Fund managers are only human, and this is a problem. While algorithms get ever-smarter, funds run by people are losing out. Quant hedge fund CEOs only too happy to emphasize this – Man Group’s Manny Roman said that fund management will become more automated, others have predicted the demise of human traders entirely.
And yet, technology is not necessarily the enemy of flesh and blood fund managers. “We see the future of investment as man plus machine, not man vs machine,” says Clare Flynn Levy, who was a hedge fund manager for ten years before starting Essentia Analytics. “The only traders whose employment is under threat will be the ones who don’t embrace technology to hone their skills.”
Essentia works with clients like Man Group, Union Investments and Artemis Fund Managers to help fund managers and traders overcome the very things that tend to create a bad run: biases, emotionally led decisions and trades fuelled by fear. Much of this is done through using big data and behavioural finance techniques. Technology here is an enabler and something that could prevent bad performance that, ultimately, could mean a trader is fired.
“Our technology provides an ongoing, data-driven feedback loop, which helps the trader stick to his plan and resist acting on emotional bias,” says Flynn Levy. “And by showing him, with data, where his strengths actually lie, we enable him to play to those strengths, and explain them to investors.”
One advantage human traders have over machines is their “gut” instinct on the movement of particular investments. This is a strength, but it quickly becomes a disadvantage when what seems like an instinct is actually a pattern of behaviour that could ultimately become destructive.
Boris Pilichowski was a prop trader at Deutsche Bank and Morgan Stanley before launching his own hedge fund in 2011, but two years’ ago he quit to start Axis Minds, an investment management coaching service. The theory behind coaching fund managers is akin to that of developing professional athletes – talent has to be nurtured and performance refined.
“Technology replacing traders has been the main trend during the last 15 years. But I believe we have now reached the limit of this. 80% of volumes are done by machines. In the end, everybody has the same technology and use similar techniques. Machines just become tools," he says. "Deciding what to do with those tools is what makes performance and this is where the human element comes back into play. We think that we are at time where technology offers new solutions to support decision makers without replacing them."
Quant hedge funds had a great 2014, but this follows a period when unpredictable moves by central banks led markets to react in an irrational manner which hoodwinked even the most sophisticated algorithms. Human traders have an edge here, or at least that’s the argument. Man Group's Roman admitted that "a computer doesn’t see things that you and I can see like the mood of Mario Draghi".
But technology is central to coaching fund managers and traders. On the one hand Axis Minds uses huge amounts of data and quantitative analytics to assess an individual’s performance and look for patterns, strengths and weaknesses. Or they use video cameras while a trader works to look at technique or signs of stress and psychological strain. They also use psychometric testing to analyse behavioural styles.
"A classic case we tackle is someone who wants to step up from managing $200m to a $1bn portfolio and the steps needed to take that. Or we’ll help someone who is used to, say, trading in Asia make the transition to European markets,” he says. “But fundamentally, humans will go through cycles of over-confidence and under-confidence and we have to manage those cycles.”
“Technology can help traders overcome the fears, biases and emotional drivers that affect decision making by holding up a mirror: highlighting exactly when emotional bias is evidently interfering with the decision process and in what contexts that occurs,” says Flynn Levy.