AI to Bring Back Active Strategies, Eventually
The increased reliance on risk-adverse passive investment strategies has hit asset managers hard, but it just is the latest swing of the pendulum as the markets adapt to the greater use of artificial intelligence, according to experts.
“Last year was the year of outflows from many hedge funds and distribution away from actively managed funds,” said David Aferiat, co-founder and managing partner at Trade Ideas. “This year is being marked by not by outflows, which are still happening, but by the closing and folding of hedge funds. The era of 2% and 20% is over.”
The markets are in a state of flux as the standard tools to access the market no longer work and AI-based tools continue to evolve.
Aferiat is aware of people applying AI with a laser-like focus on each segment of a trade’s life cycle. Eventually, he predicts that there will be a pan-AI that could handle all of the factors and variables that come from trade-idea conception, research and confirmation that the idea is a good idea, its execution, and exiting from the trade.
“I see people talking about AI along that chain, he said. “But that’s not to say that there will not be this singularity in one AI technology spanning all of those steps.”
How long will it take the markets to acclimate the still-maturing AI-based trading?
It’s hard to say, according to Aferiat.
Unlike other major technological changes made to the equities markets like decimalization, there is no clear delineation between before the market adopted AI-based trading and strategies and after it did. “It might not be a day, but I could see it being over a span of 12 months where we see markets changing and we see them behaving differently,” he added.
However, it will take an effort to swing the pendulum back towards active investing.
“Passive investing is a power pain medication,” noted Aferiat. “You can set it and forget it while knowing that you will not gain any more than whatever anyone else gains from the index but you won’t lose anything more. Its comfort has to be its greatest benefit.”
Just as algo trading decimated front office headcount, AIs are ready to reduce the middle and back office.
Chatbots, robotic process automation, and natural language processing top the AI must-have list.
Deep learning may do to HFT what HFT did to statistical arbitrage.
AIs may flag "unambiguous" rule violations in the future.
A difficult, but not impossible, task