One need not have a crystal ball to trace the pattern of forthcoming innovation. This road map is neither mystical, political nor magical; it’s just the typical way market forces play out over time as technology first transforms and then increasingly replaces labor as the source of value and profits. What remains unknown is whether these new systems will eventually equal or exceed human capabilities, leapfrogging from cost-effective research tools to actual decision-making platforms. The good news is that after initial successes by boutiques serving wealthy clients, institutional investors will be the next to benefit at scale, boosting pension trustees’ odds of achieving today’s actuarial assumptions.
It’s not hard to envision AGI systems first augmenting human analysts, portfolio managers and consultants — and eventually supplanting at least some of them if the next-level AAI pans out. Office workers who repetitively perform routine rules-based functions have the most to fear once we pass beyond the garbage-in/garbage-out phase, perhaps in three to four years. It’s a fair bet that institutional portfolio design and management will never be the same.
For historical perspective, we’ve seen three revolutions in the world of public pension portfolio management. The first included the prudent-person rule taking hold, along with modern portfolio theory, the capital market theory and Eugene Fama’s seminal treatise on efficient markets. Together, those concepts liberated public pension funds from lower-return bond portfolios.
Thereafter, index fund management caught on as the largest pension funds came to realize that they could not regularly maneuver their aircraft-carrier-size portfolios in the increasingly efficient public markets with enough agility to beat the averages.
The third revolution was the growing use of alternative assets, led most powerfully by the endowment fund wizards who figured out that private equity investments in particular could yield better returns over time in exchange for accepting less liquidity and marketability in their portfolios. Real estate, hedge funds, commodities and private credit managers also caught on as an alternative asset class of its own.
Looking ahead, don’t be surprised to see a few large yet fast-moving firms succeed in building powerful investment-tech platforms that enable multiple companies to deploy AGI and eventually AAI agents across a variety of enterprise tasks and workflows. Use cases are already emerging in the financial industry. Industry consolidation has already begun with the acquisition of a leading storehouse of private market data by one of the largest investment management houses. With deregulation and relaxed antitrust enforcement on the horizon from federal policymakers, the big are likely to get bigger with increasing market power. Boutiques are cute and intriguing, but they won’t move the actuarial needle: Size matters when capital, expertise and technology intersect with pension fund assets.
The second stage of the coming pension-investment AGI revolution will be particularly interesting in the realm of private and alternative assets, such as hedge funds, private equity, private credits and real estate. Here, the inner workings and information advantages of these non-public partnerships could eventually be supplanted by AGI — and especially by AAI if it lives up to its hype. Proprietary and “insider” knowledge that is presently inaccessible to other investors may continue in spots, but much if not most of it probably cannot be contained forever. AAI tools could significantly close the performance gap that some managers now enjoy from their privileged access to the juiciest opportunities.
Reshaping the Pension Marketplace
This does not mean that the smartest, savviest and richest people in the world will not still find ways to hoard sweet deals and skim the cream off the top of investment markets. But why should startup entrepreneurs, private company CEOs, corporate borrowers and real estate developers rely so heavily on private fund-manager middlemen to supply them with vital capital that they could secure directly at lower cost from pension funds via a smarter AAI-driven portfolio network?
Such a platform could provide the end users of capital with direct access to megabillions of institutional dollars — a particular boon for those unwilling to bear the hefty costs of management fees, the performance fees known as carried interest and passthrough expenses for the privileges now enjoyed by middleman managing partners. That funding would be especially valuable for experienced CEOs of later-stage venture companies and many in the growth equity stage, as well as for middle market companies and proven real estate developers. It would also help institutional investors avoid the losers and improve their success ratios. But pension funds must clear one hurdle first: public-sector freedom of information (FOI) laws that put pension portfolio managers at a competitive disadvantage for getting into the better deals with companies that prize their “secret sauce.”
The information advantage now so profitably enjoyed by portfolio middlemen will dissipate as smart, competing lower-cost systems can process data, model alternative trends and scenarios, assess risks vs. reward potential, and design better portfolios that eliminate or at least reduce the reliance on high-fee money managers. A baby-step harbinger of what is likely to come has already popped up in the private credit marketplace. Concurrently, one of the nation’s premiere investment consulting firms has already wised up to this game by going into the business of assembling its own private equity portfolios.
Because they can provide a protective buffer for confidential information immune to FOI laws, the pension consulting companies are ideally situated to initially become some of the industry’s ultimate “disruptors via disintermediation.” It doesn’t take a genius to foresee that the consulting industry (which is typically paid annual flat-fee retainers) will be strongly rewarded and thus motivated to gradually displace high-fee money managers. Over time, the efficient markets hypothesis will come closer to its crowning corollary — that investment fees need not eat up potential market-beating returns, as they often do today because of the lopsided information advantage historically exploited by successful private asset managers.
Strategic Consortia
This brings to light the underlying reason that public pension funds need to play to where the puck is heading, to borrow the overused hockey metaphor. This requires creating some kind of institutional consortium to steer the industry toward a commonly held platform for confidential exchange of secured, selective, non-public strategic information for the mutual benefit of both the providers and the end users of public pension fund capital. That would make the entire asset class accessible at lower cost.
For starters, pension funds could establish their own AI-supported proprietary captive database of portfolio holdings, management contracts and performance, along with related information that can eventually include secured private data. The database could be held in a public benefit company, with users paying license fees and royalties credited to the participating pension systems. But that’s just first base. Then the pension funds could focus on the highest-cost part of their portfolios and create their own consortium, effectively functioning as something like an outsourced deputy chief investment officer, that might be structured as a captive governmental public benefit company or an intergovernmental nonprofit. It could operate the entire alternative investments asset-class allocation in the pensions’ portfolios at far lower cost, with fewer middlemen.
Initially the consortium could contract many of these functions with leaders in AAI investment applications without building them itself, and still reduce costs. Eventually, AAI-savvy younger members of private-asset underwriting teams will realize that they can be the new top dogs by jumping ship, and the consortium can thereby staff these functions internally to rival the high-fee old-school competition.
Entrepreneurs could enjoy lower-cost capital without the overhead of carried interest extracted today by managing partners of private asset funds. Pension funds could potentially cut their higher fees in half and enjoy better net returns from most alternative asset categories. Also importantly, a public consortium could include an independent audit and verification function to assure that all these AI systems are telling the truth about their results — something likely to be missing in the private sector.
The new technology is already setting the stage for a private-asset marketplace that shields confidential non-public information from the freedom of information laws that hobble our public pension funds. At the very least, a restricted two-way database maintained by a pension fund consortium could be accessed confidentially by approved consultants for a fee as well as by the participating pension funds directly. Without this intermediary, most pension plans will always be captives of the middlemen who presently provide the FOI buffer at outrageous cost. That makes it a great project for industry visionaries and brilliant pension attorneys — even if AGI and AAI eventually prove to be overhyped and ultimately fall short of insightful, creative human intelligence.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management. Nothing herein should be construed as investment advice.
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