“John continually conducts research and development on the refinement of current investment strategies, the implementation of new investment strategies, risk management and portfolio construction for IMRF’s internally managed portfolios. John demonstrates the skills and proficiencies required for his position. He takes the initiative to ensure that there are no process gaps, and he takes the opportunities to resolve problems quickly. He uses good judgement when making decisions and continuously produces quality work. John is a valuable team member, and he leverages other team members and is willing to share his knowledge with them. This makes him even more impactful as he strengthens the entire team. He is dependable and self-motivated to perform well. He wants to succeed and is always in process improvement mode. He cooperates well with others and offers assistance without prompting. He is always willing to help, and he brings a differentiated view to complex situations and ideas. John is self-disciplined and takes responsibility to correct problems. He acts in a professional manner and adheres to IMRF’s policies and procedures. He supports the values and vision of IMRF and the Investment Department. He’s intellectually curious, detail-oriented and well-organized, as he continuously strives for success.”
—Angela Miller-May, CIO, Illinois Municipal Retirement Fund
The CIO Editorial Team shared a dozen questions with all our NextGen nominees and asked them each to pick six to answer. Their answers informed our decision to include them as a NextGen. Below are the answers from John W. Pearce.
CIO: What roles do AI and large language models have in the future of institutional investing?
Pearce: Allocators need to be aware of how asset managers are approaching artificial intelligence. Ideally, managers would embrace new technologies in a thoughtful and measured fashion. Quants have been interested in AI and large language model problems for decades. While these methods provide an opportunity to uncover gold, there is the ever-present danger of data mining. Recent advances in technology have upgraded the pickaxes of yore for dynamite, exacerbating the risk of finding mere pyrite.
Separately, generative AI has shown much potential to supplant young career professionals for basic modeling and coding. The opportunity to frugally expedite this work is offset by the risk that the next generation of investors will miss out on critical repetitions in analysis that provide the experience required to develop deep understanding. Aspiring musicians practice scales and études because mastering these building blocks allows them to be able to improvise and create new sounds entirely. A computer could outperform any player at these rudimentary tasks, but honing a craft requires repeated practice. I fear that being overly eager to embrace generative AI for the foundational exercises of investing risks trading off near-term gains for long-term talent development problems.
CIO: What traditional and/or alternative asset classes do you think are most important for institutional investors, and why?
Pearce: Stocks and bonds are the meat and potatoes of pension fund portfolios. Lately, though, it feels like all the attention has been on the side dishes. The historic returns and public market equivalents of alternative investments are compelling. Alternatives can also provide access to unique corners of the market that may be difficult to access and hold the promise of alpha. But the contribution of alternative strategies to the bottom line of many asset owner portfolios, to say nothing of the risk, doesn’t justify the amount of attention they’ve received recently. A typical pension fund allocates about 80% to traditional assets. Even assuming a large return premium for alternative assets, traditional assets contribute nearly 70% of the bottom line of returns for such funds. Yet I would posit that far less than half of the time and attention of such allocators, let alone fees, is paid to traditional asset classes. Alternatives certainly have important return and diversification roles to play in a portfolio, especially for those with long-duration liability profiles. Sure, beta is cheap, and persistence may be difficult to spot, but many investors cannot afford to overlook the massive impact of good old stocks and bonds.
CIO: What asset class or investment troubles you most right now, and why?
Pearce: As the investment department for a mature fund, the most important job we have is to make benefit payments to our annuitants. Accordingly, the pace of growth of new investments in illiquid asset classes is troubling to me. Over the last decade, public fund allocations to illiquid investments have scaled up. The promises of high returns, diversification and inflation hedging will mean little if plan sponsors find themselves in a cash bind. Increasing unfunded commitments form a dangerous combination with slowing distributions at a time when publicly traded risky asset classes have sold off. The dreaded “denominator effect” has pushed some allocators between a rock and a hard place. Do I sell illiquid investments in the secondary market at a steep discount? Or do I sell other risky assets to raise cash, worsening my strategic target mismatches? The “numerator effect” caused by GPs coming to market ever faster and larger complicates things further. Allocators should take care not to make an unforced error that puts them in the position of having to be a forced seller. Frequent headlines reveal that this is a common dilemma. Reconsidering pacing and focusing commitments to only highest conviction opportunities are possible remedies.
CIO: What should be an investment trend, but isn’t (yet)?
Pearce: Allocators should consider taking a page out of the alternative investments playbook when restructuring fee arrangements with their traditional investment managers. The use of internal rate of return and the importance of carried interest encourage efficient capital stewardship. By calling and distributing capital in a timely manner, both GPs and LPs are better off. The traditional compensation structure of assets under management times a percentage fee does not align incentives as effectively. Even when performance-based bonuses are included, the main driver of the fee to a traditional manager is the AUM. Managers whose revenues are based on this model will always tell you the time is right to invest in their space. Moreover, strategies with a positive equity beta are operating with a constant tailwind, as AUM grows with market appreciation. This compounds over time, regardless of the manager’s reinvestment in their business. Cleverly designed incentives might overcome this asymmetry of interests. Private markets fee structures may offer some clues despite some persistent problems, including management fees on ever-growing fund commitments and various manipulations of IRR. Change will be difficult, but forward-thinking managers who are confident in their ability to add value will adapt.
CIO: What investing decision have you made for your organization that you’re most proud of?
Pearce: I am most proud of our thoughtfulness in growing IMRF’s internal asset management program. People ask whether internal management is a substitute for or a complement to external active managers. We maintain that the answer is “both.” Managers who add idiosyncratic alpha at a reasonable fee have a role to play in our portfolio. On the other hand, managers who add little more than market beta, factor beta, or who charge inappropriately high fees for their services can be replaced by internally managed strategies. This is not to say that replacement is easy. Delivering alpha through active management is challenging, even for the world’s largest and best-resourced managers. Cos- effective beta delivery through passive management, believe it or not, is also challenging, owing to razor-thin margins for error. As our mandates have increased to encompass about 10% of the fund’s assets, we have been cognizant about keeping our expectations proportionate to our resources. We have strategically designed the program to emphasize our unique advantages, scaled opportunistically to achieve portfolio efficiencies through time and worked through the crucial operational details in partnership with external vendors and internal stakeholders. It is thrilling to watch this vision come to life.
CIO: Which asset manager (exclusive of their firm) has most influenced your growth as an institutional asset manager?
Pearce: I have learned from many fantastic investors, but three individuals have been especially influential in shaping my growth as an institutional asset manager. My first manager, Pete Cahill, gave me the freedom to learn by doing things on my own and grounded me with a systematic approach to decisionmaking. Pete taught me that disciplined processes based on empirical research can protect against behavioral biases. He embodied the mantra of continuous improvement and maintained an admirable temperament when things got tough. At IMRF, I have been fortunate to work with two wonderful CIOs. Dhvani Shah hired me to help build out internal management capability and made savvy design choices that set us up for success. She challenged my colleagues and I to think differently, never accepting the status quo without thorough investigation. Dhvani encouraged me to pursue graduate school, and I am proud to now share an alma mater with her. Angela Miller-May is an incredible cheerleader who skillfully leads through subtle cues. Angela is a champion of diversity in our industry, bringing her expertise to an impactful program nurtured by Dhvani at IMRF. I am lucky to count Pete, Dhvani and Angela as friends and mentors.
