Can robots make good investment managers?

So much has been written about artificial intelligence, yet as it stands, we have barely scratched the surface on its use and potential. The world of investing is no different when it comes to what machine learning and robotics can do on improving investment performance.

In a world where big data and information has become so extensive, it is natural for investors to believe that robots will someday be able to replace humans in giving financial advice and managing investments.

Recently, a lengthy but great article was written about investing without humans by Howard Marks, a very well-known US money manager. In the article, he discussed extensively about passive investing, quantitative investing and how robots and humans fit in into the picture. Below, we have taken a snippet of a couple of these important concepts in how they fit into the world of investing.

Advantages of machines:

Passive index investing

With one of the longest bull markets in history still appearing strong, more and more investors are flocking to passive or index investing as the cheap and easy option to gain market exposure and returns. By definition, passive investing is simply a form of computer aided investing as all stocks can be quantified appropriately through their size or some other quantitative factors. It is aided by the findings that many fund managers have not consistently beaten the market after fees are considered. In this sense, machines can efficiently and cost-effectively provide investors with a “can’t lose” strategy to keep up with the index, even though it can also be seen as a “can’t win” strategy as well as it cannot generate returns above the average.

Quantitative investing and arbitrage

Quantitative investing means that humans provide the instructional codes for machines to follow. We have no doubt that computers will be able to do an unrivalled job in shifting and sorting through the massive amounts of data and information. Those which are quantitative and objective can be done by machines at a much faster and more accurate pace than any human can do.

Machines can detect very small (statistical) arbitrage opportunities. A host of “quant funds” use this investment approach and strategy to make money. However, these profit opportunities are also limited by the amount and size of these opportunities. As such, the capital required to profit from the arbitrage opportunities are also limited. When many machines are set up to find and arbitrage on these opportunities, the scale of the profit pool as well as the time taken to close the opportunity also lessens. As such, limitations exist.

Artificial Intelligence (AI) and judgment

While the rate of progress has been very fast, in our opinion we are, at best, only at the second innings of a very long nine innings journey. Artificial intelligence (AI) and machine learning is very much still at its infancy. Although we are full advocates of AI and excited (and sometimes nervous) observers of the potential of this technology, there are still many more questions and problems than answers at the current time. Some of these questions that relate to generating strong investment performance relates to the ability for machines to make a complete judgment on qualitative and subjective matters. These matters can make a huge difference when it comes to the long-term success of investing. For example, can machines listen to the discussions of a CEO and figure out whether he is likely to be the next Steve Jobs?

Certainly, machines can decipher through big data and have a level of artificial intelligence over the next decade to enable humans to make better decisions and results. However, until these machines can fully take on human creativity, feelings, and subjective judgment, we believe that there will always be a role for humans to produce better than average results. It is not that we believe humans can be better than machines in arithmetic, accounting or finance, but in our opinion the main advantage lies in our ability to use the qualitative factors we see to enable us to make judgments that result in better than average long-term performance.

As Einstein correctly noted “Not everything that can be counted counts, and not everything that counts can be counted.”

Please feel free to discuss the above or any financial matters you may have with your advisers.