The age of AI, otherwise known as the third industrial revolution, many fear will disrupt the industries and displace humans. Autonomous cars will put drivers out of jobs and drones will displace your mailman. Does it seem evident that AI will eventually displace humankind in the hedge fund industry? We say NO. Here are three arguments why we don’t see AI automating investment decisions.
“Machine Learning is the field of study that gives computers the ability to learn without being explicitly programmed.”
It’s Not About Duplicating
A simple set of rules and some practice. That’s what it takes for a 16-year-old to learn driving. Humans don’t find it complicated to follow a simple set of rules - follow the traffic rules and don’t hit anybody. Then, it doesn’t seem too difficult to teach a machine to drive by itself. Plus, they only drink petrol. They are even quitting that nowadays. Automation is evident in the tasks humans have the capability to fully understand as machines will just bring in efficiency.
Making investment decisions, however, doesn’t come with a rule book. The market dynamics might be easy to understand but well convoluted for humans to predict the movements. Past decade or so we have been borrowing tools from other sciences to get more systematic in making investment decisions. PMs still haven’t found a magic potion to get returns with full certainty. The complexity in market dynamic makes it hard for a human brain to understand it completely. AI would, therefore, be a tool to deepen our understanding and not just duplicating our existing method. The uncertainty in this business is what will keep humans in-charge.
Not the Last Step
The rule is that you make money on something that others haven’t recognized yet. Firms have long been using algorithms and statistical arbitrage to predict market movements. It works at first but eventually faces crowding effect and that strategy doesn’t provide competitive advantage anymore.
Same is with AI. Machine learning techniques left to their own tend to overfit i.e. It finds nonsense patterns that will not hold up in a broader context. AI too will require upgrades and further innovations. This is especially true for financial data as information in price movements a decade ago might not be relevant to today’s situation.
To maintain competitive advantage, new developments are necessary which requires creative thinking. Can you automate creativity?
There is Going to Be Some Shake-Up
Knowing the Markovitz portfolio construction taught at business schools wouldn’t be sufficient for a PM to get hired. Hedge funds might not require analysts for basic decision making. Instead, the demand will be for engineers to automate basic tasks and for scientists and researchers to bring innovation in decision making and make investing more systematic.
Business models matter too. Although technical prowess will be important but not sufficient to run the business.
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