Most investors are getting their exposure to AI and other big technology themes through the public markets, and typically through passive exposure to the Magnificent Seven. But Prabhu Palani, CIO of the $10 billion City of San Jose Retirement System, says that the innovation investors should really want to tap has to come from the private markets.

“These entrepreneurs are risk takers, and those risk takers are meeting risk capital,” Palani told the Top1000funds.com Fiduciary Investors Symposium at Stanford University.

“And that magic happens here in the Valley and in other parts of the world. That incubation has to happen in startups and early-stage startups. What large companies do well is scale that innovation, right? They have deeper pockets, they have transparency, they have access to resources.

“Once that breakthrough has happened, how do you scale those businesses? Being in the public markets is all about scaling… but if you want breakthrough technology, it has to come from this ecosystem.”

About half of the plan Palani manages is in public equity; roughly half of that is in the US, and mostly passive. It’s been “automatically getting a lot of exposure” to the biggest components of the index. A quarter of the total plan is in private assets, with five per cent of that – or a quarter of that quarter –  allocated to venture capital.

“We’re here in the Valley, which we believe gives us an edge,” Palani said.

“I’m 20 minutes from Sandhill Road, and that is just tremendous. For some time there was talk that, you know, the centre of gravity is shifting away from the Valley. But come AI – it’s all here. It’s at Stanford, it’s at Berkeley, it’s at San Jose State, it’s at UC Santa Cruz and so on.”

But Nick Rubinstein, managing director at global investment firm Jennison Associates, thinks that “innovation in the public space is definitely not dead”.

“Just recently, Google released their newest imaging model,” he said.

“They call it Nano Banana, and it’s an amazing product – and suddenly, in the app store, ChatGPT dropped into the top 10 and Google’s AI system for imaging immediately popped to number one, and the order of download increases was [significant]. So I think it might be somewhat short-sighted to take all of this innovation that’s happening in the private markets and say that these companies will become the next leader.”

Jennison Associates plays almost entirely in the listed equity space, and was an early investor in Tesla, though it does meet with private companies too. But the amount of capital that the listed incumbents have is “still massive, and they are still innovating”, Rubinstein said.

“Going back to the Mag Seven, you think about what they started as and what they are now; they’ve successfully transitioned their business models one, two, even three times. And I don’t think that trend is over.”

Jackson Garton, CIO of Makena Capital, which provides investment services to asset owners including endowments, family offices, pension funds and sovereign wealth funds, says that the firm is a “big believer” in the innovation coming out of the private markets space, but there’s also the “liquidity component of the equation” to consider.  OpenAI is a $500 billion company, but it’s still relatively illiquid.

“From a plan perspective, from an asset owner perspective, that’s a big shift,” Garton said.

“Time to IPO has at least doubled over the last 10 years. The whole equation doesn’t work if you don’t get your money back, and the liquidity part of the equation, which has been stressed as of late, is something to be very cognisant of when you think about your asset allocation models and how much you can take within venture.

“If you just plug it into a traditional mean variance optimisation model, it would say put 75 to 80 per cent into venture capital. And you can’t run a plan that way.”

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As NZ Super nuts out growing pains in processes and technology, it has made some recent decisions to change its governance route. Among them is the appointment of two co-CIOs who will lead the investment team together with collaborative decision-making and shared accountability. In a wide-ranging interview, co-CIOs Brad Dunstan and Will Goodwin tell Top1000funds.com about the fund’s “co-delegation” model, how its total portfolio approach will evolve under their leadership, and where it is hunting for new alpha sources. 

New Zealand Super has long been touted as a fund with best-practice governance and recognised globally as a strong and transparent investor. But with only 24 years under its belt, it is still a young organisation. As it nuts out growing pains in processes and technology, the fund has made some recent decisions to change its governance route. 

One of those changes is the appointment of dual decision-makers at the top of the investment team, with Brad Dunstan and Will Goodwin appointed co-chief investment officers in December 2024, which transitioned the fund to a “co-delegation” model defined by collaborative investment decision-making and shared accountability.  

“It’s a little bit in vogue,” Goodwin says in a wide-ranging interview with Top1000funds.com, citing Canada’s OTPP and the Netherlands’ APG, which both have a co-CIO structure.  

For functional reporting lines, Dunstan heads up the public markets, internal active strategies such as strategic tilting, and implementation and rebalancing, while Goodwin’s responsibilities include private markets, external mandates, direct investments, and the data analytics team. 

It is a change initiated by chief executive Jo Townsend, who has been in the role since April 2024, to ensure a diversity of investment opinions on the senior leadership level, rather than a single dominant voice.  

“We do have separate sets of delegations, and there are operations that I don’t need to be across, if he’s doing a large rebalance or some repositioning in the strategic tilting program [for example]. And likewise, he doesn’t need to be aware of what appointed managers are doing,” Goodwin says.  

Where the dual decision-making kicks in is with decisions around new manager appointments or large transactions. Goodwin says that is when both CIOs are involved from the first screen, through the confirmatory due diligence, and the final tick of approval. 

“It’s a model of being aware and being sufficiently involved across the whole portfolio but also keeping the right level of separation of power,” Goodwin says. 

It’s when there is a difference of opinion that the rubber hits the road, and one thing that both CIOs agree on is that when there is a difference of opinion, compromise is not always the best outcome.  

The CIOs are supported by contributions from the investment committee and other senior professionals, but ultimately if they can’t agree, “we do not progress”, Goodwin says.  

“We spend a lot of time communicating what we’re doing and hopefully giving the team confidence. But it’s important that they know as well that they can’t just – I’m not saying they would – curry favour with one of the CIOs and the other one will just have to suck it up,” he says. 

When disagreements arise, it’s all about having a frank conversation with each other, says Dunstan, because “agreeing not to do something is equally a decision as doing something”.  

“You actually have someone there to bounce ideas with… we get some pretty robust discussions, but I feel we get better decisions,” he says. 

Rapid growth 

The fast growth of NZ Super, with assets under management forecast to double every eight to 10 years, means a need to scale up its investment capabilities. However, Dunstan says the fund is not going on a hiring spree to expand its 79-person investment team anytime soon.  

“[We want to] make sure that the team doesn’t necessarily have to grow because the fund grows, so we are setting ourselves up to be more scalable than we have been previously,” he says, adding that the fund already has systematised and automated workflows in many public markets active strategies, from trade execution and settlement to portfolio construction.  

Another challenge that comes with growth is the need to evolve its TPA framework. The fund practices what both CIOs call “one of the purest forms” of TPA, which is defined by an unrelenting focus on total fund outcomes, integrated decision-making, more dynamic portfolio adjustments, and risk factor exposures.  

Being nimble and agile hasn’t been an issue when NZ Super was a small fund, but now it needs to have a more “pragmatic” mindset, Dunstan says.  

“A pure TPA model means that if we don’t like real estate, we’re going to own none of that… You could also have a whole lot of real estate in your portfolio, and if you think real estate is a poor investment going forward, you could sell it all,” he explains.  

“When you’re $200 billion, you can’t really say, I’m going to have $15 billion worth of real estate and no real estate team, and firing and hiring people every five years as markets move around.” 

New alpha 

Goodwin sees the diversification of alpha sources as a priority to evolve the TPA under the co-CIO leadership. Strategic tilting, which has been the fund’s biggest value-add driver over the past decade, will remain a cornerstone. But NZ Super is seeking to strengthen four other active risk pillars: beta implementation, internal credit strategies, real assets, and private equity and other alternatives.  

“If you look over the last couple of decades, a lot of larger funds than us have had strong success in infrastructure. We’ve been relatively underweight infrastructure, that’s fine, it doesn’t suit our portfolio, and we actually haven’t suffered,” he says. 

“But you also have to be aware of if we missed something… so making sure the team is thinking about that and not just resting on our laurels is really important.” 

NZ Super has added 1.57 per cent alpha per annum and returned 9.92 per annum in the past two decades, according to its annual results as at June 30, 2025. Reflecting its focus on the long term, it uniquely reports on a 20-year moving average time frame.  

The fund doesn’t disclose its actual portfolio exposures until its annual report gets published in October, but a spokesperson confirmed the fund had increased its listed equity exposure by 4 per cent since June 30, 2024, with fixed income declining slightly and all other asset classes steady.  

*Excluding strategic tilting positions 

Within strategic tilting, Dunstan says while the model has stayed consistent in the past five or six years, the assumptions that feed into the model, such as different currencies’ risk premia, are constantly reviewed. 

“The model evolves, but not a huge amount of new [long-term valuation] signals go in. It’s more scrutiny of the data and the assumptions around the existing signals… We will review the assumptions every two years,” he says.  

“The program is systematic and we don’t want to be worried about and responding to short-term volatility, because it undermines the whole basis on which the program is built,” Goodwin adds. “We want to harvest the volatility and trade off it, but not seek to change our fair value, unless something material has happened.” 

In preparing for a more complicated investment environment ahead, Dunstan says NZ Super will “prioritise what’s important to us”, including understanding macro factors and weatherproofing its portfolio accordingly, as well as adhering to its sustainability roadmap.  

“[These include understanding] how the world is changing, how we model the world, and these linkages between, say, inflation and interest rates, and do we still believe in those going forward,” he says. 

“Having a really good understanding of how our portfolio reacts in different environments will be important.” 

HESTA is laying the groundwork for a more systematic framework for using AI across its total portfolio, solidifying use cases in research, forecasting, risk management and private assets that all centre on the objective of allowing the A$98 billion ($64 billion) fund to “see risks earlier and clearer”.  

But with a huge number of potential AI applications in investment and only limited resources to implement them, HESTA is striking a careful balance of identifying areas where it can add the most value add while introducing the least complexity to its operations, says head of portfolio design Dianne Sandoval. 

“AI is not really going to give us a magic formula for higher returns, but it just gives us a better pair of glasses,” Sandoval says in an interview. “It has the ability to accelerate our understanding of factor exposures in absolute terms, but also across asset classes and really understand the liquidity and dynamics, which ultimately gives us just sharper insights on how to navigate uncertain markets.” 

Data ingestion and processing are two elements of research and forecasting where AI can make an outsized impact, she says. Some use cases at HESTA include scraping the internet for information that can inform early forecasts on job-growth data from its economists; and forecasting long-term S&P 500 returns using neural networks.  

The technology can also extract changes in soft languages in financial reports that may, for instance, indicate an improvement or deterioration in sentiment around issues such as responsible investments, and which HESTA uses to monitor companies on its watch list. 

“With research or risk analysis, with stress testing, with data mapping and cleanup, AI can do it much more efficiently because it’s repetitive and rules-based. But the judgment and analysis still sit with the team,” says Sandoval, who leads the research and asset allocation processes and oversees the rebalancing, currency overlays and portfolio risk management. 

In private markets, AI is handy in capital-call management which has taken an “egregious amount of groundwork and [been] very tedious”, she says. “Even things like cleaning up background checks and pulling data out of dusty PDFs that have forced us to do capital calls manually, AI does that much more efficiently.” 

The human touch 

But human-driven principles remain, especially in private markets. Sandoval says AI cannot yet replace investors conducting due diligence, in things such as measuring trust or the character of a management team and its ability to perform. 

Before moving to Australia, Sandoval held senior roles in some of the world’s biggest and most complex asset owners, such as CalPERS and Saudi Arabia’s PIF, and she says AI integration, like any change management, often takes time. 

“There’s obviously an upfront cost in doing this, and that’s why – in order to justify that – you really have to be thoughtful and cognisant of how I get the lowest hanging fruit,” she says.  

“And costs matter. Anytime I can reduce costs or reduce operational inefficiency, that’s a huge benefit for members as well. 

“Once you get through all of those, then you could start adding the higher value-add that takes more time, effort and institutional buy-in.” 

The ultimate item on Sandoval’s AI wish list is a structure that would allow HESTA to see its total portfolio all at once – including patterns across markets and asset classes – so that should another ‘Liberation Day’-style shock occur again, the fund can map its key positions, protect the portfolio and add some tactical positions.  

During the market turmoil in April, HESTA was able to make some trades with the liquidity it had on hand, adding to equity risk and trading FX as the Australian dollar collapsed. But there were too many moving pieces: its total fund management system, SimCorp, tracks the total portfolio exposures, but is separate from the risk- and liquidity-management systems.  

“We did that by coming together all in a room and using different systems. With AI, if all of these systems are more and more integrated, you would reduce some of the manual processes we had to do during those moments and make decisions even faster,” Sandoval says.  

“We’re not at that point, we’re mapping bits and pieces of processes, but when we can get an efficient risk map into our analysis and our key positions, as well as potential opportunities, that’s when we’ll see the whole field at once.” 

The US Department of Labor has publicly condemned the OECD for “pushing members to politicise their pension systems by integrating ESG factors unmoored from returns”.  

The Employee Benefits Security Administration, a DoL agency that oversees more than $14 trillion of the nation’s private retirement assets, launched a fresh attack on the OECD and its responsible investment principles for pension funds, declaring that it will withdraw support for such policies and that ESG is “nothing but a Marxist march through corporate culture”.  

Justin Danhof, senior policy adviser at EBSA, delivered the searing words as part of a speech outlining President Trump’s pension investing priorities to an OECD pension conference in Paris on Tuesday to a gasping crowd, one source attending the event told Top1000funds.com. 

Danhof, who is a staunch “anti-woke” crusader and previously called BlackRock, Vanguard and State Street “behemoth ideological cartel” over their ESG investment policies, said the US would not “support these policies, even tacitly”. 

“ESG, at its core, looks a lot like a Marxist march through corporate culture. What is the point of Marxism? The complete destruction of capitalism,” Danhof said. 

“If America and other OECD member companies hamstring our nations’ capital markets and pension systems with superfluous ESG costs, it only serves to benefit authoritarian regimes that do not engage in such frivolity,” he said. 

“America faulted with ESG. We are now on the mend. We invite you to join us.”  

Danhof also made a swipe at diversity, equity and inclusion which he said is a concept “that killed meritocracy leading to corporate mediocracy, which, in turn, sacrifices investment and pension returns”. 

The US DoL, under the Trump administration, is seeking to roll back a Biden-era regulation which explicitly allowed private pension funds to consider ESG factors when investing assets under the Employee Retirement Income Security Act (ERISA). The Democratic rule already received several state-level challenges, including a lawsuit from a coalition of red states led by Utah in a Texas court, which was ultimately dismissed.  

The DoL under Trump intends to finalise new rules by May 2026, which will require pension plans to invest “based only on financial considerations relevant to the risk-adjusted economic value of a particular investment, and not to advance social causes”, according to the latest EBSA regulatory agenda.  

The US pension system will focus on the “exclusive purpose” of providing benefits to plan participants, Danhof said, highlighting the limited adoption of ESG investing in corporate retirement plans (ERISA qualified funds) as a result of its “clear standards” against “politically motivated investments”.  

“That’s because ESG is not just some side-bar political or policy issue. It’s about sovereignty and security as well. Authoritarian leaders love when our member nations embrace ESG. Why? Because it lessens your prosperity and makes you less competitive,” Danhof said.  

Danhorf’s criticism of the politicisation of pension investing should be viewed in the context of US public pension plans which have elected officials as board members and over recent years have been criticised for restricting or directing pension investments. [See The politicisation of investments at US public funds] 

An OECD spokesperson declined to comment. 

In a separate speech at the OECD conference on Thursday, the US Securities and Exchange Commission (SEC) chair Paul Atkins also took aim at the European Union’s sustainability reporting requirements for corporates, describing them as “prescriptive” and “burdens” to US companies.  

“As Europe seeks to promote its capital markets by attracting more companies and investment, it should focus on reducing unnecessary reporting burdens on issuers rather than pursuing ends that are unrelated to the economic success of companies and to the well-being of their shareholders,” he said.  

The investment team of the Future Fund, Australia’s A$252.3 billion ($166.53 billion) sovereign wealth fund, is weighing opportunities for it to expand the active equity program it re-launched in 2023, according to chief investment officer Ben Samild.

“We’re constantly analysing where the best place for our equity portfolio is and how it is best expressed,” Samild said on a media call for the Future Fund’s results, which saw it return 12.2 per cent in the year to June 30, adding A$27.4 billion ($18.09 billion) of assets under management through investment returns.  

“There are real opportunities elsewhere in other markets where we can observe real inefficiencies; that’s a long-term framework and a long-term program. We’ve done more in emerging markets this year and would expect other parts of the world to be included over the next couple of years.” 

The Future Fund shuttered its active equity program in 2017 after deciding that central bank policy had warped fund manager returns to the extent that it would get more value from investing in listed equities through passive strategies.

Since it reactivated the program, the Future Fund has invested in a secretive Japanese activist hedge fund Effissimo Capital Management, which has stayed away from the media spotlight despite playing a decisive role in several of the biggest governance stories in Japanese corporate history, including by successfully calling for a probe into allegations that Toshiba had pressured investors into voting for resolutions recommended by its management.

That followed another investment in Japan’s equity market through Wellington Investment Management. It has also invested in active Australian small caps through Maple-Brown Abbott.

While the Future Fund has not yet updated its manager list to include any new active emerging market equity managers, it has repeatedly flagged that it would look to diversify away from the US amidst growing political uncertainty. In a speech in June, Future Fund chair Greg Combet said that the US was becoming a “more risky and uncertain investment destination” and that more time and resources needed to be devoted to investigating other markets including Japan and the EU. On Tuesday’s call, Samild said that the Future Fund had been moving to invest in opportunities across asset classes in both those jurisdictions.

“We have been investing actively across the capital stack in both [Japan and Europe]. We’ve been super interested in European credit opportunities and have been doing a lot of work in that space, and in Japan across the board: property, public equity, private equity – we’ve been very active.”

But while Samild noted that the US market has been highly concentrated in a handful of technology stocks, he also said that allocations to it have been “so well-rewarded” and are “very difficult to step away from”.

“Thematically it’s obviously super interesting, because to step away from that concentration you’re stepping away from a particular technology scenario… which is quite hard and we’re not sure that we have a differentiated view to the market on the winners and losers and outcomes of that,” Samild said.

“We try to be very thoughtful about that without being hubristic. So whilst we have taken opportunities all over the capital stack, private and public, in order to diversify across multiple potential future worlds, the actual index concentration isn’t one we’ve tried to mess around with, as it were, because we feel like, particularly in the US, you’re having to take a view that we’re not comfortable taking yet.”   

As at June 30 2024, the Future Fund had 43 per cent of its listed equities in the United States. Australian equities accounted for 27 per cent of its listed equities exposure, emerging markets the next highest exposure at 12 per cent.

Samild said that some of the Future Fund’s more active portfolio decisions over the last year “played out very pleasingly”. One of those was a move to increase its allocation to risk assets in the months prior to Liberation Day, spending a bit of the significant cash pile it had built up.

“That came as a result of pretty deep thinking about what we thought the various political and policy cycles would likely mean for risk assets and equity markets in particular,” Samild said.

“It’s definitely paid off; it’s been a really strong year for markets and it was very, very accretive to returns. We also thought there would be more significant volatility… and we did quite a bit of work in making sure that our portfolio was well-prepared from a liquidity and protection and diversification perspective.

“Liberation Day was a good example of that, and the fund and the investment team were very well prepared for those events and were able to really lean in to risk as markets bottomed and that was quite a profitable outcome.”

The Future Fund recently received permission from the Australian government to begin making direct investments in Australian property and infrastructure without using an external manager, which it has been required to do since its inception in 2006. 

But while Samild said that the Future Fund hadn’t yet made any direct investments itself, the sovereign wealth fund has been investing in the areas of “national priority” that it must consider under the controversial changes to its mandate made by Treasurer Jim Chalmers, including by increasing its stake in data centre operator CDC.

“We’ve been strong investors (in private markets) since the inception of the fund, and we were able to find some really significant domestic infrastructure opportunities this year,” Samild said.

“Candidly, it looks to us like there is an awful lot of capital needed throughout the developed world, especially in the infrastructure space, but that then floats down through credit and equities and private equity. The cost of that capital seems to be going up, which is a good situation for us, so we’re extremely alert to and interested in all manner of opportunities both domestically and across the world, but in particular Europe and Japan.” 

President Trump has fired the starting gun on encouraging America’s 401(k) plans to invest in private assets but corporate plans remain concerned about fees, structures and litigation. Meanwhile, many defined benefits funds are voicing their concerns about how it might impact access to investments, and alpha, and change the asset class.

President Trump’s latest executive order, the snappily titled “Democratizing Access to Alternative Assets for 401(k) Investors”, is widely viewed as firing the starting gun on increasing sophistication and diversification in the vast $8.9 trillion asset pool held by the country’s defined contribution corporate pension plans.

It is expected to provide a boon for private asset providers who have lobbied long and hard for regulatory support to market their wares to DC funds which overwhelmingly still invest in low-cost, passive strategies.

Moving into private markets brings a multitude of complications for DC funds in the US, not the least because 401(k) funds have seen healthy returns off the back of their existing strategies thanks to record-breaking US equity markets.

Investment executives at DB funds, which increasingly rely on private assets for alpha, are also voicing their concerns about how the private markets landscape could change with the advent of DC investors.

It leaves experts Top1000funds.com spoke to for this story questioning if America’s 715,000 corporate plans will rush to abandon index-tracking stocks and bonds and follow DC investors like Australia’s superannuation funds into global private equity, real estate and infrastructure any time soon.

Most importantly, one reason progress could stall is the executive order doesn’t allay fears among US companies of being hauled in front of the courts for how they manage their corporate pension schemes.

Over the last decade, particularly as dollars in the corporate DC system have swelled to dwarf the $3-4 trillion DB industry, companies like Walmart, Boeing and GE, to name a few, have been tied up in costly and time-consuming class action litigation, sued on matters like fiduciary duty, misusing funds or excessive fees. In part, this litigation has resulted in these funds being more risk-averse in their investment allocations.

In 2024, law firms estimate 60 new 401(k)-related lawsuits were filed (there were 100 in 2020) so that although corporate DC funds are already permitted to invest in private assets, most stick to investing in low-fee public markets and steer clear of alternatives or any kind of innovation lest they invite more litigation.

Trump’s executive order pledges to reduce the regulatory burden and litigation risks that have blocked up the system, and commentators believe new guidance will raise the pleading standards for bringing lawsuits and encourage 401(k) plans to consider the investment merits of alternatives.

But the president’s edict doesn’t explicitly resolve the litigation issue that has evolved into ever-changing lines of attack. As it stands, for most 401(k) fiduciaries, the thought of offering private investments simply creates greater liability risk and raises the spectre of more fee-focused litigation given the higher cost of alternatives.

“If I can invest in alternatives in my DB plan, why can’t I invest in the DC plan?” asks the CIO of a $35 billion corporate plan split between a $15 billion DC allocation with “zero exposure” to alternatives and a $20 billion DB asset pool with 20 per cent in alts, speaking on the condition of anonymity. “This democratizes access and that is good, and I have sympathy for this line of thinking.”

However, the risk of litigation and the absence of a track record of investing in private markets among peer DC funds, means he has no plans to change strategy yet.

“There is no upside to do this first. We will wait and watch and see what happens; let others stumble and stub their toe, and then we might do something.”

America’s largest DC plan the $1 trillion Thrift Savings Plan (TSP) doesn’t intend to alter course either. It runs five funds invested in large-cap and small-cap US stocks, government and corporate bonds, and international developed markets in an investment strategy prescribed by law.

“The TSP will not change how it invests based on recent policy changes,” confirms spokesperson James Kaplan.

“Unless the litigation question gets answered I don’t see a lot of up take from 401(k) fiduciaries,” says Dennis Simmons, executive director of CIEBA, which represents around 118 large corporates collectively managing $2.2 trillion across DB and DC plans. “The cost of alternative investments compared to a passive index fund and the litigation environment the way it is, means the pros and cons of alternative investments just won’t get talked about at investment committee meetings.”

Why state-run DC plans might be more enthusiastic

State-run plans hold much less (estimated at $1.5-2 trillion) of America’s total DC asset pool, but they are more likely to dip a toe first. States like Michigan and Alaska have fully transitioned to DC systems for new employees. Elsewhere, public retirement systems like Florida and Oregon have DC plans alongside their larger DB plans, which already have chunky allocations to private markets. These funds could use their scale and capability in alternatives to port over to their DC participants.

O’Meara

Public pension funds are also governed by different laws from corporate plans which means litigation is less of an issue, says David O’Meara, senior director at WTW, head of DC investment strategy. “There is a question of conflict of interest for corporate sponsors that government investment officers just don’t have when it comes to providing benefits for employees,” he says.

It leads him to flag another potential impediment to corporate 401 (k) flows entering private markets: sponsor enthusiasm. Corporate plans are motivated to use alternatives in their DB plans because strong returns directly impact the balance sheet in an explicit benefit. The company is also on the hook for any pension shortfall but in corporate DC plans, the employer isn’t liable for returns.

“In theory, investments in a DB scheme are solely for the purpose of members, but in reality the better the DB plan investments perform, the lower the cash cost and lower the cost of managing the plan for the sponsor,” he says.

Other factors limiting enthusiasm

Even if President Trump’s order sees off class action attorneys, corporate pension funds need to navigate other barriers to entry that will also test their enthusiasm for change. Alternative assets are harder to value and sell than traditional stocks and bonds and will introduce illiquidity, leverage and opacity, demanding a risk tolerance and ability to withstand losses.

It would be wise for 401 (k) fiduciaries to begin by investing in other assets outside stocks and bonds before jumping straight into alternatives, suggests the anonymous CIO.

“Some plan designers don’t even provide access to emerging markets as an asset class. How many understand the risk of illiquidity?” they ask, pointing to the fact that many sophisticated investors were wrong-footed by liquidity gates during the pandemic. “They were qualified investors. My question is, will people really know the risks they are signing up to?”

Investment teams at DB public sector funds that view 401(k) investors in a similar bucket to retail investors, even though 401(k) plans have an employer-based structure, also flag concerns that they will flock to private assets without fully understanding what they are investing in.

“With so many 401(k) plans in the US, there’s a risk of capital chasing the trend without fully appreciating the asset class or its liquidity constraints,” reflects Anne-Marie Fink, CIO of private markets and funds alpha at the $171 billion State of Wisconsin Investment Board which targets a 35 per cent allocation to private markets in the core trust fund over the long term.

Fees are another potential barrier. Few 401(k) plans have any experience of being charged performance fees. The sector’s hyper-focus on fees and a mentality that lower fees are always better, will make alternatives a hard sell. It requires education and endorsement of new concepts like fees also equating to a higher return or protection on the downside, and net-of-fees value for end savers.

Are fees the problem?

Commentators also flag the risk of additional layers of fees being levied on 401(k) plans, similar to retail products where more intermediaries take a cut and the net return for the final customer is degraded.

CEIBA’s Simmons counters that participants will come to understand the pay-off between returns and fees in alternatives.

“Those that have defaulted will say you ‘go ahead and do it for me’, but those that are engaged and want more diversification and the potential for higher returns understand that comes with a cost,” he reasons.

Moreover, DC funds in Australia and the UK are comfortable with the risk-return trade-off, putting in place the right governance frameworks that include professional boards and skilful investment teams.

In Australia, a 30-year old defined contribution system, funds have seen the benefits of investing in private assets. According to industry body the Association of Superannuation Funds of Australia, the average MySuper fund has a 24 per cent allocation to private assets.

Similarly in the UK, NEST, the country’s largest DC fund, has around 20 per cent allocated to private markets and hopes to increase this to 30 per cent by 2030. It has pioneered an investment approach that includes calling its own tune on the fees it is prepared to pay, including refusing to pay performance fees.

“We wouldn’t work with a manager not willing to offer products at a fee the team feels is justified,” says Rachel Farrell, NEST’s director of public and private markets.

Rachel Farrell - Asset Management Business Leader, Alternative and Traditional Investments | LinkedIn
Farrell

Although 401(k) plan participants may not be sophisticated, the idea that plan fiduciaries, skilled CFOs, directors and treasurers of sophisticated organisations, aren’t up to the job is plain wrong, surmises WTW’s O’Meara.  It’s as much of a red herring as the notion that 401(k) plans will suddenly plough into crypto assets, specifically identified as an alternative asset in Trump’s executive order.

“The 401(k) system is using fewer asset classes and has less diversification and less sophistication than any other asset pool in the world not because fiduciaries are incapable but as a consequence of how 401(k) has evolved,” he argues.

Cue another headwind.

In contrast to DB pension funds, the 401(k) system comprises asset allocation structures like target date funds and managed account solutions that are rooted in a mutual fund world. They require investments in the fund are marked to market at the end of each trading day ensuring daily liquidity to rebalance or support plan participants who might leave the company or take a distribution and for this reason are incompatible with private markets.

But proponents argue these structures can still support illiquidity. Cashflows going into 401(k)s are typically positive for the first 40 years and only turn neutral and then negative as people retire. Participants in these funds are unlikely to trade their portfolios and shouldn’t be compared to hot money that moves in and out of asset classes quickly.

Alternatives won’t be offered as separate, designated options in the plan. Instead, participants can wrap illiquid exposures within target date funds selected to match their age, or as part of another co-mingled, balanced fund in a blended and balanced approach.

“401(k) plan participants are as able as any other investors to withstand illiquidity. The idea that funds need to liquidate the entire portfolio in any given day is not a reality and puts an unnecessary constraint on the portfolio,” says O’Meara.

Once again, the UK’s NEST provides a case study in how it could be done. It boldly shaped evergreen investment structures with the UK’s asset management industry to create the type of products that allow it to invest in private markets with the transparency, liquidity and ongoing investment opportunity, it requires.

“In evergreen structures, NEST can constantly monitor deployment, see their pipeline and see money being put to work. In many cases, NEST was the first evergreen fund [a] manager had done, so the structures were really designed in consultation with us,” explains NEST’s Farrell.

Moreover, managers soon realised the cost-saving benefits of not having to raise capital all the time. A saving, she says, which is now accrued to the LP.

Why DB investors are worried

Still, the concept that target date funds resemble institutional asset pools raises eyebrows among DB investment teams, concerned that their ability to access and continue to source some of their most prized returns from private markets will be impacted by a new type of investor that doesn’t have the same long-term horizon.

Like $367 billion CalSTRS’ CIO Scott Chan who oversees a 35 per cent allocation to private markets of which private equity boasts a 10-year return of nearly 13 per cent. Chan says the pension fund will lean into its experience, partnerships and ability to create sophisticated investment vehicles to navigate the next wave of investment into private markets which he predicts will “significantly dwarf” previous flows.

“Whenever the flow of capital starts to happen, it could drive the ability to find excess returns lower,” he says.

It’s a similar story at SWIB where Fink particularly seeks more clarity on how 401 (k) plans will access private equity where SWIB targets a 20 per cent allocation (including private debt).

“We’re cautious about how retail flows might affect institutions so we’re engaging GPs early. The focus is governance, co-investment access and fair fee structures,” she says. “We will continue to advocate for structures that preserve fairness and protect long term returns.”

Texas Retirement System is also concerned about asset managers rolling out new products that will put semi-liquid private market products into the hands of retail investors.

“We are above our allocation to private equity, so we are slowing the pace, but at the same time the largest asset managers are creating products for retail and distribution to deploy products that are coming to market as we speak,” said Neil Randall who oversees TRS’ (overweight) 12 per cent private equity allocation. “Private equity firms with the largest platforms and strongest brands are expected to be the early winners.”

Randall’s main concern involves transparency regarding the amount of retail capital raised alongside institutional capital in a particular fund.

He says the investor aims to work with GPs to devise a cap on the amount of retail money in the same fund they also invest in.  Other potential impacts could also be felt in LPs’ valuable co-investment pipeline if retail investors eat into this deal flow.

“Differing time frames could reduce co-investment opportunities,” acknowledges Fink.

As long-term investors do their best to ready for what lies ahead, another concern looms large. They can’t hide their alarm that the policy shift is a result of an executive order.

“An executive order has made this available, but what happens if another executive order makes it unavailable? How do you unwind it? Nobody knows the future,” says the CIO of the corporate plan.

Whatever the future holds, the genie is out of the bottle.