How AI is Changing the Way We Invest

July 14, 2017
By: Special Guest
Paul Sciglar, Journalist

Artificial intelligence is rapidly evolving. Unprecedented advances in machine and deep learning have even called for some concern. Elon Musk, futurist billionaire and CEO of SpaceX (News - Alert) and Tesla Motors, has dubbed it mankind’s “greatest existential threat.” Indeed, driverless cars, a technology Musk himself is developing, would displace up to 15 percent of the world’s workers – a figure the Tesla CEO provided himself. The world of finance is by no means immune to the disruption AI will cause. In fact, artificial intelligence is already changing the way we invest.

According to Investopedia, algorithmic trading already comprises 70 percent of daily trading. As trading becomes more automated, the need for human analysts has sharply decreased. Traders are already being replaced by AI and, as each day goes by, the technology only grows more sophisticated. Quantitative analysis, a strategy that involves crunching numbers and analyzing data, is a task much better suited for advanced software systems as they are much less prone to error and have the ability to absorb a greater amount of data at a much faster speed.

When AI traders do make mistakes, they are able to learn from them at an exceptionally fast rate. What takes traders months to learn, an artificial intelligence program can learn in mere moments. Additionally, quantitative analysis, when performed by machines, is not marred by emotional or wishful thinking. It relies purely on data.

Some hedge funds are taking the technology a step further by allowing intelligent machines to make their managerial decisions. Almost alarmingly, AI-led hedge funds have been consistently outperforming firms led by humans. “Humans have bias and sensitivities, conscious and unconscious,” Babak Hodjat, co-founder of Sentient Technologies, an AI company aimed at improving various sectors with smart software, told Bloomberg. “It's well documented we humans make mistakes. For me, it's scarier to be relying on those human-based intuitions and justifications than relying on purely what the data and statistics are telling you,” he continued.

Babak’s claim that the cold logic of computers will supersede the hapless decision-making processes of humans is not unfounded. On average, AI funds have experienced annual returns of approximately 8.44 percent, which is significantly higher than many other indices. To put this number in context, Eurekahedge hedge fund index indicates an annual return of 2.29 percent. There are many factors that shape this figure, however, which may be unrelated to AI’s superior reasoning capabilities. It is possible, for example, that we are inundated with quantitative analysts (as there has been an influx of funds being poured into quantitative investing strategies as of late), and this surge has caused a marked dip in quality. Still, AI’s outperforming traditional quantitative firms cannot be ignored.

AI could affect more than the firms themselves. The proliferation of robo-advisors has the potential to vastly reduce the fees associated with consulting an advisor. Charles Schwab recently launched the Schwab Intelligent Portfolios, which provides investors with the ability to get portfolio recommendations from a few hundred lines of code. Instead of consulting a professional, customers rely on an algorithm to create a portfolio tailored to their level of aversion to risk and their long-term investment goals. Instead of employing a stock broker to carefully curate your portfolio, customers can utilize intelligent systems and software to accomplish their goals. Still, many are leery of entrusting such an important service to a program. Even more remain concerned about robo-advisors eliminating more jobs which would result in a further displacement of financial professionals.

Furthermore, although data points to artificial intelligence being far more efficient and effective as advisors, traders and financial decision-makers, investors are still hesitant to leave important decisions entirely up to the discretion of an AI system. Even the most technical skills, such as financial modeling, demand a great deal of human intuition to be done expertly.

Fundamental investors and followers of Warren Buffett’s investing philosophy may still believe they have the upper hand. “Much of the information and data that humans try to process when thinking about markets is largely meaningless when applied to the fortunes of individual companies,” Miles Johnson writes in his piece about AI and finance for Financial Times. “Computers will have an edge in processing large amounts of economic data, but may struggle with the more qualitative judgments Mr Buffett has excelled in such as judging the character of a chief executive or the durability of a brand.”

Despite our manifold fears and reservations, artificial intelligence is already reshaping finance. Trading is largely automated. Portfolios can now be generated by programs. Computers have the ability to supplant – and surpass – hedge fund managers at their own game. It is no longer a question of whether or not AI will change investing. It seems fairly obvious to even the most casual of observers that AI will dominate financial markets if the current trend of rapid advancement continues. Rather, we are now faced with the question of how we plan to integrate humans in the process. AI certainly has the capability of phasing out stock brokers and financial analysts, but it also has the ability to bolster the existing skills of humans, if we are willing to learn how to interact with the powerful technology.

About the Author

Paul Sciglar is a journalist interested in international policies and economic affairs. He is also a certified accountant with broad experience in strategic analysis, FP&A, investment banking, and investment management. You may connect with him on Twitter




Edited by Alicia Young