The rise of the machines

You just walk into any manufacturing plants on the planet these days and you are likely to find smart robots rather than humans on the factory floor assembling anything from computer equipment to cars. Robots are invading the factory floor just as they are invading our life because they are able to perform repetitive tasks much more efficiently than humans in high speed.

Elsewhere, the global financial industry has also become increasingly comfortable with powerful computers or machines running things. The bolder firms on Wall Street are hiring and deploying armies of programmers and mathematicians which cost millions or even billions of dollars to develop new tools to add to their arsenals in their search for alpha.

On Wall Street, data science and machine learning techniques are being used to manage significant amounts of client money. Money management giant BlackRock announced not long ago that algorithms would take over a much larger share of the investment decision making process.

Is it just another bluff that is being hyped so much? While there may be an element of hype, the underlying technology is undeniably here and is going to grow. Indeed, riding on the machines to make money from the markets is nothing new. Some players in the managed futures space including some of my partners have been doing quant stuff for decades.

We are already seeing a broader acceptance of quant strategies from mutual funds, hedge funds and other institutional investors than in the past. In case you want to know, quant strategies use repeatable and sustainable analysis of vast data pools to manage large, liquid pools of funds generating uncorrelated returns.

According to a partner who is smarter than me, “Quantamental” techniques, which use data to track economic trends and company performance to look for trading ideas for their human traders, have become a core strategy of many of the fastest growing alternative investment funds.

Simply speaking, the growing interest in computer-driven funds is part of a global pattern, as investors bet machines, devoid of emotion such as greed and fear, are better placed to make money or protect their capital in uncertain markets. Machines have no emotions.

Are the machines taking over the human? There are some people who are very excited, and some people who are scared. Not so easy. It is not about removing the human element completely, not in my lifetime. As with any model, it is only as good as the human who develops the program.

The human puts their instructions into the program, which then can process those instructions rapidly and with less or no errors that can result if the human were to do it completely themselves. The human needs to monitor and adjust or improve the program to reflect changing market conditions. Even in the manufacturing sector, some tasks are not going to be replaced by the robots anytime soon.

According to a report, quant hedge funds are responsible for 27% of all US stocks traded these days, just slightly behind individual investors at 29%, and now comfortably ahead of such trading by “other hedge funds” and traditional asset managers.

In this part of the world long dominated by long-only equity strategies, more Asian hedge funds are starting computer-driven strategies, as investors disillusioned by the poor performance of some traditional funds search for alternative options. Local investors who are generally more conservative are seeking to diversify and turn to investment styles that have less correlation with stocks and bonds.

On the other side of the equation, it is not all sunshine and lollipops. It remains to be seen how much money the industry can absorb from the specialized, high technological approaches to the markets. To be sure, there will always be losers and winners in anything. There are quants that bucked the positive return trend. There are managers who have not been performing up to expectations.

I have heard this from some people all the time that systematic firms or quants are risky magic black box trading run by some crazy scientists where nobody can understand what the hell is going on inside. They can easily blow up in the next financial crisis and what else? You can open the box and see what the smart people are doing things in proper manner.

It is a matter of education. I have been hammering away at my followers at private events about one theme and that is investors should embrace alternative investments which are often seen as the bad guys in the mainstream media.

Are quant funds for you? For some of you especially the stubborn ones generally still stuck with homegrown meat and potatoes and who suddenly find the world a very surprising and confusing place, you may want to have a closer look at quant funds which has zero or low correlation with traditional assets.

I speak from hard experience over the years. At least, it is a good idea to combine them with traditional strategies to achieve real diversification. Like it or not, quant funds are here to stay and they are likely to continue improving how investors grow their money. Imagine a “Terminator” running your retirement money without catching a stray bullet. The choice is yours.