U.S. pension funds are following in the footsteps of endowments and foundations by ramping up their alternatives portfolios while cutting down on equity and fixed-income allocations.

According to a new report from Greenwich Associates, pension plan sponsors are making the significant changes to expand their holdings of alternative investments, especially hedge funds and private equity, and increasing their exposure to international investments—particularly foreign equities, which plan sponsors expect to outperform domestic stocks by a wide margin.

While allocations to p.e. and equity real estate declined slightly last year across all U.S. institutions, allocations remain substantial among certain types of investors: Public pensions allocated 5.6% of assets to equity real estate, and endowments devoted 8.3% of assets to p.e.

Hedge fund allocations continued to climb: Institutions allocated 2.6% of total assets to hedge funds in 2007, up from 2.2% in 2006, 1.9% in 2005, and 1.6% in 2004. And allocations among active users of hedge funds were much higher.

At the same time, institutions increased their allocations to international stocks to 17.9% of total assets in 2007 from 15.2% the prior year while allocations to domestic equities continued to drop, falling to 41.7% in 2007 from 44.8% in 2006. Funds cut domestic fixed-income allocations to 21.4% from 22.4%, continuing a steady decline that now dates back at least five years.

Greenwich’s research results suggest that many of these trends will remain in place and even intensify in 2008: Nearly a third of institutions plan to significantly increase allocations to private equity, 23% expect to increase hedge fund allocations and 21% plan to boost equity real estate allocations. In each case, only 1% to 2% of institutions plan to cut their allocations.

“Our research reveals that diversification remains the dominant trend in institutional portfolios,” said Greenwich Associates consultant William Wechsler. “And in general, this diversification is taking two forms: The shift of assets into alternative investments and allocation adjustments that reduce the level of 'home-bias' and change portfolio composition to better reflect global market capitalization.”