By Ashby Monk, Executive and Research Director at Global Projects Center, Stanford University & Dane Rook, Research Engineer at Global Projects Center, Stanford University
“The world needs institutional investors to save society as we know it.”
Say these words to your mother, and she may check your temperature; say them at a party, and folks will start wondering if the punch has gone bad. But, as strange as that statement sounds, society is facing extraordinary, planet-wide challenges; and the most realistic solutions require capital from institutional investors in some form or another. Climate change, rickety public health systems, demographic upheaval, decaying infrastructure, urban migration, wealth inequality, and diminished supplies of critical natural resources are all challenges that will, at least in part, need to draw on the long-term capital and enormous scale of the world’s beneficial institutional investors. Indeed, it will be up to this community of public pension funds, endowments, foundations, family offices, insurance companies, and sovereign funds to deploy the long-term capital needed to tackle these unprecedented threats.
With collectively $US 100 trillion in their care and the capacity to take a multi-decade view, these beneficial institutional investors really do have a chance to save the world. But they’re not doing so, at least not yet. Why are they failing to channel enough investment in the long-term projects that could rescue society? Because they’re rooted in the bureaucratic and often non-commercial environments of their sponsors (e.g., governments, universities, foundations), which makes them particularly slow to innovate. Quite simply, the vast majority of them weren’t designed with innovation in mind, and their governance systems, cultures, and incentives serve more to hinder innovating than facilitate it. And yet, successfully investing in transformative long-term projects will require novel decision-making processes, new ways of analyzing and monitoring risk, and state-of-the-art mechanisms for anticipating possibilities far into the future. In short, to save the world, institutional investors must innovate.
That’s where technology steps in. We’ve undertaken a half-decade research program to test whether technology might be able to solve this innovation impasse in institutional investing. Our chief finding: embracing advanced technology can empower institutional investors to innovate in ways that let them capitalize on their ability to take a long-horizon view of the world. This flies in the face of conventional the belief that being innovative is what permits effective use of advanced tech. Instead, as we detail in our new book, The Technologized Investor: Innovation through Reorientation, the relationship is bidirectional: appropriately embracing new technology opens the door to deep innovation, which opens doors to embracing still more advanced tech… But, you might now be grumbling: “You can’t really expect public pension funds and government-run sovereign funds to use advanced tech as a means of catalyzing innovation, can you?”
But that’s exactly what we’re proposing, based on years of extensive research in the field with dozens of real-life institutional investors. We’ve found, over and over, that the longstanding supposition of institutional investors being unable to “do” technology is a fallacy. It’s a fiction that’s perpetuated by intermediaries (mostly external asset managers) whose bread is buttered by institutional investors being too scared to dive into tech with full gusto. There are three basic strands to this fallacy of tech inability. Let’s quickly dismantle them here (but please read our book for the complete demolition!). First, there’s the assertion that institutional investors’ organizations are set up in ways that block them from winning with technology.
True, many institutional investors lack a Chief Technology Officer (tech often falls in the Chief Operating Officer’s ambit of responsibility); and ‘tech roles’ in their organizations are often confined to IT departments that mostly serve to keep existing tech on life support. But this back-seating of tech is not some cosmic rule: it’s simply a norm that persists because these prudent person-bound organizations are satisfied when “everybody does it”. The fact is that very little structural change is needed to jumpstart tech proficiency. Most of what’s needed comes from merely giving those in charge of technology in the organization a genuine "seat at the table" when it comes to resources and organizational decision-making. Let staff and the Board see that tech is a priority, and that those tasked with looking after it will have their voices heard loud-and-clear. We’ve seen institutional investors who’ve jumped from tech mediocrity to being high-fliers soon after making this one tweak.
Second, there’s a common refrain that the shoestring budgets on which most institutional investors must subsist don’t have room for better tech. This is bogus. Institutional investors regularly spend 20 to 100 times more on fees to external asset managers than what they spend on their own tech systems and people. There’s a widespread conception that institutional investors are better off "outsourcing" their tech needs to external managers - i.e., pay those outside managers to deal with the burden of investment tech and put it to use in markets, instead of doing so themselves. Sure, it may make sense to engage in some outsourcing of tech needs in this way. But is it really the case that external managers are 20 to 100 times better with technology than institutional investors? Common sense says no; and our research confirms this. Institutional investors can afford top-notch advanced technology if they stop giving such lavish - and too often un-deserved - handouts to hedge funds and other outside managers who (falsely) proclaim such outlandish tech superiority.
Third, there’s the "slowness" falsehood: using advanced tech in finance is really only useful for faster decision-making; and this speed-driven tech evolves at a blistering pace. Since institutional investors shouldn’t be short-term investors, and they’ve historically not been adept at adapting to new technology, wouldn’t pursuing advanced tech be ill-advised? Nope. Throughout history, progress in investment technology has largely centered around increasing the speed with which data reaches decision-makers, or deepening inferences that can be made in investment decisions (we give a pretty cool guided tour of the history of investment technology in our book, from inventions in ancient Babylon to Renaissance Italy to Georgian England to present).
We’re pretty close to being maxed-out on how fast data can be transmitted (with fiber-optic cables, we’re butting up against the hard limit of lightspeed), and the main gains in speed are coming from how fast data can be gathered, which has recently gotten a boost from remote-sensing devices. But the sheer proliferation of datasets (and the sizes of them) have caused the value of deeper inferences to skyrocket - thus the ballooning importance of inference technologies fueled by machine learning, probabilistic programming, etc. Couple this fact that there’s a growing impetus to lower the bar for using such technologies by making them more user-friendly (e.g., Uber’s Ludwig toolbox for no-code AI), and it’s plain to see that keeping up with tech evolution is becoming ever easier for institutional investors - or at least those who commit to making tech a priority for their organizations.
While the above unravels some incorrect assumptions about institutional investors, we recognize that bringing technology into these organizations entails more than just using it more extensively in investment operations. Technologizing as we describe it (and from what we’ve seen work in the real world) involves making tech a centerpiece of the organization - reorienting everyone’s thinking around it, rather than only "plugging it in" here and there. The reorientation needed for technologizing needn’t be daunting and painful; it can (and mostly should) be gradual, and doesn’t demand that institutional investors completely overhaul their governance systems, cultures, or operating processes before getting started. To begin technologizing, all that’s really needed is a shift in mindset and willingness by one or two senior leaders who are willing to pour in the requisite energy and time to be stewards of tech change in the organization. After that, there are clear paths to follow (we’ll skip going over them here; those interested can find them in the book).
So, what exactly does a technologized future look like for institutional investing? The most honest answer is: diverse. Being technologized means using technology to build and extend comparative long-term advantages for the organization; and every institutional investor has its own unique features that will lead to distinct advantages. As such, the tech armament of any two properly technologized investors will differ. Yet two broad categories of technology that we see as being applicable to most technologized investors are alternative data (alt-data) and knowledge management (KM). Alt-data - the expanding universe of unconventional (at least in mainstream finance) datasets, like satellite imagery, social-media archives, remote-sensing streams, geolocation tags, etc. - will be key to expanding the bases on which institutional investors make investment decisions and manage assets, by giving them more varied and rich inputs.
Meanwhile, KM technologies will help investors to better curate what their organizations and networks know about the world, so they can better identify what relationships and patterns are likely to hold well into the long-term future. Alt-data and KM technologies will assuredly be a part of the suite of "superpowers" that technologized institutional investors will call upon for investing in long-term projects that can save the world. One final thought that we wish to impart before closing is that, in their missions to save the world, each institutional investor shouldn’t expect to go it alone. They can count on side-kicks and teaming up with one another - just as any decent superhero would.
As we talk about at length in The Technologized Investor, for advanced tech, institutional investors should increasingly be turning away from standard vendors, and toward partners who can help drive real innovation: startups. Strange as it may sound, our research has shown that close partnering with startups can help institutional investors not only get access to more robust, personalized technology at the cutting edge, but also make them better innovators in the process. This means being more than just a customer and consumer of tech; it means forming more durable unions that allow two sides to better grasp one another’s needs, align their incentives, and come up with superior solutions that create long-term advantages. We’ve seen this work. It’s utterly awesome. And it’s something that practically any institutional investor can do if they’re willing to commit to technologizing (there’s a swelling number of startups willing to work with institutional investors, and build themselves around serving them).
Collaborating with other institutional investors on technology is also something that we’ve seen produce inspiring gains for those involved. There’s a huge number of ways in which institutional investors can collaborate on technology, from engaging in joint experiments to sharing case studies, impressions of providers, and best practices. But all paths of collaboration that we’ve studied (and we’ve studied every one that we could find!) yield benefits to all parties involved, so they’re well worth pursuing. Indeed, saving the world is a big job: finding friends who can help do it makes it not only easier, but more rewarding along the way.
Interested in contributing to Portfolio for the Future? Drop us a line at content@caia.org