Public pension funds are the largest institutional allocator of capital to hedge funds by dollar value.  Accordingly, how public pension fund managers approach asset allocation matters profoundly to the size, strategies and revenues of the hedge fund industry.  Recently, managers of some prominent public pension funds have been rethinking their approach to asset allocation in light of the lessons of the credit crisis.  Three of the more important lesson from the crisis relate to liquidity, risk and correlation.  The liquidity story is well-known: it dried up, and many hedge fund investors who needed liquidity were not able to get it.  With respect to risk, the crisis highlighted the inadequacy of existing risk management tools employed by hedge fund investors.  And regarding correlation, the crisis witnessed assets heretofore considered uncorrelated moving – generally downward – in lockstep.  Some public pension fund managers have revised, or are considering revising, their asset allocation strategies to incorporate these three lessons.  Under the old paradigm, pension funds allocated their considerable assets based on asset class or type.  That is, they invested designated percentages of their assets in bonds, stocks, real estate, private funds (hedge funds, private equity funds, venture capital funds, infrastructure funds, etc.) and cash.  Under the new approach, pension funds are allocating their assets to categories defined by three key considerations: drivers of return, liquidity and risk.  For example, as explained more fully below, under the old approach, Treasury Inflation Protected Securities (TIPS) generally were grouped with bonds for allocation purposes.  However, the Alaska Permanent Fund Corporation (Alaska PFC) now groups TIPS with other assets intended to protect against inflation, including real estate and infrastructure investments.  (The Alaska PFC is the state-owned corporation in charge of administering the Alaska Permanent Fund.  Under the Alaska state constitution, 25 percent of the state’s mineral revenues are placed in the Alaska Permanent Fund, which is invested in a diversified portfolio and pays income dividends to qualifying Alaska residents.)  Similarly, Denmark’s ATP Fund, the largest Danish pension fund, reportedly has combined public and private equity for allocation purposes because the returns of both asset classes are affected to a significant degree by corporate earnings.  Previously, the ATP Fund had separated public and private equity for allocation purposes.  This article examines the potential paradigm shift in pension fund allocation strategy in more depth.  In particular, it discusses the evolving views of pension fund managers on liquidity and risk.  In addition, based on an interview conducted by the Hedge Fund Law Report with Michael Burns, CEO of the Alaska PFC, the article provides a detailed description of Alaska’s revised allocation approach.  Since CalPERS is also considering a shift to an allocation strategy based on drivers of returns, Alaska’s revised approach may serve as a persuasive precedent.  Finally, the article discusses the potential impact on hedge funds of pension funds’ changed allocation strategy, and briefly describes the related trend toward “liability-driven” investing.