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The impact of AI on hedge funds and asset managers

Posted in Insights

Artificial Intelligence, or AI, is one of the most talked about concepts in the tech world today. From retail, to energy, to finance and beyond, AI is finding application in just about every industry. Recently, hedge funds and asset managers have started seriously investigating the AI craze and experimenting with the technology. The early results have been very interesting to see.

AI-enhanced and AI-only strategies come out on top
There’s nothing new about quantitative investing, but the last few years have seen a notable adoption of AI and algorithm-based trading. ValueWalk published the findings of a Eurekahedge report and found that there’s a good reason for this: many AI-based funds are outperforming both traditional quant teams and human-led fund managers.

According to Mark Melin, an alternative investment practitioner at ValueWalk, AI-enhanced hedge funds provided investors annual returns of 8.44 percent between 2010-2016. For comparison, the Eurekahedge CTA / Managed Futures index delivered 2.62 percent growth over a similar period, and the Eurekahedge trend following index went up just 1.62 percent in that time.

On the back of this performance, it’s obvious that AI-based funds are reaching a level of dominance in the hedge fund world. A report from Financial Times revealed that “computer-driven” hedge funds have made it onto the list of all-time top-20 best performers based on an index that measures the total dollars made for investors since the funds’ inception. That’s impressive, considering that funds have only been using the technology for a short period of time.

This shift away from purely quantitative and fundamental investing reflects the growing importance of big data analysis and systematic trading. Allowing algorithm- and AI-based trading systems to augment or in some cases replace the more traditional modes of analysis and trading makes it possible to analyze large datasets passively, among other value-adding tasks.

On top of that, it’s clear that allowing AI to do research and make decisions takes the emotional factor out of the process. The effect of human bias is well-documented among investors and traders, and having an impartial source of insight and automated decision-making can improve performance in the face of uncertainty.

Algorithms bring returns in bad times, but aren’t foolproof
2016 was a tough year for hedge funds. Per analysis from the aforementioned Financial Times article, returns last year were somewhat improved over the year prior, but most funds barely beat the average, if at all. Some fund managers even faced criticism for charging high fees for weak results.

In this case, even computer-driven funds weren’t immune to the overall malaise in hedge fund growth. In November 2016, Bloomberg reported that three of at least four computer-driven hedge funds managed by Man Group Plc’s AHL division lost money through September 2016.

Regardless, there’s strong evidence to suggest that even in tough times, investors are more willing to invest capital into computer-driven hedge funds. Some analysts believe that the models used to run these systems were disrupted last year, but that continued uncertainty with Fed surprise risk will give computer-driven funds the advantage over fundamental managers in the long-term.

AI is still in its infancy when it comes to institutional investing and hedge funds. It’s certainly not a magic bullet that guarantees stellar returns. The early results, however, are clear in showing that augmenting and replacing older investment approaches with AI and machine learning capabilities can provide a notable advantage. It’s the future of hedge funds, and likely, the wider financial industry.

Zac keeps Elsen running. From recruiting and managing a top-performing executive team, to driving critical decisions and developing partnerships with world-class companies, he ensures all areas of the business are aligned with the company’s strategic goals. An engineer by training, Zac worked at Schneider Electric before catching the finance bug. During a later position at Credit Suisse, he applied his engineering and programming skills to macroeconomic research. His ability to create solutions that address complex problems in manageable ways gave him the tools he needs to solve difficult finance problems. What Zac loves most about Elsen is its talented team of dedicated people who want to do something awesome every day. When he’s not leading the team, he enjoys longboarding, surfing, cooking, watching Chef's Table, and playing board games. Zac holds a B.S. in Mechanical Engineering from Northeastern University and holds several patents for cool stuff like fluid mechanics.