Asset management firms are using AI to deliver higher returns for investors
By Francesca Campanelli, Chief Commercial Officer, Axyon AI
Amidst all the harrowing events of 2020, there is one piece of welcome news that stands out for asset management firms: individual investors are opening brokerage accounts at record rates.
In 2020, more than 10 million new brokerage accounts were opened, and according to Alliance Trust, 66% of investors between the ages of 18 and 34 invested for the first time that year. These new investors are younger, more diverse and have disposable income – as well as high expectations.
With interest rates on savings accounts at all-time lows, demand for stock market investing will only increase. Asset management firms are in a unique position to take advantage of the upsurge – but only if they can meet expectations.
Investor expectations in 2021
In 2020, the market shock in March hit fund managers hard, with some losing as much as 44% in a couple of weeks. It was also a year full of volatility, with the CBOE volatility index surging over 80 – higher than its 2008 record.
Ultimately, 2020 ended with high hopes, as several countries started executing recovery strategies and implementing vaccine programmes. In fact, when the vaccine was first announced in November 2020, the stock market responded by increasing by 14% in just a week.
As a result, investors are optimistic. Figures from The Economist Intelligence Unit estimate that by late 2021, developed areas like the UK, EU and US will be fully vaccinated – with other developed countries to follow by mid-2022. We’re already seeing evidence of a V-shaped recovery: since March 2020, the S&P 500 has returned an astonishing 68%.
But while 2021 may be looking a bit more stable, we’re not out of the woods yet. Countries are still feeling out the repercussions of the Covid-19 pandemic, and many are saying that US companies have stretched valuations in a way that mimics the tech bubble of 2000. So, there’s nothing to say that we couldn’t have another bubble and more volatility.
All in all, though, expectations are high for 2021: investors are demanding better customer experiences, higher returns and better risk management. If asset managers want to take advantage of the surge in new investors, they need to focus on redesigning client journeys, managing volatility, and offering decent returns.
What happens if expectations are not met?
Both expectations and demand are high – but what happens if expectations are not met, and funds once again underperform?
It’s clear: retention will drop and therefore so will business performance. In order to adapt to the situation in 2021, asset managers need to change their business models. The current models may be effective during stable markets, but they aren’t as reliable in unpredictable ones. Why? Because they rely mostly on historical performance rather than up to date information.
By basing risk scenarios on historical data, most asset managers are badly equipped for a possible second market shock. With the pandemic crisis far from over and a possible bubble looming, asset managers need a system that can account for volatility and manage expectations more accurately.
We saw this happen in 2020 when passive funds such as index funds and ETFs weren’t able to adjust the risk and took a larger hit than expected. The market shock put chaotic data into the quantitative models, which led to inaccurate views of market changes.
Although investors may have been forgiving in 2020, they won’t be in 2021. Hedge funds that rely on AI are already outperforming regular funds and are more likely to mitigate a shock during unpredictable markets. Investors won’t hesitate to move their funds elsewhere, which will have a large impact on asset managers: losing investor confidence and a decreased retention rate can have a long-term impact on funds and make it harder for asset managers to plan for the future.
Why implement AI in asset management?
Technology is democratising the world of retail investing: novice investors can now invest without paying fees, follow their favourite traders on platforms and start investing with minimal amounts using fractional shares. It’s also changing the world of financial modelling: by using AI and Machine Learning (ML), asset managers can transform and improve the way they make decisions.
How does it work? Instead of basing models on historical data, AI is completely agnostic and can be trained to build models based on data without the legacy of historical theory. Deep learning allows models to capture more complex, non-linear patterns, and also input other kinds of data that humans can’t, such as GPS data, satellite imagery, internet searches and even tweets.
AI and ML also help to dismantle data silos and set rules for standardised data, making it a lot easier to analyse information and raise alarms whenever there’s an anomaly. With better organised data, asset managers make improved and more accurate decisions, and also have more time to prepare and adapt to possible catastrophic events. It also mitigates the negative influence of humans, helping to detect bias, improve model interoperability and enhance monitoring performance.
The results speak for themselves: hedge funds with AI-based models offer cumulative returns of 34%, compared to the 12% of the global hedge fund industry. Not only do these advanced technologies offer higher returns, but they also help asset managers decrease costs, with automation predicted to reduce personnel expenditure by 20%.
Asset managers are already jumping onto the AI bandwagon, with 56% confirming they would start using ML in their trading in 2021. Clearly, it’s those that embrace these technologies that will be the best equipped to whatever 2021 brings us.
Soon, AI and ML won’t be “cutting edge technologies”, but the norm. All asset managers will need to rely on advanced technology in order to keep up with competition and meet investor expectations. As such, these technologies will not only serve as a powerful tool to retain investors, but will also help acquire new individual retailers who want to be prepared for the unpredictable.
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