Why Replace The Human
Investment Manager?

May 21, 2019

When investors ask me what I do, I cheekily tell them that I intend to replace their human investment manager. They think I am doing a marketing pitch for them to appoint me as their investment manager. When I clarify that I am not proposing myself in place of their investment manager and add that I am not claiming to be better than their investment manager, they get puzzled and curious

The key word is “human” which they understandably missed and took for granted. That’s understandable. Human behaviour is biased. We tend to seek similar data or examples to reinforce what we already know or what we expect based on prior experience – whether personal or derived from someone else we think knows more than us.

For too long, we have been conditioned to let someone more experienced or “professional” (who does it for a living) manage our money for us

So someone who analyses horse races all the time – and places bets for others, should do a better job than someone who is not doing it every day, right?

Investing and Horse Racing analogy

Making Money Off Your Money

Now to sharpen the horse racing analogy, why would a professional horse analyst and bets placer need to do so for others if the track record of getting it right and winning is so good? They can easily make money for themselves and avoid all the hassle of dealing with so many people.

Likewise, if you think someone is such a good investment manager, then why would that manager need to persuade you to park your money for him to invest on your behalf? If that investment manager is so good, why not just invest his own money? Why does he need to invest your money?

Well, the fact is that professional investment managers make money for themselves off your money. If the investment manager can get more investors to park assets with him, the more money he will have to place bets on every investor’s behalf. He extracts a management fee from the sum of monies parked by investors – whether he does well of not for you and the other investors. The management fee is a percentage of the total assets combined from all investors. So, the investment manager makes more money if he can amass more people like you!

Aligning Investor Interests

Hold on! Shouldn’t the investment manager make money for you before he makes any money?

Aligning Investor Interests

Truth is, you lose money even before your chosen investment manager invests a cent of your money! Why? Well, there may be sales charges that are offered by the investment manager to salespeople to persuade you to park your money with the investment manager! These sales charges can be hefty. Do you realise that when the investment manager loses (your) money in the process of “investing your money”, you are the one who bears all the losses?

And when the investment manager makes money for you, do you realise that it may well have been the hard work of the overall market, and not the specific talent or skill of the investment manager? [1]

Yes, some call it the luck factor. But of course, there is some skill. But even the most skilled or experienced investment manager can be caught on the wrong side of the market! It’s quite statistical and in layman terms, investing is like a game of chance.

Truth is that investment managers may do well, but studies have shown that it is rare for that same manager to do well year after year. [2]

Even a longer cycle study of investment manager skills came to the same conclusion as other studies that bets taken by investment managers to beat the market are proven statistically to be unable to beat even passive market index trackers in the past 10 years. [3]

Almost all active managers have not beaten the market

Like it or not, the evidence suggests that when you pick an investment manager, you are just playing a game of chance!

So, should we still use an investment manager to invest for us?

As a former financial analyst and former investment manager, my biggest lesson is that we are never right. Instead, the market is always right. The market always wins! Our opinions and bets do not matter, except when we use perfect 20/20 hindsight! We tend to talk about how we got it right, but we seldom talk about how we got it wrong, hoping that people will quickly forget.

The truth is, no analyst or investment manager can ever “track the markets” even sufficiently to make clear decisions. Instead, investment decisions are often made on personal whims and fancies, justified by some documented rationale which would under the scientific standards look more like a hunch!

Why Replace The Human Investment Manager?

The truth is that investment decisions are driven by personalities of the investment manager and others involved – in a human investment manager setting. Will the human investment manager ever admit that it was the work of the market that delivered the returns? As they say, a rising tide lifts all boats.

Just imagine if the market is enjoying a bull run. How smart do you have to be in order to make money as an investment manager? It is when the market is in a bear phase, that the truth and fallibility of human investment managers become clear. [4] There are enough research studies to support this

Using Artificial Intelligence (AI) to replace the Betting Behaviour of Human Investment Managers

Frankly, at any given point in time, any human — let alone an investment manager — is just making a guess based on whatever he can make sense of (or not). He is simply betting, and being on your behalf, while earning a fee from your money. Throw in the business trips and entertainment meals from eager brokers offering their betting advice, and you get the picture. Not bad!

I would know. I was an investment manager until about 10 years ago.

Knowing what I know now, I will not consider managing your money as your investment manager. It simply won’t be right. Unless, I use artificial intelligence.

When I suggest that AI can replace much of what human investment managers do, many are quite unsure.

Look, I don't blame anyone for offering to manage your money, or to be quite explicit, to bet on the heat world of stocks and shares on your behalf.

Doing the Right Thing for Investors

After all, for many, it's been the only thing they have done for too long. With the claim of experience, it is only sensible to continue offering the services they only know how. But as any professional wishing to improve and do better for clients, can we do better? The answer is a resounding “YES”! If only they would.

Why would they? After all, the current way is familiar and it still early them decent fees. Why change?
Now, you are asking, “what change are you suggesting?”

Why Replace the Human Investment Manager

Why am I replacing the human investment manager? It's not the “why,” but the “what” that gives me the “why”. Allow me to share the truth with you.

AI is not new. AI is a very broad all-encompassing word for a non-human process that is done with logic automatically without human intervention. How traffic lights offer motorists a “green wave” though several blocks or how your email identifies junk emails. Microwave ovens, washing machine cycles or how YouTube recommends videos you should watch are examples of AI at work every day. Now, you can even speak to a device that recognises your voice and acts on your commands. Even cars can drive themselves. And of course, many of us marvel at how a computer has beaten the world best at the formidable game of Go.

Thanks to the combined quad effects of massive low cost computing power, cheap cloud storage, fast internet connectivity and ubiquitous social networks, AI has moved several layers from basic logic automation to machines that can learn for itself without being explicitly programmed to, and to machines can network via cyberspace to reinforce each other to since complex problems with a hint of machine imagination. This rapid evolution of simple AI to “Machine Learning” is the “why” I advocate replacing the human investment manager.

With application of Machine Learning, it’s time to shift from outsourcing human betting behaviour to predicting risks and returns without emotions. That’s what “Smart Investing” should be.

[1] Jeff Bukhari, “Stock-Picking Fund Managers Are Even Worse Than We Thought at Beating the Market”, Fortune, 13 April
[2] CNBC, “Active Fund Managers Rarely Beat Their Benchmarks Year After Year”, 27 Feb 2017
[3] Financial Times, “European active managers beaten by passives, 10-year study finds”, 26 Mar 2019
[4] “MYTH: Active management performs better in bear markets”, Vanguard 2018

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