $6.02 billion surplusPension funds record overallocation to private equity in Q1 2025^[1]. These figures underscore a systemic issue: pension funds are now constrained in their ability to deploy new capital, as older vintages trap over $1 trillion in net asset value (NAV) with limited exit pathwaysPrivate Equity for Pension Plans? Evaluating Private Equity Performance from an Investor’s Perspective^[3]. The result is a misalignment between capital commitments and liquidity needs, forcing funds to rethink their private equity pacing models.

Compounding this challenge is the uneven performance of private equity strategies. While buyout funds demonstrate modest risk-adjusted outperformance, venture capital and real estate underperformPrivate equity and liquidity challenges | Deloitte Insights^[4]. Public pension plans, which benefit from preferential access to top-tier deals, have outperformed other limited partners (LPs), but this edge is not sustainable without disciplined selectionPrivate equity and liquidity challenges | Deloitte Insights^[4]. Underfunded plans, meanwhile, often gravitate toward riskier strategies, a trend linked to agency issues and political pressuresPrivate equity and liquidity challenges | Deloitte Insights^[4].

Partial Divestment: A Strategic Rebalancing

To address liquidity constraints, pension funds are increasingly adopting partial divestment strategies. Secondary market transactions, for instance, have gained traction as a means to streamline manager rosters and redirect capital to more liquid alternatives. The secondary market, though undercapitalized relative to deal flow, is experiencing a surge in fundraisingPrivate Equity Trends in 2025 - With Intelligence^[2]. For example, the partial divestment of Indonesia's Jasamarga Transjawa Tol (JTT) in 2024—reducing its stake from 99% to 65%—attracted strategic investors like GIC and Metro Pacific Tollways Corporation, generating $1 billion in liquidity while preserving long-term valueDivestment - Case Studies Public Private Partnership^[5].

GP-led continuation funds represent another avenue. These structures allow general partners (GPs) to provide liquidity to LPs by extending the life of a fund or spinning off a subset of its portfolio. This approach not only unlocks capital but also retains ownership of high-quality assets, potentially enhancing value through operational improvementsThe Opportunities Across Private Equity’s Current Liquidity Landscape^[6]. Similarly, mid-life co-investments enable GPs to secure additional equity for portfolio companies without full exits, supporting liquidity needs while maintaining strategic controlThe Opportunities Across Private Equity’s Current Liquidity Landscape^[6].

Liquidity Optimization Frameworks

Beyond divestment, pension funds are embracing liquidity optimization frameworks to align with evolving investor expectations. Custom capital structures blending debt and equity features are gaining popularity, offering attractive yields and flexible return profilesThe Opportunities Across Private Equity’s Current Liquidity Landscape^[6]. For instance, private IPOs—where GPs sell minority stakes in portfolio companies to private investors—are emerging as a viable exit alternative. Deloitte forecasts that such structures could account for 40% of private equity exits by 2028 if public market valuations remain elevatedTimeline of Divestment Milestones - LGPS Divest^[7].

Regulatory scrutiny, however, looms large. As pension funds migrate capital to private credit, infrastructure, and renewable energy, concerns about opacity and complexity persistPrivate Equity for Pension Plans? Evaluating Private Equity Performance from an Investor’s Perspective^[3]. To mitigate risks, funds are investing in digital transformation initiatives, enhancing transparency and operational efficiencyDivestment - Case Studies Public Private Partnership^[5].

Ethical and Strategic Considerations

Partial divestment is not solely a liquidity play. Ethical considerations are reshaping strategies, as seen in the UK's local councils divesting from fossil fuels and arms manufacturersDivestment - Case Studies Public Private Partnership^[5]. New York City's pension funds, which successfully defended their fossil fuel divestment in court, exemplify how governance and risk management intersect with investment decisionsDivestment - Case Studies Public Private Partnership^[5]. These cases highlight the growing alignment of pension fund strategies with ESG (Environmental, Social, Governance) objectives.

The Path Forward

For pension funds, the path forward lies in balancing risk, return, and liquidity. As defined benefit plans mature, the role of private investments is reevaluated to align with funding objectives and inflation hedgingDivestment - Case Studies Public Private Partnership^[5]. While buyout funds remain a core component, the shift toward private credit and infrastructure debt reflects a broader emphasis on consistent cash flowsPrivate Equity Trends in 2025 - With Intelligence^[2].

Conclusion

The overallocation to private equity is a double-edged sword: it reflects confidence in the asset class but also exposes pension funds to liquidity and governance risks. By leveraging partial divestments, secondary markets, and innovative liquidity frameworks, funds can unlock trapped capital while maintaining strategic exposure. As the private equity landscape evolves, the ability to adapt—without sacrificing long-term value—will define the success of pension fund strategies in the years ahead.