Rise of the Machines: How Machines are Changing Portfolio Management

By Bo J. Howell and John Simmons

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 be focusing on quantitative versus human execution. Active management isn’t going anywhere, but it will be increasingly based on quantitative strategies, not 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 the 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 morphed to fit 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 0.03-0.09% of assets under management each year [while a]ctive managers often charge 20 times as much.” The price discrepancy between passive and active funds has led to one of the hottest topics in asset management over the past decade. But the debate is framed incorrectly.

As discussed in March of the Machines, humans will still have a role in portfolio management. Firms will still need people to oversee how the computer’s strategy performs. To the extent it identifies potential factors, humans will need to evaluate whether those factors are false positives.

Further, machines will need humans to identify the data sets that the computer should evaluate. It may not be obvious to a machine that GPS tracking of trucks should be a factor considered when evaluating logistics firms. Forming and exploring creative connections is one area where the human brain still excels relative to the artificial mind. Another area where human portfolio managers will continue to outperform machines is the evaluation of small data sets. Machine learning requires huge amounts of data, which can take years or decades to develop.

What future portfolio managers should expect

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

Having the know-how and capabilities to obtain large sets of data will allow computers and artificial intelligence to create efficient solutions for clients. The large powerhouses in the industry will have a clear and impactful advantage because of research and development costs. Technology will allow these companies to scale at a faster and cheaper rate than the typical advisor.

Technology will also force the asset managers and money managers to adapt. As digital natives, students and young professionals in the workforce today are more integrated with technology. The continued disruption caused by technology will require newer portfolio managers to focus more on the quantitative field and computer programming.

Previously, portfolio managers built portfolios based on personal strategies and models. In the future, portfolio managers will need to integrate more technology and quantitative strategies into their daily methods. Fortunately, the continual addition of technology in asset management will allow for more objective investment decisions. By shifting away from any human bias, portfolio re-balancing and trades being made will strictly be based on data and analysis.

In the eyes of students, this is an exciting opportunity because we are coming of age 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” portfolio manager responsibilities.

These responsibilities and skill sets may include what is considered at most universities as Business Analytics (“Analytics”) and Information Systems (“Info Systems”) majors. These degrees, in addition to finance courses, will be critical in the years to come. Analytics and Info Systems focus on how technology can support business practices and operations. How students and universities integrate the typical Finance, Analytics and Info Systems classes will be influential on the industry shift.

Will the typical “Finance Student” come out of school with a better understanding of Analytics and/or Info Systems? The industry has gone through several changes and this is one that can significantly benefit asset managers who accept and embrace the 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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