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Diary of a fund manager - Change Management - 18.06.18

David Miller, Investment Director, Quilter Cheviot

This week’s Diary is a real and virtual travelogue, taking in the past and the present before looking at the themes that will define the future and so drive investment returns. Artificial intelligence (AI) is enhancing human intelligence (HI) and the pace of change is accelerating.

All things considered it was a reasonable week for investors, with equities moving ahead and bonds marginally down. The dollar held centre stage in currency markets. Whether it was economics or politics, UK assets underperformed the rest. Influential central banks met, decided and communicated. The Fed raised interest rates for the seventh time since the start of 2016, but even close textual analysis of the accompanying statement failed to illuminate the future with any degree of clarity. The ECB statement was interesting because it contained a commitment to end QE by the end of the year, but then to keep interest rates unchanged until later in 2019 than previously expected. The bottom line is that monetary policy is moving away from the emergency measures put in place ten years ago.

Free markets have a way of taking many matters into account, acting as a clearing house for fact and fiction. There is also a self-righting mechanism that works reasonably well, even at extremes of optimism or pessimism when it is hard to see a day ahead let alone a decade. For example, something appears to be not quite right in the state of Germany just at the moment. The new coalition is struggling to work together, expectations for the economy have turned down and inflation is moving higher. As an exporter to the world it could be that German industry is expressing collective concern about tariffs and trade wars or then again, perhaps a period of euro weakness driven by the growing gap between US and European interest rates will restart the engine of growth. Company results, as they emerge, will provide better guidance than any number of central bank statements.

In the US the good news is in plain sight. Economic growth is picking up and confidence indicators are on a rising trend suggesting, if anything, that there are upgrades to come. Those looking to forecast the next recession are turning their attention to 2020 or later, which is too far in the future for most to bother about. Alternatively, we might be in the foothills of irrational exuberance which, eventually, will lead to a more painful ending than a mild recession. The Trump rampage is having more of an effect on the rest of us than on America just at the moment. This is either a permanent change, or just another cycle. It isn’t much of a stretch to link a strong dollar, higher wage costs, higher raw material prices and higher interest rates to less profit for corporate America. As I said earlier, markets self-right when left to their own devices and a shift back to German exporters doesn’t require much imagination.

Those looking for signs of excess need look no further than fund raising activities by companies looking to change the future. Bird Rides, an electric-scooter ride-sharing business formed less than a year ago, is raising money to develop its idea, and is already valued at over $1 billion. On this side of the Atlantic, shares in a financial technology company called Adyen are in demand despite being on a PE multiple of 170. Lest you think that I have turned into a luddite, I did spend most of last week fully engaged with the modern world. Structural change and disruption is all around us.

Mid-week it was back to Frankfurt for the third time in the last couple of years to attend and, this time, speak at a conference designed to bring together those interested in using AI to make investment decisions. Rather like hedge fund conferences of 15 years ago, the attendees were an eclectic mix of innovators, investors and academics looking to share ideas rather than to be ‘sold’ a fund or operations platform. Momentum is building. Conventional fund managers are developing hybrid funds combining HI and AI. Pure AI funds, which were a nice idea just a couple of years ago, are now being launched and, although the numbers are still small, the trend is clear. Adding value using AI is just as difficult as conventional ways of managing money, but the exponential increase in computing power is facilitating change. As one of the speakers said, ‘if you look at the data, you see new things,’ and the amount of data is going up all the time, whether through the analysis of social media trends or using security cameras to judge how full shopping centre carparks are on a day-by-day basis. AI is not the philosopher’s stone of investment but its influence is on an upward trajectory. Another quote sums up the state of play. ‘Markets are a challenge because there is a lot of noise and not much signal. That means they are almost a random walk, but not quite.’ Finding the ‘not quite’ is the gap which active managers, whether driven by HI or AI, are trying to exploit.

Then to Liverpool to talk about the Chinese future as a follow up to last week’s Diary. The chance to see the excellent Terracotta Warriors exhibition at Liverpool’s World Museum was an added bonus as the resonances between past, present and future were hard to miss. And finally to Cambridge where, in amongst the glorious past, the discussion was all about implementing the future. End of term concerts, plays on the lawn and parties on a mid-summer evening are an unchanging pleasure.

Between all of this I did attend a packed technology conference. Investors with capital to deploy and companies looking to raise finance need to find ways to meet each other and face-to-face still works. The level of interest was intense. Setting aside concerns about irrational exuberance, it did strike me that a lot of these exciting companies will never make it to public markets, preferring instead to grow in private, thus avoiding onerous listing requirements and constant public scrutiny. Silicon Valley has developed its own eco-system for growth, well away from Wall Street. The Israeli technology sector is on the same track as are many innovative Chinese companies. Investors in the search for return are looking beyond conventional markets. Getting it right will require imagination, a fair amount of frog kissing and plenty of due diligence. The human mind still has the edge in terms of breadth, but AI is a good way of adding depth.

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Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

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