Artificial intelligence makes winning moves in asset management

In the distant year of 2014, Michael Lewis came out with Flash Boys, a book that made villains out of the coders who were creating software for high frequency trading and that made heroes out of the founders of the IEX, especially founder Brad Katsuyama. On Lewis' script, they and he were foiling the nefarious HFT interests. Flash Boys drew a lot of public attention: a lot more, one would feel safe in wagering, than any earlier discussion of the development of trading software and technology. What may have sold it was Lewis’ stress on, well … the inhumanness of it. The trades faster than the blink of an eye, trades so fast that strategies play out that no humans can be thought to be monitoring, seemed alien and, inherently, wrong. And not far from the front of the brain there was the old anxiety about high tech: are these machines even going to need us for long? Is this the birth of Skynet? A lot has happened since 2014. HFT no longer seems so scary. And the question of the disappearance of humanity in the trading world has migrated, so that it now involves much more than ‘just’ the execution of the trade. Analysis, portfolio construction, risk management, all seem to have been passed over to the machines, leaving few tasks for humans greater than marketing such systems to each other. Is this an overstatement? Perhaps. Let is ask two men who know the subject of artificial intelligence in the alternative investment world (AI squared?) quite well. Working from a sentiment index Alternatives Watch spoke with Reginald Nosegbe, the founder and chief executive of Valspresso Investment Management LLC, which has developed a ”suite of rules-based artificial intelligence software applications that automates the entire asset management process -- from analysis to portfolio constructions to trade execution -- with the objective of reducing risk while improving returns.” It began with the idea of a metric for sentiment. “At the University of Virginia in the 1990s,” Nosegbe said, “I studied the great market crashes, including that of 1929.” The then Fed chairman Alan Greenspan gave a speech in which he asked, “how do we know when irrational exuberance has unduly escalated asset values”? The phrase caught Nosegbe’s attention, and he "wondered whether it was possible to measure irrational exuberance." Eventually (in 2011) he received a patent for precisely this -- a method of measuring stock market sentiment. This proprietary method underlies both a sentiment index and a sentiment quotient. As an illustration: if the SQ of an equity issuer is 0.8, then 80% of the company’s stock price is attributable to expectations of future earnings. The implication is that 20% is due to current fundamentals. In 2009 Nosegbe teamed up with Ty Seddon (Valspresso’s chief technology officer) and Dr Jo Carol Porter (product quality) to create Valspresso. Valspresso’s work focuses especially on the equity space. Presumably sentiment enters into other investments, and the underlying idea of quantifying the role that expectations play versus the role fundamentals play, the method suggested by that Greenspan comment of Decades back, could be applicable to debt or derivatives. But Valspresso has this far stuck with equity. Alternatives Watch also asked whether this amounts to disintermediation. But automating the whole process, don’t they allow, say, pension funds to do their own investing, so that the carbon-based life forms working at, say, a long/short equities hedge fund would have no role to play -- the pension fund, enabled by Valspresso’s software, can invest in the underlyings itself? Part of Valspresso’s business plan is to pitch itself to pension fund managers precisely as a way in which they can overcome what is otherwise the difficulty and expense (given the high price that the limited number of capable humans charge for their services) of the internal management of investments by such funds. In terms of the human-versus-machine aspect of the situation, Nosegbe also said: “The reality is, people are always going to have their own way of doing things.” They will, for instance, have investment theses, or a conception of social responsibility. They will want to use the available software not to replace themselves but to enable their own theses. Valspresso’s goal, he said, is “not to replace the asset manager, but to empower him”. Mosegbe has a view as to why high frequency trading has receded from the headlines. “If you look at the performance of HFT, you’ll see that it performs dismally. We are not HFT.” The edge of transformational change Alternatives Watch also spoke with John Bailey, the founder and CEO of Lumenai Investments LLC. Lumenai has just gotten up and running, though its AI partner, ETS Asset Management Factory, has been working on the application of artificial intelligence to investment since 1987. ETS speaks to the old Mary-Shelley question on the homepage of its website, which says, “Humans are great for creativity, faith, and passion. But not for processing huge amounts of data or making statistical decisions.” It also refers to “the Machine” as disciplined and objective, free of “fear or ambition.” So there is still a role for Viktor, but if wise he will remember his place. In Lumenai’s founding group Bailey is joined by Fernando Bolivar, the CEO of ETS, and Javier Sanchez, the head of equity solutions for ETS. Before creating Lumenai, Bailey founded Spruce Private Investors, an OCIO, led investments for a community foundation, was CEO of a family office, and a research analyst at Oppenheimer. Asked whether he was a ‘quant’ in such roles, he said, “no, I took more of a fundamental approach, but today the benefits of AI are too great to ignore.” The business model of Lumenai is to offer “hyper-customized portfolios designed by investors and implemented and managed using artificial intelligence.” This is, he says, “not just a beta play at all,” in fact we are approaching a point where even novice investors can achieve alpha through AI -- an important development as many arbitrage plays accessible to human intuition are disappearing. And, yes, as AI comes online in this capacity, “there will be a lot less need for most managers, or for taking the fiduciary risks that go along with hiring opaque funds”. In March 2020, equity prices tanked due to the dawning realization that COVID-19 was no simple “flu.” Not equity prices alone, either. Bailey said that Lumenai’s AI system was managing a paper portfolio at that time. “The AI did a very credible job of identifying COVID as a risk event,” he said. The system established that it could steer even through a once-in-a-century risk into, for example, precious metals, Treasuries, consumer staples, healthcare, and internet stocks. One of the consumer staples companies the system favored was the Clorox Company, maker of the famous cleaning wipes brand. On March 25, Clorox was at $195. It headed steadily up until August, peaking at $237. Bailey concluded our conversation with this: “We’re on the edge of transformational change. People will look back at AI versus human intuition in our time the way we now look back at Netflix versus cable companies.”

Artificial intelligence makes winning moves in asset management

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Christopher Faille

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Christopher Faille

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