Asset owners have traditionally counted on external asset managers to pursue bold innovations, such as AI applications in investment, rather than stretching their limited internal resources to do so. But leading Stanford academic Ashby Monk has warned that this long-standing model is distilling short-term thinking in pension management and calls for asset owners to lean into their natural advantages and innovate.
Resource and governance constraints have pushed asset owners to offload bold innovations to external asset managers, who are commercially incentivised to pursue them, rather than building up internal capabilities themselves. But leading Stanford academic Ashby Monk has warned that this long-standing model is distilling short-term thinking in pension management, and is a missed opportunity for asset owners which focus on the long term.
Monk, who is executive and research director at the Stanford Research Initiative on Long-Term Investing, says the fundamental problem with asset owners outsourcing innovations to intermediaries is that their time horizons, and objectives, are misaligned. It’s an idea he explores in his latest paper, The Asset Owner Gearbox: Why Investment Innovation Grinds and How to Make It Turn.
“If you’re outsourcing all your innovation to asset managers, you’re going to get shorter-horizon innovation. A classic one is high frequency trading, because that is a timescale by which the asset manager can monetise that innovation in their business,” Monk tells Top1000funds.com.
“But a pension fund, they can monetise those innovations for 50 years. They’ve got these long, distant liabilities, and in fact, they need to manage these 50-year liabilities if they’re going to do their job.
“So increasingly – and I’m not alone in thinking this – we’ve come to believe the asset owner community needs to do some of the innovation.”
Monk defines innovations as inventions or discoveries. “Somebody inventing something is a very powerful form of innovation, but you can discover something that somebody else is doing and seek to apply it in your organisation – that’s still innovation,” he says.
Long-term innovations should ultimately help asset owners conduct better risk management, ensure portfolio resilience and improve returns. One prominent example is the total portfolio approach which more allocators are seeking to implement
But bringing about such change in asset owner organisations is difficult and Monk’s paper highlights a slew of roadblocks which might stifle risk-taking, such as cost visibility. Political and public pressure on US public pension funds to keep the cost low, for example, leads to under-resourcing in research and development.
“The irony is that external costs (those paid to managers, consultants, and service providers) are often much larger, yet less visible and less politically salient than internal headcount. Internal capability-building is experienced as ‘overhead,’ while external fees are frequently treated as ‘market cost’,” reads the paper.
“This visibility bias produces a predictable operating model: the organisation remains lean internally, while relying heavily on intermediaries for discovery, implementation, and even diagnosis.”
Another obstacle is the so-called “career-risk asymmetries”. The paper points out that in most asset owners, penalties for failed experiments are “immediate and personal” while the rewards are delayed and attributed to institutions rather than individuals. In turn, decision-makers in funds are less inclined to be “first movers” and only want to adopt strategies after they become common “best practices”.
This dynamic means initiating change becomes somewhat of a “heroic” act, Monk says.
“We hold up David Swensen as the hero of the Yale Model, swooping in and figuring out how to build the pacing models, the talent program, the compensation, and by the way, using the golf course on the Yale campus to recruit all the managers. Those were all the innovations that came together to be the Yale Model, but it required this central character as a hero,” he says.
“We want that ‘heroic innovator’ to become a thing of the past.”
principles for innovation
Monk proposes that innovation should not be driven by personalities or crises but by an “operating capability”. The paper suggests the following principles for asset owners when initiating innovations:
- Favour small, reversible bets over significant commitments;
- Use explicit kill criteria agreed before the start of the experiment;
- Specify pathways through which successful pilot programs can be absorbed into official processes;
- Resist ‘innovation theatre’ – the practice of adopting new policies and tools just to appear modernised to fund stakeholders.
Monk says technologies help investors either via speed or inference, and the latter is where real opportunities lie for long-term investors.
“For most of our careers, technology has been about speed – getting trades done faster, getting analysis done faster – but inference is really the power that comes with AI. These are new insights we didn’t even think of,” he says. “Inference is something that is really powerful over longer horizons. You can draw inference over what the world looks like in 10 years.”
“I actually think there is a world where these long-horizon investors become the best investors in the world, because they have the time horizon to allow these inferential insights to get priced in markets. So building their own tech that can adopt these longer horizon viewpoints that no private sector manager would do, because they might not even be in business 15 years from now, is another opportunity.”
