This Article was first published on 29th Oct 2017 on our Asia-In-Focus Newsletter. To get the latest newsletters, click here.
October 2017 Edition
The Future Of Investing
Robots are taking over the world. Elon Musk has been warning us for a long time on the danger of Artificial Intelligence (AI). Although we do not know if AI would really bring us to the world of Skynet (Terminator), we do know that AI is beginning to start disrupting traditional industries, leading to job losses of the old and job creations for the new.
Some of the sectors that are clearly being disrupted by technology and Artificial Intelligence are the retailing sectors (E-Commerce), the transportation sector (Ride-Hailing & Autonomous Driving) and advertising (Digital Advertising).
Now it seems that AI is coming for the next big industry; fund management.
The Way It Used To Be
Fund management has always been a very traditional business. We depend on a group of humans, who run around (or sit around) looking for good investments to buy. They form a strategy and start to sell this strategy to a fund. Banks, brokerages and other intermediaries would help them promote their fund for a fee (sales charge).
Customers like ourselves would buy these funds after deducting from sales charge and annual management fees. All these for the chance to underperform the market 97% of the time. It is true, there was a study done that fund manager has underperformed their own benchmarks 97% of the time over the last decade.
The Way It Is Moving Towards
So you see, there must be a better way. Over the last few decades, there has been a shift towards passive investing. The Vanguard Group, founded by legendary investor John Bogle, started a series of passive funds since the 1970’s.
Instead of having fund managers and analysts who assumed they can invest better than the market, the passive fund is index tracker funds. It means there is no need for expensive fund managers or analysts, the fund would just buy and track whichever companies are included in an Index.
For example, a Straits Times Index passive fund would buy the 30 constituents stocks within the Straits Times Index, according to the weighting provided by the index.
In this way, the fund can operate at a much lower cost and that savings mean that many long-term passive investors might actually outperform those actively managed funds. Some of Vanguard flagship passive funds can have an expense ratio of less than 0.1% of its funds, compared to the 1% to 2% fees charged by active funds.
However, passive funds have their own sets of issues. For one, passive funds guarantee you that you will underperform the market since you are merely tracking the market and still playing some fees for it.
On top of that, what is more, serious as passive funds gain more popularity is the risk of a more volatile market. This is because passive funds are easily tradable as an Exchange Traded Fund (ETF). We are able to buy and sell these funds like a stock. While this means you can easily cash out whenever you need the money. However, that would also mean that as the market might see higher peaks and bottoms as the crowd rush in to buy during a bull market and rush to sell down their investment during a market crash.
The Disruption Way
Earlier this month, some interesting development is showing in the industry. News has broken that an Artificial Intelligence Powered Equity ETF has been launched in the US. Unlike the passive funds where there is no stock picking involved. And there will be no human fund managers or analysts who will be researching and selecting the stocks for the fund as well.
In fact, this AI fund is using IBM Corp’s Watson AI technology to select stocks to invest in. In short, the robot is trying to replace fund managers and analysts. Watson would utilize both artificial intelligence and machine learning ability to scan through 6,000 U.S. stocks and scan through all the regulatory filings, news stories, company profiles and even sentiment gauges to find the perfect stock to buy.
Although this is just the first AI-powered fund to be launch, it marks the beginning of a very interesting sea of change. Personally, I am very optimistic about this development. In theory, the greatest weakness of an investor is the lack of patience and the inability to control one’s emotion during a market crisis. Warren Buffett has been such a great investor in part because he has been so effective at controlling his emotions when investing. Thus, the best investor would be one that has no emotion at all; aka a robot.
BUT, and that is a big BUT, the robot can only as good as the parameters set by its programmer. For now, robot fund managers might not be perfect, but with machine learning, where it can learn by itself and adjust its own investment philosophy, one day, we might really see the robot version of Warren Buffett and it might be much wealthier than Buffett ever is.
As V.I.K.I said, “My logic is undeniable.”
Onward my human friends,
Value Invest Asia