Technology's Impact on Investing: Black Box or White Knight?
Technology’s impact on investing has a well publicized dark side as the potential root cause behind market meltdowns – think program trading in ’87 and the flash crash of 2010 – or as a vehicle for market manipulation – think high frequency trading “Flash Boys” and the ubiquitous rogue, “London Whale” type trader using technology to both expand their footprint on the markets while covering their trading “tracks”. Many investors feel powerless and even victimized in the wake of these technologically fueled maelstroms. There are, however, other less dubious sides of technology that are actually proving beneficial to the average investor. In many ways technology has lifted the veil to the inner-workings of wealth management and made possible several advances in delivering financial products and services to a broader audience of investors at far better price points. While technology seems to give an advantage to professional investors over the rest of us, it is also stripping away costs and enabling more people to have access to investment advice and products once only available to the wealthy.
Take for example the gathering and interpreting of big data. In the increasingly crowded and noisy world of fundamental research, big data tools are helping fund managers make sense of overwhelming amounts of information. These new tools can help with traditional research, such as searching through the securities haystacks for pins of value, as well as newer approaches, such as tracking inventories as they move from stockrooms through the retail sales process or combing through countless media mentions to fathom out the next hot new trends. Big data is allowing fund managers to utilize every bit of information out there – which is especially helpful in the days since Reg FD and crackdowns on insider trading have made getting a scoop or new perspective ever more difficult.
Risk management has also benefitted from the harnessing of big data. Vast amounts of risk data gathered over the history of market events can now be easily pulled together and sliced and diced to create unique views of potential scenarios. Beyond simply calculating value at risk, nowadays fund managers can look at a variety of risk scenarios by combining specific parts of past market events into a risk view that more accurately reflects the present or near future. Risk managers can cobble together securities level data spanning across different market events and show how a given portfolio might behave to, say, a sudden rise in rates or emerging market collapse. These views help fund managers manage risk more efficiently, therefore enabling more risk-mitigating solutions to be made available for investor portfolios under the guise of products like liquid alternatives and unconstrained bond funds. Essentially fund investors can now have access to hedge-fund like risk strategies without hedge-fund like price tags.
Then there are the perhaps ambitiously named “smart” beta products (aka alternative, fundamental or enhanced index funds to name a few names). These strategies are what are known in the industry as “rules-based” which is a nice way to say they are largely driven by quantitatively derived rules or screens that pick the securities in a portfolio and continuously scan the markets to make sure only the most worthy securities make the cut at the next scheduled rebalancing. The screening criteria can run the gamut from value stocks and income generating assets to specific fundamental and attribution factors. At the risk of ascribing too much acumen to these products, there are some who suggest that they have automated alpha by capturing the essence of excess return generation from actively managed mutual fund managers and making it available –sans the often conflicting influence of human nature – at discounted fee levels. Needless to say, this proposition sounds pretty good to investors seeking good performance while keeping a lid on fund expenses.
“A recent disruptive trend in wealth management has been the march of the “robo-advisors”. Think of it as smart beta let out of its cage”
A recent disruptive trend in wealth management has been the march of the “robo-advisors”. Think of it as smart beta let out of its cage. Here the approach is to overlay rules-based strategies on top of fund of fund portfolios with specific goals or characteristics that are defined by investor profiles and savings goals. Underlying many robo-offerings are low priced ETF’s based on passive or enhanced indexes. The overlays often incorporate multiple asset classes and mirror strategies once available only to wealthier clients with private advisors. Robos have effectively cut out many of the expensive aspects of delivering wealth management solutions and lowered the barriers for servicing smaller investor accounts. Not everyone needs to have a personal advisor to speak with – they really just need a thoughtful allocation across asset classes that is rebalanced and readjusted as conditions change and investors close in on their goals. The success of these robo-advisors has spurred imitation from major financial services firms and generally brought more choice and better value to a broader investor base. Not all robots are inhuman it seems.
Overall, technology has enabled the industry to separate out activities that once involved human intervention at lofty fees and, in turn, automated many of those same features to deliver similar performing investment solutions at reasonable prices to a broader audience of investors. Much like replacing workers with robots on a factory floor lowers costs and enables more affordable prices to consumers; technology has essentially helped lower investment manufacturing costs. So, while in the hands of those with ill-intent, technology can find itself used in ways that seem disempowering, it can also be wielded for good and many investors are now enjoying the benefits of fairly priced investment solutions that deliver value, risk management and competitive, market-pacing returns.