The rise of machines: how machines are changing portfolio management



By Bo J. Howell and John Simmons

The march of the machines notes that computers have been used in portfolio management since 1975, when Vanguard created the first index fund.

Rather than debating the benefits of passive versus active strategies, asset managers should focus on quantitative execution versus human execution. Active management is getting nowhere, but it will increasingly rely on quantitative strategies and not on human management. Additionally, the debate will focus on the two general types of quantitative strategies: those that use computer models to mimic human strategies and those that use artificial intelligence to determine strategy.

The rise of portfolio management theory, first developed by Eugene Fama and Kenneth French, created a list of economic factors that has since grown and transformed to accommodate various investment strategies. Quantitative managers have digitized these factors into computer models that act like an active manager.

The result, according to the articles, is that “[p]assive funds charge 0.03 to 0.09% of assets under management each year [while a]active managers often charge 20 times more. The price differential between passive and active funds has led to one of the hottest topics in asset management over the past decade. But the debate is poorly framed.

As discussed in The march of the machines, humans will always have a role in portfolio management. Businesses will always need people to oversee the performance of IT strategy. As it identifies potential factors, humans will need to assess whether those factors are false positives.

Additionally, machines will need humans to identify which datasets the computer needs to evaluate. It may not be obvious to a machine that GPS truck tracking should be a factor when evaluating logistics companies. Forming and exploring creative connections is an area where the human brain still excels compared to the artificial mind. Evaluating small data sets is another area where human portfolio managers will continue to outperform machines. Machine learning requires huge amounts of data, which can take years or decades to develop.

What to expect future portfolio managers

Technology offers many advantages to asset managers; it can create economies of scale in areas such as account management, portfolio trading and marketing. Some of the main benefits of artificial intelligence in asset management are improved operations, improved product development, and cost savings for investors. The technology used often encompasses big data and alternative data.

Having the know-how and capabilities to obtain large datasets will enable computers and artificial intelligence to create effective solutions for customers. The big powers of the industry will have a clear and impactful advantage because of the costs of research and development. Technology will allow these businesses to scale at a faster pace and cheaper than the typical consultant.

Technology will also force asset managers and fund managers to adapt. As digital natives, today’s students and young professionals are more integrated with technology. The continued disruption caused by technology will force new portfolio managers to focus more on the quantitative realm and computer programming.

Previously, portfolio managers built portfolios based on personal strategies and models. Going forward, portfolio managers will need to integrate more technology and quantitative strategies into their day-to-day methods. Fortunately, the continued addition of technology in asset management will allow for more objective investment decisions. By moving away from any human bias, the rebalancing of the portfolio and the transactions carried out will be strictly based on data and analysis.

For students, this is an exciting opportunity as we mature during this disruptive time which means we can help shape the industry. Millennials and graduates will need to be able to adapt and apply what they have learned in school. By keeping an open and curious mind, graduates will be able to grasp the “new” responsibilities of portfolio manager.

These responsibilities and skill sets may include what is considered in most universities to be specializations in business analysis (“Analytics”) and information systems (“Information systems”). These degrees, in addition to finance courses, will be essential in the years to come. Analytics and information systems focus on how technology can support business practices and operations. How students and universities integrate typical courses in finance, analysis and information systems will influence the change in the industry.

Will the typical “finance student” come out of school with a better understanding of analysis and / or information systems? The industry has gone through many changes and this can greatly benefit asset managers who embrace and embrace change.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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