{"id":35743,"date":"2018-11-13T19:55:15","date_gmt":"2018-11-14T00:55:15","guid":{"rendered":"https:\/\/digital.hbs.edu\/platform-rctom\/submission\/machine-learning-and-ai-impacts-on-the-financial-markets\/"},"modified":"2018-11-13T19:55:15","modified_gmt":"2018-11-14T00:55:15","slug":"machine-learning-and-ai-impacts-on-the-financial-markets","status":"publish","type":"hck-submission","link":"https:\/\/d3.harvard.edu\/platform-rctom\/submission\/machine-learning-and-ai-impacts-on-the-financial-markets\/","title":{"rendered":"Machine Learning and AI Impacts on the Financial Markets"},"content":{"rendered":"

A Barclay\u2019s Hedge survey found that the majority of hedge fund managers use Machine learning in their investment strategies to \u201cformulate investment ideas and build portfolios informed by data analysis that the human brain could never hope to accomplish.\u201d [1]<\/a> It is pivotal to understand how machine learning is impacting the financial markets as this megatrend is controlling large movements in security prices and making alpha more difficult to find than ever before.<\/p>\n

Almost a year after completing my undergraduate studies, I started working as a long short equity investor at Citadel, a Chicago based hedge fund. Citadel\u2019s aspired competitive advantage comes from being able to use technology, machine learning, and human capital to amass all available public data, and then to \u201cextract the most relevant pieces of information and then be able to make the right interpretation of that data.\u201d[2]<\/a> Machine learning is used in many ways at Citadel, predominantly to assist in predicting metrics like same store sales, identifying risks in the portfolio, and generating ideas.[3]<\/a><\/p>\n

However, machine learning at Citadel is used to assist human judgment, rather than to substitute it. CEO Ken Griffin discusses this idea at the GS Systematic Investing Conference where he states that balancing the influx of new technology with the \u201cpower of the human mind\u201d is key for better decision-making in the financial markets.[4]<\/a><\/p>\n

Other funds like the $96 billion AUM Man Group have close to half of their investments in technology vehicles that find patterns and execute buy and sell orders independently.[5]<\/a> Sandy Rattray, CIO of Man Group, stated in an interview with CNBC that Man Group will steadily increase its investments in models that are not directed by humans but learn from data on its own.[6]<\/a> One example is “instructing computers to listen to multiple earnings calls at a time, whereas the individual portfolio manager can only listen to one.”[7]<\/a>\u00a0 However, Man Group concedes that humans remain better at data interpretation at this point in time. [8]<\/a><\/p>\n

As machine learning improves, Citadel\u2019s reliance on human capital will be challenged. Machines will be able to analyze data, interpret data, and trade on ideas quicker than humans. Citadel already has senior machine learning employees working to stay at the forefront of technology. The company has been hiring specialists like Pradeep Natarajan, a senior quantitative researcher in machine learning, joined from Amazon, where he was a senior research scientist.[9]<\/a><\/p>\n

However, Griffin believes that for now machine learning has its limitation and investing free of human judgment is a long time out.[10]<\/a> Citadel prefers to invest in ways to make investors more productive. The company also invests in ways to identify why stocks are moving the way they are moving to enable investors to capitalize on the crowding that comes about from machine learning insights.[11]<\/a><\/p>\n

I would recommend Citadel to test out strategies that are solely machine learning for industries that are more cyclical, more mature, and less on high growth stocks where valuations are more susceptible to changes in perception.<\/p>\n

Along with the amazing insights that machine learning allows, there are negative considerations as well. More reliance on technology and engineering enables bigger funds to have an advantage over the average investor thus making the markets perhaps less fair.<\/p>\n

Another consideration is that machine learning creates interesting insights and patterns but will also lead to crowding, (when many people are buying the same stocks). This can potentially have exacerbating effects and large swings for stocks causing large amounts of volatility. The degree to which these machine learning algorithms exacerbate selloffs has been \u201chotly contested, with some managers arguing they are too small to spur such an impact.\u201d[12]<\/a><\/p>\n

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[1]<\/a> BarclayHedge. (2018). Majority of Hedge Fund Pros Use AI\/Machine Learning in Investment Strategies – BarclayHedge<\/em>. [online] Available at: https:\/\/www.barclayhedge.com\/majority-of-hedge-fund-pros-use-ai-machine-learning-in-investment-strategies\/ [Accessed 13 Nov. 2018].<\/p>\n

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[2]<\/a> Citadel. (2018). Fundamental Analysis at Citadel \u2013 Inside the Job with Tio Charbaghi – Citadel<\/em>. [online] Available at: https:\/\/www.citadel.com\/news\/fundamental-analysis-citadel-inside-job-tio-charbaghi\/ [Accessed 13 Nov. 2018].<\/p>\n

[3]<\/a> YouTube. (2018). Billionaire Kenneth Griffin: Investing, A.I and Career Advice (2017)<\/em>. [online] Available at: https:\/\/www.youtube.com\/watch?v=nO0wQEGDF7s [Accessed 13 Nov. 2018].<\/p>\n

[4]<\/a> Goldman Sachs. (2018). Goldman Sachs | Talks at GS – Ken Griffin: How Talent and Technology Are Shaping the Markets<\/em>. [online] Available at: http:\/\/click.gs.com\/l8md [Accessed 13 Nov. 2018].<\/p>\n

[5]<\/a> CNBC. (2018). One of the world’s largest hedge funds is now letting computers trade completely on their own<\/em>. [online] Available at: https:\/\/www.cnbc.com\/2017\/09\/28\/man-group-one-of-worlds-largest-funds-moves-into-machine-learning.html [Accessed 13 Nov. 2018].<\/p>\n

[6]<\/a> Ibid.<\/p>\n

[7]<\/a> Ibid.<\/p>\n

[8]<\/a> Ibid.<\/p>\n

[9]<\/a> Microsoft, C., Clarke, P., Clarke, P., Butcher, S. and Butcher, S. (2018). Citadel has just hired a new head of artificial intelligence from Microsoft<\/em>. [online] eFinancialCareers. Available at: https:\/\/news.efinancialcareers.com\/us-en\/288118\/citadel-has-just-hired-a-new-head-of-artificial-intelligence-from-microsoft [Accessed 13 Nov. 2018].<\/p>\n

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[10]<\/a> YouTube. (2018). Billionaire Kenneth Griffin: Investing, A.I and Career Advice (2017)<\/em>. [online] Available at: https:\/\/www.youtube.com\/watch?v=nO0wQEGDF7s [Accessed 13 Nov. 2018].<\/p>\n

[11]<\/a> Ibid.<\/p>\n

[12]<\/a> Bloomberg.com. (2018). Bloomberg – Are you a robot?<\/em>. [online] Available at: https:\/\/www.bloomberg.com\/news\/articles\/2018-03-12\/robot-takeover-stalls-in-worst-slump-for-ai-funds-on-record [Accessed 13 Nov. 2018].<\/p>\n","protected":false},"excerpt":{"rendered":"

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