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Diary of a Fund Manager Supplement – is it time for some artificial intelligence?

David Miller, Investment Director, Quilter Cheviot

In March, I attended the first NextGen Alpha Artificial Intelligence Investor conference and since then have been reflecting on what I heard and reading all that has come across my desk. What impact will artificial intelligence (AI) have on financial markets and how can I, as a conventional investment manager, take advantage of the accelerating rate of change we are surrounded by?

To start with I should admit to biases, or perhaps more correctly, where I have come from and where I am today. Back when gene sequencing was in its infancy and when we programmed computers using low level languages to leave enough memory space to do calculations, I studied the natural sciences. Sad to say not much is left of what I learned other than basic numeracy and a working knowledge of scientific method. However, scratch the surface and you will find a rational empiricist, less interested in clever theories than real results and that those who want to believe in something should go to church.

For over 30 years, I have been immersed in financial markets, gathering information, making decisions and reporting results to those whose savings I have responsibility for. The fund manager I was in the 1980s is very different to today’s version, and I fully expect to be different again tomorrow. As Heraclitus said: “No man ever steps in the same river twice, for it is not the same river and he is not the same man”.

So what right have I to write about the impact of AI on investment other than acknowledging the importance of embracing change? Progress has always been driven by those who ask questions and then either search for answers themselves or provoke others into action. When he was still at school, Einstein asked himself what the world would look like if he rode on a beam of light. The answer is full of paradox and that made it hard to answer, but a few years later he got there with his famous 1905 paper.

Running ahead of progress is imagination and, as ever, literature and films are way ahead of reality as anyone who has read Asimov’s, I Robot, Orson Scott Card’s, Ender’s Game or Do Androids Dream of Electric Sheep? by Philip K. Dick will know. The film version of the Androids, Blade Runner, was all about questions, whether the Voight-Kampff Test or, most memorably, the Roy Batty character in search of a longer life asking, “questions, yes questions”, before doing something gruesome to his creator.

So this first, but not last venture into AI is a collection of questions. Some will expose my ignorance, whilst others will provoke immediate answers, but if I’m lucky a few will fall into the hard to answer category. When Edmond Halley asked Newton if he could describe the motion of the planets around the sun, his immediate response was that they followed an elliptical path and that he would send the proof as soon as he could find it amongst his papers. It took three years to deliver on this promise, but his Principia Mathematica was worth waiting for.

There is no doubt that AI is changing the world. The Google AI search engine is our favourite gateway to the internet, machines can now beat humans at chess, Go, Poker and America’s favourite quiz show, Jeopardy! The question is whether AI is better than humans in the game of investment which has seven billion moving pieces (all of us) and also has to cope with the weather. Although it is obvious that man plus machine, will win against man without machine the fund management industry has questions to answer. Most importantly, are machines alone already good enough to win without human intervention? If not now, then when or could it be never?

A variant of this question is, does the fund management industry need AI? Various answers occur. Is AI better than other technologies designed to replace human intervention in the decision making process? Time and the acid test of performance will tell. At present, the way in which AI investment strategies are described tends to be rather two dimensional, and so it strikes me of limited use in a three dimensional world. Beating indices is one thing, but making money is quite another. Gathering and analysing the huge amounts of information that we now have access to followed by efficient execution should be a winning combination, but arbitrary rule changes initiated by governments or the occasional collective emotional crises that remove liquidity from markets are hard to predict or plan for partly because there tends to be no time to react or learn. What happens if listed markets fail to capture growth opportunities because winning companies stay private? What if inflation makes a comeback widening the gap between nominal and real value to extremes not seen in the major economies for a generation? Will AI investment strategies be able to cope? In extreme circumstances, and how do we define extreme, who will be empowered to switch the machine off? Yet another science fiction allusion by the way, this time Obi Wan Kenobi talking to Luke Skywalker as he was attacking the Death Star in the first (and best) Star Wars film.

The move from single capacity stock markets to dark pools and high speed trading may have narrowed the bid offer spread, but hasn’t changed returns. As AI gains ground in the investment world, will it alter markets, creating more or less volatility? More profoundly, will AI change the cost of capital for the companies that we invest in and which drive the global economy? Questions, questions.

What is clear is that the rate of change is accelerating and so those of us who consume investment products or create them need to be better informed than we are at the moment. Judgements will have to be made about change, whilst acknowledging that some of the constants of investment never will. Just like the natural world, financial markets can be red in tooth and claw, nasty, brutish, short and chaotic. Attempts to model certainty are doomed to failure. Faites vos jeux.

I will be chairing a panel discussion at the second NextGen Alpha Artificial Investor Conference in Frankfurt on 26th October, which will be an ideal opportunity to quiz the experts about these questions and many more.

Investors should remember that the value of investments, and the income from them, can go down as well as up. Investors may not recover what they invest. Past performance is no guarantee of future results.

Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.

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DIARY OF A FUND MANAGER: 01/08/2017
In March, I attended the first NextGen Alpha Artificial Intelligence Investor conference and since then have been reflecting on what I heard and reading all that has come across my desk. What impact will artificial intelligence (AI) have on financial markets and how can I, as a conventional investment manager, take advantage of the accelerating rate of change we are surrounded by? To start with I should admit to biases, or perhaps more correctly, where I have come from and where I am today. Back when gene sequencing was in its infancy and when we programmed computers using low level languages to leave enough memory space to do calculations, I studied the natural sciences. Sad to say not much is left of what I learned other than basic numeracy and a working knowledge of scientific method. However, scratch the surface and you will find a rational empiricist, less interested in clever theories than real results and that those who want to believe in something should go to church. For over 30 years, I have been immersed in financial markets, gathering information, making decisions and reporting results to those whose savings I have responsibility for. The fund manager I was in the 1980s is very different to today’s version, and I fully expect to be different again tomorrow. As Heraclitus said: “No man ever steps in the same river twice, for it is not the same river and he is not the same man”. So what right have I to write about the impact of AI on investment other than acknowledging the importance of embracing change? Progress has always been driven by those who ask questions and then either search for answers themselves or provoke others into action. When he was still at school, Einstein asked himself what the world would look like if he rode on a beam of light. The answer is full of paradox and that made it hard to answer, but a few years later he got there with his famous 1905 paper. Running ahead of progress is imagination and, as ever, literature and films are way ahead of reality as anyone who has read Asimov’s, I Robot, Orson Scott Card’s, Ender’s Game or Do Androids Dream of Electric Sheep? by Philip K. Dick will know. The film version of the Androids, Blade Runner, was all about questions, whether the Voight-Kampff Test or, most memorably, the Roy Batty character in search of a longer life asking, “questions, yes questions”, before doing something gruesome to his creator. So this first, but not last venture into AI is a collection of questions. Some will expose my ignorance, whilst others will provoke immediate answers, but if I’m lucky a few will fall into the hard to answer category. When Edmond Halley asked Newton if he could describe the motion of the planets around the sun, his immediate response was that they followed an elliptical path and that he would send the proof as soon as he could find it amongst his papers. It took three years to deliver on this promise, but his Principia Mathematica was worth waiting for. There is no doubt that AI is changing the world. The Google AI search engine is our favourite gateway to the internet, machines can now beat humans at chess, Go, Poker and America’s favourite quiz show, Jeopardy! The question is whether AI is better than humans in the game of investment which has seven billion moving pieces (all of us) and also has to cope with the weather. Although it is obvious that man plus machine, will win against man without machine the fund management industry has questions to answer. Most importantly, are machines alone already good enough to win without human intervention? If not now, then when or could it be never? A variant of this question is, does the fund management industry need AI? Various answers occur. Is AI better than other technologies designed to replace human intervention in the decision making process? Time and the acid test of performance will tell. At present, the way in which AI investment strategies are described tends to be rather two dimensional, and so it strikes me of limited use in a three dimensional world. Beating indices is one thing, but making money is quite another. Gathering and analysing the huge amounts of information that we now have access to followed by efficient execution should be a winning combination, but arbitrary rule changes initiated by governments or the occasional collective emotional crises that remove liquidity from markets are hard to predict or plan for partly because there tends to be no time to react or learn. What happens if listed markets fail to capture growth opportunities because winning companies stay private? What if inflation makes a comeback widening the gap between nominal and real value to extremes not seen in the major economies for a generation? Will AI investment strategies be able to cope? In extreme circumstances, and how do we define extreme, who will be empowered to switch the machine off? Yet another science fiction allusion by the way, this time Obi Wan Kenobi talking to Luke Skywalker as he was attacking the Death Star in the first (and best) Star Wars film. The move from single capacity stock markets to dark pools and high speed trading may have narrowed the bid offer spread, but hasn’t changed returns. As AI gains ground in the investment world, will it alter markets, creating more or less volatility? More profoundly, will AI change the cost of capital for the companies that we invest in and which drive the global economy? Questions, questions. What is clear is that the rate of change is accelerating and so those of us who consume investment products or create them need to be better informed than we are at the moment. Judgements will have to be made about change, whilst acknowledging that some of the constants of investment never will. Just like the natural world, financial markets can be red in tooth and claw, nasty, brutish, short and chaotic. Attempts to model certainty are doomed to failure. Faites vos jeux. I will be chairing a panel discussion at the second NextGen Alpha Artificial Investor Conference in Frankfurt on 26th October, which will be an ideal opportunity to quiz the experts about these questions and many more. Investors should remember that the value of investments, and the income from them, can go down as well as up. Investors may not recover what they invest. Past performance is no guarantee of future results. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.
DIARY OF A FUND MANAGER: 31/07/2017
This week’s Diary is a mishmash of US politics, corporate results, reasons to be cautious and reasons to be optimistic, together with some recommendations for holiday reading. My intention this week was to focus on the company results season, but unfortunately the chaos enveloping Washington is just too overwhelming to ignore. Take your pick from healthcare, gender or Russia. When the Senate votes 98-2 and Congress 419-3 against the wishes of the President and the Chairman of the Joint Chiefs of Staff of the military says that he doesn’t take orders from the Commander in Chief by Twitter, you know that there is a problem. Political strife tends to be bad for the dollar and so it was last week. Gold went in the other direction, in terms of dollars that is, whilst bonds and equities slipped back, but for other reasons. Almost unnoticed, except by those paid to keep an eye on these things, the Fed met, used the phrase ‘relatively soon’ when talking about policy change and went home for the summer. Amongst the usual run of statistics, two bits of information gave pause for thought. Buried in the UK employment report was the observation that in 1856 the average working week was 59 hours compared to 32 in 2009 when last measured. Elsewhere, the Office of National Statistics noted that it was possible that 100,000 foreign students had remained in the UK after the end of their courses, but then admitted that it hadn’t been collecting data for those who left the country between 10pm and 6am. Perish the thought that students use cheap flights in the middle of the night. Normally, I am one of the first in the office vying with the dealers, but not last week. An avalanche of company results kept the analysts busy, many putting in 19th Century hours. A lot of what we learned was flagged in advance and so only of passing interest, but some trends did emerge. Leading US companies reported earnings that were ahead of forecasts in the ratio 3:1, with exporters benefiting from the weak dollar and consumer related companies noting the lack of inflation. Unsurprisingly, pricing power was hard to find other than Facebook, which earned 24% more per advertisement in the second quarter than in the first three months of the year. In Europe, the numbers were also very satisfactory, but upward revisions were harder to come by as the strong euro started to affect competitiveness. And just when it seemed safe ‘to go back in the water’, other events emerged to disturb equity investors with AstraZeneca announcing disappointing trial results for a cancer drug that had all the makings of a long-term winner. Then, late on Friday afternoon, the US Food and Drug Administration (FDA) announced a plan to change the regulation of cigarettes and other nicotine products. With market ratings above average, any unexpected or disappointing news is unwelcome and share prices are reacting. Two things are proving particularly hard to explain at present. Why is market volatility so low when there seem to be so many things to worry about, and why are leading economies suffering from declining productivity despite all the advantages presented by new technologies? On the subject of low volatility, reports from three separate sources arrived this week, each in their own way highlighting what happens when complacency sets in and risks ignored. I have noted some of these warning signs in previous Diaries, but it was sobering nonetheless to see these and a number of others crossing my desk at the same time. From a short-term trader, the observation that those using derivatives to add value and reduce downside risk are making the assumption that markets will trade within a +/- 4% range for the foreseeable future. Outside this range, strategies that dampen volatilities will turn into amplifiers as the virtuous circle of complacency turns vicious. A hedge fund manager with a good long-term track record commented that he is not using any hedging strategies at the moment because they are too expensive and that leverage is unappealing despite low interest rates. At the moment he is focusing on stock selection with a good weighting to US Treasuries. And finally a well-respected strategist, who has been around long enough to say what he thinks, concluded by setting out a check list of eight questions as a test of market sanity and safety. None of these are easy to answer in a positive way. When we get out of bed every morning we know that there are asteroids out there and that earthquakes do happen, but that doesn’t stop us getting on with life. Nevertheless, sobering stuff. On a more optimistic note, if low productivity continues then this is a problem for economic growth particularly in the aging developed economies. Those who focus on country averages tend to be pessimistic about reversing this downtrend. Well, who wants to be average? The evidence from the corporate world is that technological advances, which may have been thought to lower the barriers to entry for new companies, seem to be having the opposite effect. In many industries, it’s ‘winner takes all’. These winning companies are becoming ever more productive at the expense of the losers. Average productivity may be low, but the range is wide. Investors, as well as anyone thinking about how to get or keep a job, should take note. As this is the last Diary before my summer holiday, it’s time for some book recommendations. As an escape from the modern world, infested as it is with rolling news, instant communication and social media, I will be taking refuge in the 19th Century with Emma by Jane Austen and the Tenant of Wildfell Hall by Anne Brontë and, of course, the latest John Grisham. For non-fiction, The Gene by Siddhartha Mukherjee. Back in September. The diary is now available as a podcast.   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.
DIARY OF A FUND MANAGER: 24/07/2017
The numbers matter when it comes to making investment decisions, but which ones can we rely on? Market and inflation indices are the subject of endless analysis, as are GDP and employment statistics, whilst companies provide weighty tomes describing their activities and results on a regular basis. The answer is a curate’s egg of good and bad, which is the main theme of this week’s Diary.Those trying to judge the direction of markets from 50,000ft are finding it hard to identify consistent patterns from statistics designed to capture what is going on in economies around the world. For the record, last week saw bond markets move higher, along with US and UK equities. The dollar and sterling were down against a strong euro. The good news is that economic growth in the first six months of this year was better than anticipated in the US, Europe and China. As a result, investors have continued to add to both bonds and equities in order to get away from zero return cash.In the short term, markets are in ‘show me’ mode as we work through the company results season and as attention shifts from screen to beach. Only Washington seems to be immune to seasonal influences as attempts to create a legislative agenda for 2017/18 struggle for presidential attention. A visit to a UK company that relies on long-term contracts from the US government was reassuring, because all around the table, including me, agreed that the Republicans had to make use of their majority position before the mid-term elections at the end of next year. However, I must admit that it’s getting harder to maintain the courage of my convictions, as US short-term money markets start sending out distress flares ahead of debt ceiling legislation which Congress will need to pass by October.Back in March 2000, the technology-heavy NASDAQ index passed 5000 for the first time before collapsing to an intra-day low of 1108 in October 2002. It was a long wait, but in April this year it finally made it to 6000 and now is a few hundred points higher. So much has changed in the intervening years. Back in 2000, the average PE multiple was at 73, whilst now it is similar to the US market as a whole at 19 times. The market value of the top five companies has increased from $1.9 trillion to $2.7 trillion, which is interesting, but not remarkable. What is notable is that only Microsoft has retained its top five ranking. Cisco, Intel, IBM and Oracle have been relegated in favour of Apple, Alphabet (Google), Facebook and Visa. Passive investors beware: valuation and stock selection drive returns.Making judgements about which companies will win and which will lose is hard enough, but at least the numbers can be analysed and the management teams held to account. Economies are much harder to get right, because the statistics are never more than best guess estimates and there is no one to fire when things go wrong. For example, the US non-farm payroll report is analysed to death each month by those trying to gauge the temperature of the economy. Almost every time, the numbers from previous months have to be revised because the sample taken is small relative to the total working population and so, rather like opinion polls, is subject to error. There are other measures of employment which provide contrast and so this unreliability is not a major problem, but it doesn’t stop the commentators fitting stories to numbers which, with the benefit of hindsight, are shown to be misleading. More seriously, it seems as if since 2010 the UK retail price index (RPI) has been overstating inflation by about 0.5% per annum. According to the FT, this has cost tax payers £15 billion so far.The size of an economy and whether it is growing or contracting is the foundation of many investment decisions. The Irish economy has been on a roll in recent years, as it recovered from the dark days of the credit crunch which destroyed banks and property speculators alike. Strong GDP growth has helped restore confidence both domestically and internationally. Unfortunately, it seems that some of this ‘growth’ is related to the restructuring of multinational companies taking advantage of Ireland’s low rate of corporation tax, and is unrelated to what is happening in the domestic economy. An alternative statistical model of the economy which measures Gross National Income describes a domestic economy that is about a third smaller than the one portrayed by GDP. The point of all of this is that although we use these centrally generated statistics, it’s the detail that matters when it comes to making the right investment decisions.Although some of my best friends are economists, I’m glad that long ago I studied natural sciences. Softening the hard edges of rational empiricism is so much easier than the other way around. If he hadn’t been a physicist, Heisenberg (not the lead character in Breaking Bad), would have made a good investment manager. His Uncertainty Principle, which in summary states that the more precisely the position of a particle is known, the less precisely its speed and direction can be measured, applies to financial markets and, come to think of it, everything else.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.