A number of public pension funds have invested a significant portion of their assets in artificial intelligence companies, drawing mixed reactions from market observers. While professionals had differing perspectives on the impact of AI as a concentration risk, most agreed the risk is increased for allocations to any equities.

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The Equable Institute, a non-profit that works with public retirement system stakeholders to solve pension funding challenges, estimates 10% or more of public plan assets face exposure to AI businesses. 

Of the top 25 public pension funds reviewed by Equable from SEC filings, 23 of them disclosed specific holdings for all or a portion of their public equity investments. Out of the 25, “8.6% of their assets were concentrated in a basket of 51 publicly traded A.I.-related companies,” according to the report.

Some public pensions “don’t have good regular reporting on where their public equities are,” which makes it hard to gauge the extent of the concentration, Equable Executive Director Anthony Randazzo said.

“We know that there is a lack of complete transparency from some of these funds, and so it’s a thing that we try to be careful in calling out,” Randazzo said. “An example on our list is the Washington State Investment Board. They use external asset managers, which is totally fine, if not wise in some cases. But there isn’t quarterly reporting of the value of their assets.”

“Equable is estimating it from available information, and the information that plans provide,” Fitch Ratings Senior Director Douglas Offerman said. “The window that we have to see individual holdings of plans is pretty limited. It’s not super clear what the total exposure is.”

Outside analysts believe AI concentration presents a risk; however, their concern stems from allocations to equities in general rather than a specific sector.

“It’s not just this 10% allocation. It’s a bigger picture look at the risk that investment loss could create,” Hilltop Securities head of public policy and municipal strategy Tom Kozlik said. “It’s a combination of the concentrated allocation to not just the to one particular subsector, but also to equities in general, that increases the potential investment loss.”
Another potential issue for funds is the valuation of AI assets.

“Contribution rates for these pension funds are predicated on the value of assets today relative to the value of liabilities, and if the value of AI assets is overstated, then it would mean that there’s larger unfunded liabilities than are currently accounted for,” Randazzo said. “Even if there’s not a massive AI bubble, if there’s overvaluation of AI companies today, there’s reason to be concerned.”

While high valuations look great for reports and economic trends, overvaluations have consequences. 

“Pensions are experiencing the same thing that the rest of the economy is experiencing. It’s great for pensions insofar as valuations improve, and that puts downward pressure on actuarially required contributions,” Offerman said. 

If these valuations are incorrect, the actuarial contributions would increase, which would be an impact felt gradually over time, he said.  

Despite the risks, the economy seems to pour more resources into AI and related projects.

“Capex numbers are crazy, and that’s what’s causing a little bit of heightened concern,” Principal James Welch said. “But on the other side of the coin, we have higher Treasury rates, we have higher other rates, we have a really good performing stock market. So there is another balance in these portfolios that should — assuming that they stay on track — help offset any sort of concentration concern.”

Generally, public pensions funds have also demonstrated strong performance, according to Equable and Moody’s.

“Assets have been growing at a very healthy clip. At the same time, you’ve had higher interest rates pushing down the present value of liabilities. Contributions have been really strong and have been growing,” Moody’s Analyst Christopher Yared said. “The indicators that we look at are doing well.”

AI and the broader technology sector are increasing private-sector spending, capital flows and economic growth. S&P Global Ratings reports 55% of the U.S. increase in private domestic final demand over the last four quarters concerned AI-related contributions, and high-technology sector issuance grew by 160% in the first half of the year.  

The boom of AI, data centers and tech has contributed to economic growth; however, analysts are aware of the exposure if this growth slows.

“Concentration in AI and tech leaves investment and economic output in the country exposed to any cooling in the AI boom,” according to an S&P report. “Rising debt-funded spending, complex financing, and concentration risks could amplify market stress if returns disappoint.” 

Moody’s analysts explained risk regarding concentration of any asset depends on the structure of pension funds.

“U.S. public pensions systems are large pools of investments that are highly diversified, and, like any challenged sector of the capital markets at any particular time, whether it would be AI or anything else, the chances are that exposure exists because of that high level of diversification,” Moody’s analyst Thomas Aaron said. 

Even though Moody’s acknowledged strong pension performance, analysts are cognizant of the risk that investments as a whole present for these public funds and AI investment is part of this bigger picture.

The potential for significant investments losses was identified as a considerable risk to pension funding because very few U.S. public systems have de-risked their investments, according to Moody’s report. While “heavy equity and alternative assets allocations have materially” benefited government credit quality, this investment approach subjects funds to market volatility, Moody’s said.

“One area we’ve pointed out consistently in our research has been a relatively heavy allocation to what you would call growth assets,” Aaron said. “The past few years have absolutely benefited greatly from those investments. The returns have been, in most cases, above target. But the potential downside to that is it can be a volatile path.”

“On one hand, asset growth has been by far and away a clear driver, but on the other, the contributions have improved over time,” Moody’s Yared said. “The number one risk really is if you have a market decline. You know, it’s live by the sword, die by the sword.”