All of us have heard the term 'changing the playing field' and while this is normally used as a metaphor it actually refers to something that we can see in the real world - at times literally.
For example, in hockey the playing field changed from grass to astroturf and suddenly a whole different set of skills became important - from skilful dribbling and stickwork of the Major Dhyanchand era, the need of the hour was to be fast and fit. Indians didn't adapt and fell off the top hockey league.
Currently we can see something similar happening in the automobile market where companies who do not adapt to electric vehicles risk becoming obsolete.
On a new playing field, old instruments and techniques don't work, no matter how skilful the player. The legendary Bjorn Borg couldn't make a comeback with his old wooden racket.
The Playing Field is changing in Investment Management ...and How!
Advanced tech is doing to investment management, what it did to many other fields of play.
Traditionally, investment decisions were made only by the human mind.
If you put your money in a mutual fund or portfolio scheme, your "human" fund manager painstakingly analysed Company and industry data in order to decide where to invest...at least you hoped they did!
Almost all investment management practices today, remain frozen in a 1940s-1990s time warp.
But the world has moved on.
For one, a large part of what made the traditional model work was getting additional or differential information by meeting companies and their management. This was true not just of India but of all markets around the world where large fund managers could sit in a closed room with a company and get information.
However, this edge has been regulated away across the world - information availability has been made uniform. All call transcripts for instance have to be out in the public domain.
In fact, now the problem is something quite different, which is an absolute surfeit of data which is humanly unmanageable.
And this is where the machines come in...
Advanced computing power makes extreme data crunching prowess accessible.
Models can analyse more securities AND more data points in each than is possible even for large teams of humans.
Most important, they can do consistently and without bias - something which is impossible for human beings.
Machines do the thinking for you. Machines "learn", quicker and better than humans ever can.
Adaptive learning systems can replicate human inventiveness, only much better.
Artificial intelligence & Machine Learning are set to transform future of investing.
An expertly constructed Quant ML model can do bewildering things: it can read millions of research papers, balance sheets, conference call transcripts, social media feeds!
It can analyse a company's auditor's reports and management commentary. It can distinguish between good accounting policies and bad.
It can granularly analyse ratios, in time series as well as cross section, across thousands of companies.
A well developed machine can expertly analyse reams of data, discern patterns & linkages, across stocks and securities across the world. No set of humans is equipped to cast such a wide and narrow eye, contemporaneously, on data.
Investing, the way it has been done so far, is nothing but luck masquerading as skill, with most gains coming from just a handful of stocks. As Charlie Munger says: "If you take away our few big winners, Berkshire's record is very mediocre".
This, in mathematical terms, is luck. Not skill.
Machines reduce the role of luck hugely, bringing skill to the fore.
Which is exactly why the traditional investment management business worldwide has been in crisis for years - because traditional fund management simply cannot beat markets, owing to their severe cognitive limitations.
Human beings are biased and inconsistent. Plus they have limitations - for example, at First Global we analyse over 20,000 securities globally and about 6-700 in India. Even if a large team if human beings does it, each human being's way of looking at it will be different which means the entire picture can never be consistent.
Machines are consistent. They will look at data with an even, un-jaundiced eye.
And this, in turn, translates into consistent market beating performance which the traditional fund managers simply cannot match.
Another interesting aspect of quantitative investing: the more the data fed into machines, the more accurate predictions they generate. This is absolutely the opposite in humans! Most human brains decline in capabilities, with age and load.
Because humans can process only limited data, they tend to build more concentrated, clustered portfolios, largely around their comfort zones. This increases correlation in the portfolio, leading to very volatile returns. 'I will invest only within my circle of competence' is just a fancy way of saying that I will only invest within my comfort zone. And as an investor why should your investment be constrained by your fund manager's comfort zone?
In contrast, Machines can build far larger, more carefully diversified portfolios, across a wide spectrum of securities: reducing correlation, thereby reducing Risk, while not sacrificing returns.
Also, machines are clinical about acknowledging and analysing mistakes as well as correcting the process that led to these mistakes. Each of these steps is extremely difficult for a human being as we are hardwired to defend our decisions and stories.
Reality is: humans have limited capacity to absorb data and when confronted with vast amounts of data the human brain simply shuts down and resorts to reliance on underanalysed, oversimplified lazy opinions and simple stories.
Quantitative Investing is free from behavioural biases and emotions. The human mind, no matter how intellectually sound, cannot be emotionless.
The Investment Playing Field is changing and you cannot afford to be left behind
The Machines are coming to the Investing Game. The playing field is changing. Sticking to the old way of doing things will only mean that you will be out of the game.
Don't become obsolete like the combustion engine will be in an era of Electric Vehicles.