U.S. public pension funds increasingly face negative net operating cash flows as benefit payments exceed contributions. We study how these funds incorporate cash flows into their asset allocation and investment decisions using aggregate pension fund data and granular holdings data obtained through FOIA requests. While asset allocation models predict that investors should accommodate negative cash flows by adopting more conservative portfolios, we show empirically that target allocations are independent of cash flows. Instead, negative cash flows make pension funds predictable net sellers and liquidity demanders in financial markets. Pension funds accommodate predictable negative cash flows by selling fixed income and equities, but they meet negative cash flow shocks by liquidating equities and even alternative assets. These liquidity-driven sales of equities occur even during periods of negative equity returns, which confirms that liquidity sales are separate from portfolio rebalancing. At the security level, pension funds sell across equities and do not follow a liquid-assets-first approach. Pension funds more exposed to alternatives rely disproportionately on equity sales to meet liquidity needs.
