The long arc of automation stretches back to the inception of the industrial revolution. Room-sized computers once performed calculations that can now be accomplished by cell phones, which include a calculator as an afterthought. In fact, our cell phones have many times the computing power of the machines that first guided humans to the moon, and back. Should anyone be surprised that the hedge fund industry is exploring artificial intelligence, data mining, machine learning and advanced mathematics to enhance its ability to make profitable trades, time buys and sells, determine investments and select strategies?
In the Beginning
The computer has played a significant role in the hedge fund industry for decades. The hedge fund industry is not populated by Luddites. A number of hedge funds driven by artificial intelligence already exist and, according to a 2016 Eurekahedge survey of twelve such funds, these funds achieved gains of about seven percent through June. Even if one assumes these firms were cherry-picked, the results, nevertheless, demonstrate the potential implicit in employing this technology.
Quant funds are the obvious forerunners of artificial intelligence in the hedge fund industry. However, unlike quant funds, those driven by artificial intelligence go a step further—improving over time by mimicking the human brain’s ability to learn.
Hedge funds such as Bridgewater Associates, Point72 and Renaissance Technologies have invested heavily in advanced technology. These firms use artificial intelligence to generate ideas, but they are miles from turning over decision making to the machines.
This is not the case with Yoshinori Nomura’s Simplex Equity Futures Trading Fund, an early Japanese adopter of artificial intelligence. The technology proved itself June 24, Brexit day, by generating a 3.4 percent gain.
The Future of Money Management
It is premature to label artificial intelligence and machine learning as the future of the hedge fund industry. The technology has much to prove to the investment community. Moreover, few hedge funds have the financial wherewithal to make the necessary investment in artificial intelligence and those that do, are taking baby steps with regard to its integration.
That said, the promise offered by the continued development of these technologies is enormous. How rapidly they come on line in the hedge fund industry will depend on the success or failure of pioneers like Yoshinori Nomura’s Simplex, Bridgewater, Sigma Two and others.
No one can say with certainty that automation is destined to be the future of the hedge fund industry. Hedge funds may be the financial services equivalent of the automotive industry. Early automobiles were lovingly handcrafted, and then were brushed aside by cookie-cutter cars rolling off an assembly line. It is possible that hedge funds will become the Rolls Royce of alternative investment, with strategies and trades cunningly crafted by gifted artisans.
Realistically, the future of the hedge fund industry is likely to fall somewhere in between these extremes. Hedge funds will not be Chevrolets or Rolls Royces…maybe BMWs.