Asset Managers: The tide turns | Hacker News Reader

Asset Managers: The tide turns

economist.com

154 pointsdmmalam96 comments

Active management is an overpriced, tough to beat affair, but if enough people invest passively, active management will regain the upper hand.

Indexers herd, they reduce liquidity, they push up prices of stocks in the index, they increase volatility, initially smaller/less liquid stocks have prices pushed around irrationally, then bigger stocks. It starts to pay to do private equity, buy out cheap stocks, IPO them, get them back into the index universe, and sell them back to the indexers.

Indexing is not a silver bullet, it's one strategy in a Nash-like equilibrium. Too much active investing, passive can match them at a lower cost and win...too much passive investing, mispricing arises and active investors can exploit passive investors.

https://blogs.cfainstitute.org/investor/2016/02/02/active-in...

First question - "they reduce liquidity" - how?

Second, I don't think anyone is arguing that active investing can beat potentially beat passive investing.

The problems with active management vs. passive are: - Most active manager will continue to underperform (this year I believe it was north of 90%) - That it is just about impossible to predict which funds will be leaders - That the fees active managers require are too high relative to the lack of any real value

The point of the article isn't that active management can't ever beat passive - it's that the fees on investing are coming down because most active management provides little value.

So if active management is going to win, the fees may be compressed and that may change the industry.

Hedge fund guy here.

There's an implicit assumption that return profile is what matters to the investor. It very often isn't. Quite often it's a simple cover-your-ass requirement. Gotta put my money somewhere, so anyone who isn't going to embarrass me is fine. Thus status quo.

Second, strategies do exist that barely lose money ever. I've a friend who runs a strategy that has had 4 losing months out of 100. Certified by a fund administrator. Sounds too good to be true, so the fund stays small. Everyone's heard of negative skew so they stay away.

There's also strategies that print money so regularly they don't need outside investment. You would be amazed at how simple it is. But I've actually reproduced this myself. You need some good execution to do it, but once it's up you don't need or want investors. If you get a bond like income stream, you might as well finance it like a bond. It's only stuff with low Sharpe where you need to share the risk.

So what do you see then? A bunch of traditional managers doing their stock picking where the result doesn't matter too much, and some funds with some alpha that isn't stable.

There are strategies that rarely lose money and have a great risk-adjusted profile. But they are generally at least one of

a) Not scalable (e.g. most intraday market-making or scalping strategies)

b) Only available at a very high fee (think north of 3/30)

c) Not available at any price (e.g. Renaissance Medallion, which has been closed to outside investors for 20+ years)

So I'm not sure that it's particularly relevant to this discussion, which is about fee pressure on traditional, long-only asset managers.

Yeah, I went off on a tangent. The stuff ordinary guys do is very easily systematised by a machine. Problem is the "system" often doesn't do that well (looking at long period numbers, so you get long periods of non performance), so you're back to "trust me, I've done this" and then the guy with the nice marketing docs wins again. Or we'll see. It's a common idea that you might as well follow the market in some way, so maybe cheap will win this time.

you can get very high stats (good shapre , low draw-downs, lots of of winning months) just by going 'long' short-duration bonds and or selling far out of money index options. The problem is you may not make much money. You can sell a S&P 500 1000 put but you'll only make $500 over 6-12 months with $100k at risk. However, this is path dependent, meaning that large losses may be sustained on paper until the storm subsides. Even long 3-month t bills gives an infinitely high sharpe but the returns are crap

> Even long 3-month t bills gives an infinitely high sharpe but the returns are crap

If your investment has a high Sharpe ratio (especially in respect to other investments), by definition you have the highest returns at the lowest risk (variance) possible, so you can't have a "infinitely high" Sharpe ratio with "crap" returns.

Investments with low returns and low risks are penalized by Sharpe just as much as investments with high returns and high risks for the same reason: the expected value is simply less in both cases than for the ones with highest returns at lowest risk.

If you're a hedge/venture fund you will want to optimize for a high Sharpe portfolio eventually, you simply can't survive if you keep losing money for investors in the long run (low expected value).

Selling out of the money puts will almost never generate a downdown. Hence an infinite sharpe because the denominator is zero. Technically you are still beating the risk-free rate but there is a lot of downside risk not accounted for in the shapre ratio. Often a huge amount of leverage is applied to boost returns.

except for the occasional once-in-a-decade event that would bankrupt you. On the time scale where selling out-of-money puts makes sense, the market is efficient and there is no free lunch.

spending a decade high rolling at yacht week is totally worth it though. don't pretend like unsustainable luxury is a bad thing, much better than just dreaming about it

also, you can mitigate black swan events by not being too leveraged up, and going further out on expirations. and finally, just keep rolling.

No, you can't mitigate black swans that way. To get any return on selling out of the money put options (with even the remote semblance of sustainability) you have to have a crazy 100x or 1000x leverage.

And you can't just going further out on expirations without posting proper margins. That is, you can, but not legally.

I don't think you really understand the Sharpe Ratio -

    Sharpe = E[Return - Financing] / StDev[Return - Financing]

You could only have infinitely high Sharpe if the standard deviation of your returns, minus your financing cost, is zero. That means that Return = Financing + Constant. Now, some people are able to achieve that because they have abnormally low financing (e.g. they are an insurance firm with a large float, or a bank which is able to loan money at a higher rate than it borrows) but for most investors, the only way to make that equation hold is if the constant is zero or negative.

Going long 3 month T-bills does not give an infinitely high Sharpe Ratio (if it did, everyone who could would lever it up and do it in large size).

As an experiment, I simulated holding a long position in the nearest to expire Eurodollar futures contract (which give a return similar to the 3 month T-bill return) and rolling every 3 months, which gives a Sharpe of 0.92, an annualized return of 0.65% and annualized standard deviation of 0.7%.

Similarly, a long position in nearest-month two year treasury futures contracts gives a Sharpe of 0.94 with 1.59% annual return and 1.67% volatility.

These are attractive Sharpes (better than equities!) but they are certainly not infinite, and to juice up the returns to anything approaching an equity investment you need to be looking at 5-10x leverage.

Your point about selling puts, with skewness/kurtosis risk which is not priced by Sharpe, is a fair one, and probably the most common method of gaming returns, but it is a side-issue.

> Renaissance Medallion

https://en.wikipedia.org/wiki/Renaissance_Technologies#Medal...

> "From 2001 through 2013, the fund’s worst year was a 21 percent gain, after subtracting fees. Medallion reaped a 98.2 percent gain in 2008, the year the Standard & Poor’s 500 Index lost 38.5 percent."

Holy cow, that thing is kinda crazy. There has to be a catch, right? (Or everybody would be doing it.) Or is their algorithm genuinely so clever that nobody else has ever figured it out?

They were (one of?) the first serious quant fund, started by James Simon who before that was a math professor at Stony Brook. Along with the NSA they are one of the most aggressive non-academic would be employers of top notch math Phds. They also hire Phds in physics and statistics. The big draw isn't so much the salary as the ability to invest in Medallion.

If you take some of the smartest people in the world and have them intensely focus on making money via trading you get Renaissance. Everyone can't do it because there are only so many some of the smartest people in the world intensely interested in making money via trading to go around.

A side-note on the smart people: Nick Patterson, a cold-war cryptologist who had worked at Renaissance for a few years, talked a little about how they had employed some very smart people doing some very basic things like simple regression, and that the people needed to be smart to know how to apply these tools properly, and ensure the data they were applying it on was good.

http://www.thetalkingmachines.com/blog/2016/2/26/ai-safety-a...

Everyone can't do it because there are only so many some of the smartest people in the world intensely interested in making money via trading to go around.

No, everyone can't do it because they are in an 0-sum game. If everyone was as good as Renaissance, then Renaissance wouldn't make money. But if all the smart people are in Renaissance, then Renaissance makes money.

A fund that is closed to the public, yet whose results are made public, fueling other mediocre funds. Some woukd suspect there is a catch. ;)

I certainly think they are smart guys, but I doubt whether what they are doing is highly complex in the sense of being inexplicable to ordinary math graduates.

Like with a lot of math, you learn more about the basics once you are on to the advanced stuff.

And the more advanced stuff you learn, the more you see limitations. Very advanced can very well mean brittle.

I reckon what they have is a well distilled common sense setup where they are able to reject models that appear to be profitable but aren't. I'm guessing they are also able to procedurally generate models that capture the same few common sense notions in new ways as the market evolves. In contrast I reckon most quant shops are still at a stage where the models are hand coded, causing some severe issues that I'll touch upon.

There's also an organisational aspect about them. They're all very very good at math. Any BS is likely to get rumbled. Intellectual carelessness will probably be detected and the boss is a proper math guy too. Here's a subtle thing that many people I've worked with would not detect: to calculate my fund's information ratio, I take the monthly returns, average them, and divide by the standard deviation. I have to multiply by root 12 because there's 12 months in a year. Standard procedure.

Having worked with some mere mortals I can tell you a lot of time is spent convincing oneself of the intellectual merits of something one's found despite evidence to the contrary. I think the fact that quants tend to be low quality coders with high internal prestige causes a lot of funds to do less well than they should. A lot of effort goes into hand tuning models rather than trying a bunch of different ones. You get things like unconscious "optimizations" that are very hard to spot, and hard to argue against because the person doing the talking is of high rank.

Traditional, long-only asset managers are still hired mostly out of some combination of nepotism, status signalling, cover-your-ass advisory board issues.

When I worked in a long-only equities asset manager, there even were frank discussions with the client services team about how to organize materials for when a client was preparing to fire us. We actually assisted them with the process of firing us, told them what to say, etc., so they would save face with the rest of the board or whomever they answered to.

Basically, it's a lot like hiring a manager in international soccer. Very few of them actually bring results, but big, wealthy clubs will still go through a huge media circus, pay a huge wage, and do all sorts of things, to hire status-signalling managers. Then, later, when it's not working out, it is that manager's job to be sacked gracefully, once again creating media buzz that makes the club look good in front of the fan base for "doing the right thing" and firing the manager.

In asset management it's the same. "Hire-us-now-to-look-fancy" and "Fire-us-later-to-look-like-you're-dedicated-to-ideals-and-righting-the-wrongs" are both very much the major parts of the services they provide, and both are things that these companies go on at length about when courting a new prospective client.

Heck, some client service employees even get part of their bonuses based on how happy the clients are with the assistance they receive in drafting press releases, putting together slide decks, or writing white papers about firing that manager.

Would you mind sharing pointers?

So I had an undergrad do this with his Bloomberg. Well known:

Take the S&P 500, rank them by beta.

Lop off the highest x%. Say a quarter.

Rebuild the index scaled up to match.

You can see on a graph that the difference between them grows.

That is not something that prevents losses. I was hoping pointers on those strategies.

My rule of thumb: anything that sounds too good to be true usually is.

As I have found, sharpe can be a misleading measurement of risk due to path dependence.

The article is describing something that Eugene Fama (winner of the prize for economics in the memory of Alfred Nobel,) described in a paper a few years ago (2010).[1] Fama and his co-author French found that there is no evidence that any active managers of mutual funds (or any other portfolio of exchange-traded equities) have above-average skill; as a result, some will perform better than the market, and others will perform worse, but none will predictably or reliably outperform the average, and they each take some fee. What this means is that since they all have about the same expected return, and have an expected outcome of under-performing the market by the amount of their fees (as those are subtracted from their expected average returns), you should simply invest in a portfolio with low transaction costs and low holding costs.

[1] https://faculty.chicagobooth.edu/john.cochrane/teaching/3515...

>> Fama and his co-author French found that there is no evidence of active fund managers who perform better than average...

The paper you linked by Fama and French doesn't support this assertion. In fact, it's incorrect, and the paper admits that there are outliers (however few) with consistent superior performance.

From 1994 to 2014, Renaissance Technologies averaged a 71% return. From 1982 to 2012, Baupost averaged a 19% return. In the same time period the S&P 500 returned 7-8%. Even after fees, these managers easily beat the average for their clients.

It's tempting to claim that there is no such thing as beating the market, especially if that belief aligns well with a corresponding set of political beliefs about Wall St. But it is inarguable that funds and managers like these exist, it's just a matter of admitting that it's extraordinarily difficult instead of impossible.

You misquoted the grandparent to argue against a position he did not take.

Who said it was impossible?

No, it's not "inarguable". What the paper says is that some funds in the extreme right tail are able to demonstrate a modicum of skill, meaning they do better than pure randomness would suggest. However, they do not do sufficiently better to consistently generate four-factor alpha net of fees. In other words, they do not do sufficiently better that you could invest in one and have a higher expected return than you would get investing in a passive fund with similar factor exposure.

The bare fact that certain funds or managers have averaged 20%+ over whatever time period is irrelevant, as that is absolutely expected due to randomness alone. It has no predictive power over the ability of those funds to generate future alpha, regardless of what intuition suggests. Again, in other words, investing in a fund that has consistently outperformed in the past does not increase your expectation of outperforming in the future. In fact, it is more likely than not that you will still underperform a low-cost passive fund with the same factor exposure.

Arguing is about making solid arguments. It's not about cherry picking and twisting facts because of your political leanings.

> Again, in other words, investing in a fund that has consistently outperformed in the past does not increase your expectation of outperforming in the future.

So…you're saying that Bayesian updating in this case does not apply? No amount of positive results should alter the probabilities…ever?

(I'm not challenging your assertion by the way, just trying to confirm for myself.)

Sorry, no, I'm saying that historical returns have not demonstrated an ability by anyone to consistently generate alpha net of fees. Even the longest running market-beaters thus far do not fall far outside the expected range. Some have demonstrated statistically significant alpha, just not enough to account for their fees. In one sense it is certainly possible to imagine a string of returns that would do so, but it hasn't happened yet. (Also if you believe in (relatively) efficient markets, it seems unlikely to happen in the future either, at least in a fashion that could be identified ex ante, and thus profited from. But that's tangential to the point I was making above.)

The paper demonstrates this by comparing the actual distribution of returns to many sets of simulated returns over the same period. When the simulations are built assuming that fund managers have just enough skill to generate zero net alpha, the actual distribution has consistently lower returns across the board than the majority of the simulated distributions. It gets closer in the very extreme right tail (the 98th to 100th percentiles), but still not enough to generate positive four-factor alpha net of fees.

Thanks, that makes sense.

By the way, I recommend reading that Fama/French paper linked above. It's not that difficult to follow even without a finance background, and it covers all this far better than I could. (Although if you're not familiar with the Fama/French three factor model it would be good to start with that; otherwise this paper will lose you on the third or fourth page.)

The Fama/French research in this area is really like the junior high school science fair project of the finance world. It's entertaining to look at, and kind of cute, but has pretty much zero applicability to the real world.

Also keep in mind that David Booth is chairman and co-CEO of Dimensional Fund Advisors (DFA), where Fama has worked for quite a long time and where French also works, both as consultants and French also as Director of Investment Policy.

DFA is truly just another one of these shit-show asset managers that out of one side of their mouth talks about how all other active managers are ripping you off, but out of the other side of their mouth says that, of course, they know what kind of piddly freshman linear regression model really will consistently generate superior returns.

Fama's Nobel Prize in economics was the same kind of political farce as Obama's Peace Prize.

John C. Bogle, the founder of Vanguard (mentioned in the article) wrote a book called "The battle for the soul of capitalism" [1] where he describes his motivation to found Vanguard. In summary he sees that funds managers add little value but extract too much money from risk takers (=investors) and thereby turn capitalism up side down. Sounds like his thesis is winning.

[1] http://www.amazon.com/Battle-Soul-Capitalism-John-Bogle/dp/0...

Neither mutual funds nor hedge funds as a whole can match a low fee index like Vanguard. Of course there are individual outliers that outperform, but predicting which funds will win in the future is no easier than picking individual securities that will win in the future.

It's becoming pretty clear that Buffett will win his 10-year bet that the Vanguard would beat what Protege Partners thought were the five best hedge funds.

http://www.cnbc.com/2016/02/16/warren-buffett-slips-but-stil...

How many hundreds of millions will those five funds have earned for themselves while not beating the market?

It'll be interesting to see what the new equilibrium settles out to as more and more people index. It's pretty obvious everyone can't index and as more people do, there are more opportunities for smart money. But what form is that smart money going to mostly take? Large institutional investors -- pension funds, charitable endowments, sovereign wealth funds, etc. -- either investing directly or via outside money managers? Partnership style hedge funds? Family offices for ultra high net worth individuals? Or will the mass market long only mutual fund make a comeback?

The article describes the paradox. The average fund manager will perform as well as the market, but they charge fees so the net return is less.

If you think you are able to pick out better fund managers, then you should be picking stocks instead. If you're unable to pick stocks, what makes you think you're able to pick managers when you are working off opaque trades and even less information?

That is a very elegant bit of deductive reasoning. It makes their demise seem inevitable.

I'm not defending asset managers but your argument sounds specious: you only need to pick an asset manager once, whereas you need to pick stocks every day or several times a day.

I can't fix my car but I can pick a garage based on reviews, etc.

You only need to pick a stock once too. Or at most, once per several years. If you're trading stocks every day you're doing it wrong.

And you have a lot more information available about stocks than you do about fund managers.

Are you serious? You need a PORTFOLIO of stocks. It is an ONGOING effort.

Nah. Depends on whether you're in it for the average or the variance. If you're in it for the average you might as well pick an index fund.

Don't start with this condescending "nah" when you are going to make a qualification after that and exclude the very case we are discussing here.

Sorry, didn't know it had condescending connotations.

You need an information advantage to pick stocks. You need to have some reason to believe you have information that the rest of the market does not (or that the rest of the market is ignoring), which lets you better estimate the future profits of the company. And then you compare that against the market price, and if the market is being irrational, trade.

If you have this, you can get by with a very small portfolio, often just a handful of stocks. And the only ongoing effort is to periodically re-evaluate whether the market has caught on to the information advantage that you're trading on. You do need to continue to keep informed, but daily trading is ridiculous.

If you do not have this, you will lose your shirt regardless of how much you diversify.

>You need an information advantage

Yeah, exactly my point. You need to spend >20 hours to research a single company and will chose to invest in 1 out of 10. Those are the optimistic numbers.

So 5 stocks is 1000 hours. How many hours to learn how to do your due diligence? How many hours per month, every month to keep an eye on what is going on and optimize if necessary?

The information advantage is when you know something that's true that most people haven't yet realized to be true, often accredited to Peter Thiel. Examples from the past:

- Smartphones > dumb phones (invest in AAPL)

- more dollars spent with online ads than TV and Print (invest in GOOG)

- cloud computing is better than managing your own servers (invest in AMZN)

- eating Chipotle is a better option than McDonalds (invest in CMG)

These information advantages are not necessarily gained by spending many hours of research, but a side effect from every day living and working. Will a research analyst realize the impact of a scalable computing API more than engineers that relies on it for their careers?

A future example: If you're a programmer using Github for every job in the past 10 years, maybe buying Github stock if it IPO's wouldn't be so bad.

This is exactly the thinking of the average Joe who goes to invest on the bourse and gets slaughtered. The github example is especially apt. Go to Vegas. Better odds.

We're all average Joe. "Information advantage" is a very rare thing. Even those who think they have it, probably don't. Maybe they'll learn they don't this month, maybe it will be this year. This is entirely the point of Vanguard.

>often accredited to Peter Thiel

Only in Silicon Valley would people give Peter Thiel credit for an concept that's been around for 150 years of investing.

>maybe buying Github stock if it IPO's wouldn't be so bad.

Maybe? That doesn't sound very certain, and demonstrates how difficult it is to pick these things in advance. Do you know, or not?

I mean, it's all well and good to look back at some ideas that were good investments, in hindsight. Do you not think armies of people are trying to find "good" ideas that no one knows about? How many good ideas went nowhere?

"Maybe? That doesn't sound very certain, and demonstrates how difficult it is to pick these things in advance. Do you know, or not?"

Without a hypothetical IPO price, that question is unanswerable.

I honestly still agree with your general point, but that's not specifically a valid argument.

My point is that you have no way of discovering whether the fund manager you're thinking of investing with actually does that research. I know a number of people who work in asset management, I used to build software for hedge funds, and I'm married to an investment professional. There is a wide variety in the quality of research they do and their standards for due diligence. Some of them will personally build relationships with the employees and suppliers of the businesses they're thinking of investing in, so that they know of potential problems before the CEO does. Others basically invest because their friends in peer companies do, with minimal diligence on the company itself. The former tend to do a lot better than the latter.

As a retail investor, you have no visibility into any of this. Most asset management companies will not let you interview their fund managers, and most fund managers won't divulge their research strategies if asked. You basically just get their pedigree and resume, which is useless.

With individual stocks, you can at least choose to put in the legwork to do your research. Or as sibling commenters have suggested, you may get it tacitly by being embedded in the same industry as the company you're thinking of investing in. Someone who works in tech and is a user of AWS is in a much better position to judge the importance of a new AWS product announcement than someone who covers Amazon as an outside analyst.

>Most asset management companies will not let you interview their fund managers, and most fund managers won't divulge their research strategies if asked.

If you have 100k to invest, better put them in the bank and don't bother with "investing".

Until the head asset manager you "hired" effectively retires and hands the reins to youngins without ever telling you what went down.

I've seen this happen many times.

"you need to pick stocks every day or several times a day."

The usual advice for beginners is to revise ones portofolio between long intervals, say, once per year, record the specific reasons a purchase or sale was done, and progress with patience and not running after the market.

Stocks with dividens provide an interest to ones investment regardless how their price evolves in day trading.

I think ignorance also plays a part. For example, I myself thought that one of the reasons for going with a decent fund manager was access to e.g. IPOs at the discount price (+ inevitable fees) that the partner bank had access to.

If you're not able to take advantage of such things, I really don't understand the appeal.

(but then - having such large sums of money that I need help investing them would be quite a nice problem to have!)

>If you think you are able to pick out better fund managers, then you should be picking stocks instead.

I'm not sure this is right. You wouldn't say that you should be designing if you think you can hire a designer. There's no reason that hiring a good fund manager is different.

For what it's worth, I'm not good at picking managers or picking stocks with my own money so I choose a parsimonious approach.

That only works if you believe the skills needed to choose a fund manager are the same skills needed to choose stocks. That's seems unlikely.

If I've consistently picked terrible stocks for years, performing at 20% less than the market, and then I meet a fund manager who has has consistently performed at 20% above the market, are you suggesting I can't know whether or not he's better than me?

Indeed - it's like saying if you can't identify good football players, you shouldn't go about choosing good coaches / managers.

For the past few years, yes you can. For the next few...?

Surely you have an idea why you picked stocks that seemed good ideas but were not. What was the missing piece of information you did not have or the missing model you were not using?

Survivorship bias may hint at you not being able to.

Whether stock picking is luck based or not, there are (almost) no fund managers currently working who performed 20% under the market over the last 5 years.

Indeed. Past performance is a terrible indicator for future performance, especially for fund managers. A Morningstar study found that there is no correlation between historical performance and future performance, i.e. the top 25% of funds in one year was spread evenly across the spectrum in future years.

This was after adjusting for survivorship bias.

So, you cannot look at performance as an indicator.

Wouldn't the average fund manager only perform as well as the market if the market consisted only of fund managers? The definition of average here also needs qualification -- surely it's weighted by size of assets, so one huge, poorly performing fund manager should allow for the existence of many small market-beating ones. No?

You are right, but it also follows that a huge poorly performing fund won't stay huge for long.

Historically, consumer staples have much better risk-adjusted returns than any other sector. Buying and holding these stocks will beat active management and the S&P 500.

Active management, despite their access to expensive Bloomberg terminals and other financial resources, by in large, are just as clueless as retail investors, but they have more money and make up the difference in fees.

What does this prove? The fact that billionaires and hedge fund mangers – who have access unlimited data, who can buyout seats on the board of directors, and can even influence the news – are unable to beat the market but instead underperform it substantially, douses cold water on the popular belief that the markets are rigged, inefficient, or a scam. The biggest scam are these firms charging high fees for poor performance, but the market itself is not broken.

Instead, the market has become more efficient than ever, benefiting index buyers and hurting those who think the are the next Warren Buffet.

Your points are contradictory. If consumer staples regularly outperform other market sectors, markets can't possibly be efficient. If they were, there would no signal to extract from the noise.

The whole idea that markets are "efficient" is specious nonsense anyway. If they were, they'd simply be a perfect random number generator.

In fact billionaires do regularly outperform the market. Bill Gates has made far more money from investing than he did from Microsoft.

and some billionaire fortunes have been lost; in the end, you get the overall market performance. Maybe there is some excess. It would be interesting if there were a study about if stocks of companies by Forbes 400 members outperform stocks which don't have members.

I said more efficient than ever. That doesn't mean 100% efficiency.

>>> Technology also means that the strategies of active managers can be replicated at much lower cost. Take value managers, who claim to be able to beat the market by picking cheap shares. A computer program can comb the market for stocks that look cheap relative to their profits, asset values, or dividends; investors have no need to worry that the active manager might lose focus or change style. When it comes to choosing between asset markets, robo-advisers, using computer models, can help investors manage their wealth for a very low fee. Earlier this month Goldman Sachs, a big bank, became the latest big financial firm to buy one. <<<

There is absolutely no doubt that an algorithm can outperform most asset managers using traditional strategies quite well, but their implied thesis is wrong. It is extremely unlikely that any system short of an AGI, no matter how sophisticated, will be able to displace all active managers.

The reason behind that is that the best active managers try to build up positions by creating an informational edge. The very best ones are willing to do whatever it takes. Some have specialists analysing satellite imagery. Others are willing to snap up equity in private competitors of a company to check out their orderbook to predict the reality of the market before it can be reflected by the market. Or fund studies and do their own work. Whatever it takes.

A really great example of this trend is the rise of activist hedge funds which work by shorting the market and exposing malfeasance at companies. Last year an activist hedge fund manager, Whitney Tilson, found out that the products of Lumber Liquidators was laced with a carcinogen. He had lab tests conducted, shorted the stock, announced his results publicly, and created a media campaign around it resulting in a tumble. http://seekingalpha.com/article/3019166-lumber-liquidators-i...

It is extremely unlikely that any system could have replicated Tilson's work, because none of this data was online or existed somewhere that could be easily queried. At best these systems can trade far more effectively humans can with existing strategies, but that does not mean they can produce great returns, as they're operating upon the information the market already knows, as opposed to seeking out what isn't known.

There are similar examples within commodities - there are firms that specialise in using satellite imagery to predict if OPEC has increased production or what the global yield of rice / wheat is going to be. (case in point http://www.bloomberg.com/news/features/2015-07-08/satellite-... ) There is an arms race going on right now to know what the state of any economy will be before anyone else knows it. They will continue to specialise along this route by funding remote sensing companies, putting money into internet analytics to predict future usage patterns, and everything else they can think of before anyone else.

Machines just can't compete - at least, for now.

Really cool point.

I'd argue that the investment strategies you're describing are actually creating value. Getting information about carcinogens out into the world is a plus for sure. Another instance of this is Herbalife which is looking more and more like a Ponzi scheme thanks to an activist investor.

Welcome to the era of regulation through speculation.

Ah, shysters beating shysters at their own game. Now we just need people to start gaming them from both ends. Maybe it's the gold rush model where you sell the tools. Maybe Google is already one step ahead: http://venturebeat.com/2016/03/08/google-rebrands-skybox-as-...

Just FYI your Herbalife info is out of date, as it has experienced a massive rally as of late.

Imo I believe John Hempton's take on Herbalife, which is that what they sell is not the supplement but a "sense of community" that the participants strongly desire.

Another example: A friend of mine who is a MIT/Harvard Biology PhD works as an analyst reading research papers and deducing the likelihood of the drugs proposed by smaller pharma pure play companies will pan out.

He says he was never good in the lab but was always proficient and prolific at reading papers, and finds it to be a bit of a calling for him.

> Others are willing to snap up equity in private competitors of a company to check out their orderbook to predict the reality of the market before it can be reflected by the market.

How is that not considered insider trading, in the light of what happened to the Capital One fraud researchers? Both are using information that's not available to the whole market.

The rules around this stuff just seem very arbitrary.

That's because they are and it has probably caused more harm than good by leading to the creation of these strategies.

Technicaly it isn't insider trading as they aren't getting data from the company. They are guessing it from a private company that is exempt from such guidance.

The Capital One researchers were also not getting any information from Chipotle. There were getting some information about Chipotle (specifically, that Capital One customers were spending a lot of money there). This information was not from inside Chipotle, but was also not available to the whole market.

Unless you can explain otherwise, it's exactly analogous to the situation described above.

Misappropriation. The information they got was ultimately coming from Chipotle.

http://www.bloombergview.com/articles/2015-01-23/capital-one...

That clears it up, thank you. So what they did automatically counts as insider trading because they misappropriated the information from their employer.

Your post reminded me of another post[0] on the front page of HN showing how to extract sensitive signing keys for ECDSA, and it's amazing how ingenious the techniques are for doing that.

The problems seem similar in spirit: extracting a signal through side-channels. It's obvious that there's a ton of runway left to do this stuff in the investment space, and with the amount of money to be made, plenty of cash to pay for it.

[0] https://news.ycombinator.com/item?id=11358646

It's an interesting example. Another one might John Paulson who jumped on the housing short (some say it outright copied the strategy) and, like others, created products to short. Not possible for a computer or a retail stock trader.

But the point here is Paulson has been unable to replicate his success. He extracted huge money in his commodity funds while losing a lot of investor money.

So while you're right that these opportunities will exist, and that people will be required to extract them, I'd say there is no proof that these folks are more or less likely to generate returns into the future. It would be interesting to see if, like active mutual funds, there is no correlation between past returns and future returns for activist funds.

The article's basic assumptions are wrong. Money is flowing out of private investment, so they just assume it's flowing into index funds. However ... Index funds doesn't seem to be where it's going.

SPY lost 15% or more in Feb, and then recovered to only be down 5.5%. Before that a similar thing happened around new year. The trend appears to be down (in the sense that the second massive drop fell to a lower level than the first, and doesn't appear to be recovering the level the first recovered to), and a lot of banks are saying that people should sell the recovery. And if you prefer non-technical arguments : stocks in the S&P 500 are trading at a GAAP EPS multiple of ~21. Whilst that is actually a bit of a drop from before, that's still a >98% percentile for the multiple. "Normal" multiple is 16, which would have the S&P 500 trading at ~1550, and generally if you believe in mean reversal you'd expect it to drop below that before improving. Additionally the fed is raising rates, and that has always resulted in stock market drops. And all of this is assuming there isn't something more serious happening (global shipping has dropped double digit percentages since last year, which would seem to indicate a very serious issue, especially in Asia).

I'm thinking there is a general outflow out of the stock market entirely. Index funds and everything. I would even bet that private investments are dropping, partly because quite a bit of investment advisors are telling people to get out of the market.

If you have a consumer facing service and you charge on a commission basis, the tide is turning for you.

Asset managers can just get added to a list that already includes positions like real estate agents, insurance agents, car salespersons, etc.

The problem is the inability for these people to continue to provide value against alternatives that justifies taking a commission.

I don't think there's a line in the sand for when these jobs become obsolete but the slow crawl towards it has been happening for a while.

Two important factors you're leaving out:

(1) Does the intermediary add value? Sometimes they do, by facilitating better market functioning. If I sell a house and a real estate agent has access to a better buyer pool than I do -- likely, as they've been doing it for a while -- then I benefit with a higher selling price and the agent gets a commission. The loser is the "deal hunter" buyer who sits at the low end of the market, looking for a "deal" due to something being mispriced.

In some markets, e.g. public market trading and low-end insurance, it's easy to get the same benefits with a computer. On the higher end, however, like with complex business insurance, I'd gladly pay a middleman a few % to help me get through the complexity of picking out the right package, coverage, helping me think through the risks, etc.

(2) Are people afraid of doing it themselves? When dealing with a large enough proportion of wealth, some people will demand assistance, even if very expensive. I see this dynamic all the time in real estate. Most people don't want the hassle of selling a house themselves and would rather, somewhat lazily, just have someone else deal with it.

The return profile is not the end-all-be-all for an investment. There's different strategies for tax avoidance, income generation, and for handling inheritance situations.

Most folks here are clever enough to work these out on their own, but the question is whether or not it's worth it for them to do so if a small portion of that money can pay someone to do it for them.

Great podcast on this recently:

http://www.npr.org/sections/money/2016/03/04/469247400/episo...

This may be a dumb question; but as I am looking for my next project, what is so hard about setting up a robo-adviser firm?

Algorithm A : put $AGE % of funds into treasury bonds, put 85-$AGE % into index firm / ETF

Algorithm B: err?

If that's literally all you do, I as a potential client should just go out and buy the underlying assets myself.

You could, but these things have potential value because they save time.

Anyone can sit at a screen and pick stocks all day, and I'd guess most of people of average intelligence would do better than the markets given a few simple strategies - because most brokers seem happy to make more money from fees than from investment gains.

But not many people want to do this. If you start selling a maintenance-free money machine, it's not going to be hard to get sales.

Of course if enough people start using it, it stops working. But that's a different problem.

The difficult part is getting regulated, and raising money.

Robo-advisers are subject to the same regulation as traditional asset managers - a regulatory burden which is only likely to increase over time. The legal fees associated with regulation are not cheap.

Compounding the problem, a competitive robo-adviser needs to offer lower fees than a traditional asset manager. Probably they need to be in the 0.25-0.5% range, which means that for each $1m under management they are picking up $5,000 of revenue. Out of that they need to pay salaries, infrastructure costs, legal costs, rent, taxes etc. Let's be conservative and say that these costs are $2.5m per year. That means that a robo-advisor needs about $0.5bn under management before it begins to turn a profit.

I don't think it's really suitable as a side project.

Ah, well the difference seems to be in the uk there is a push for robo advisors not asset managers (recent FCA ruling).

So holding assets under management is less the issue than arranging purchase on behalf of clients.

Either way the cost issue dominates.

You could just start with a free open source product. Far more disruptive. You could launch it offshore and unregulated if you want to cut costs.

It depends on whether you want to "disrupt" or to earn a living yourself.

and to add insult to injury, investment managers are expected to pursue advanced designations such as the CFA, which takes years of hard work -- hundreds of hours of intense study and preparation

perhaps the standards settings bodies such as the CFA Institute should share some of the responsibility

All you have to do to make tons of money is buy UPRO (s&p 500 leveraged 3x) and sell it when the economy is at high risk of recession. If you chart it out historically since 60 years back it would make a fortune.

All you have to do to make tons of money is buy whatever stock that will rise by the most next week, and short sell stock that will tank the most next week.

How to find out which stock will rise or tank next week is left as an exercise for the reader.

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