AI doing better than humans are at stocks

The age old question in finance is; where do investors get the best return over the long run. In recent years there has been a lot of academic research and empirical evidence supporting the hypothesis that markets are typically efficient and can produce good long term returns for investors. But, there are always investors who wish to make more than the market returns each year. For these types of folks who wish to try and beat the market, there are a few options, doing it yourself and buying solid companies through technical and fundamental analysis, then there are fund managers who pick stocks for you, and you can invest your money with them. Unfortunately, but of those ideas are typically bad ideas overall. Most mutual fund managers don’t beat the market and most stock pickers lose money, and those that do make money, do so with a greater standard deviation. But the question some researchers have proposed is, what if AI and machines can invest better than humans can? 

Do AI Powered Mutual Funds Perform Better?

That was this article called “Do AI-Powered Mutual Funds Perform Better?” was attempting to ask. 

The researchers looked at a fund ran by IBM’s Watson, a super computer AI which attempts to review as much data as 6,000 full time stock analysts. And determined that this would be a interesting project. The researchers determined that there were 3 main reasons why a AI powered fund should out perform:

1. “AI offers super computational power to analyze mass data in a short period of time with decent performance” 

2. “humans have bounded rationality and are susceptible to various cognitive biases. By contrast, AI optimizes the
expected outcome and learns to be more efficient, and is expected to be more rational.” 

3. “the performance of human managed mutual funds has been on the decline, as the proportion of skilled fund managers is substantially dropping and almost non-existent in the new millennium.” 

All three are powerful indicators on why a AI powered mutual should outperform their human counterparts. 

To answer the question they looked at mutual fund data from 2009 to December 2019 and obtained stock prices and return data. They poured through over 2133 newly issued funds and read the summary prospectuses. 

They grouped the funds into 3 groups, 1st group being AI powered funds, 2nd group was quantitative funds with fixed rules, and 3rd group was actively managed human ran funds. 

They then went on to review the results of their findings. They compared returns over the period of 2017-2019 of human managed funds vs AI managed funds vs the market. What they found is that the AI powered fund was statistically insignificant returns in 25 out of the 26 months compared to the average market return. They do not out perform the market on a risk adjusted basis either for the period observed. 

However, when they compared the AI powered funds to the actively managed human ran funds, there was a difference. AI powered funds out performed their human managed counterparts by an annualized spread of 5.8%. The results were robust even after adjusting for equal weighting on between funds and value weighing based on market capitalization. Further, AI funds show better market predictions which is defined as position sizing before the market rises or falls. And finally, they found that the AI powered funds trade less often than the human 

Overall, they found that the AI powered funds do add value to the mutual fund space by reducing behavioral bias present in human fund managers and the AI funds showed better prediction than human managers too. 

Summary:

To use their words: ” We find that these funds do not outperform the market per se. However, a comparison
shows that AI-powered funds significantly outperform their human-managed peer funds. Our study investigates the performance of AI-powered mutual funds and provides robust evidence that they outperform their human-managed peer funds. We further attribute the outperformance to lower transaction costs and superior stock-picking skills. Such advantages of AI-powered funds could be due to the superior calculation capability that improves the efficiency of data analyses and model predictions. Moreover, the use of AI technology reduces the prevalence of the misbehaviors of traders.”

In other words, humans are bad stock pickers, AI is slightly better than us at it, but the market still provides better risk adjusted returns than either AI and actively managed funds after fees. Which is not much of a surprise to you if you have been following this website. The surest way to be able to retire and invest responsibly is to index your money. 

However, if you’re looking into investing into index funds and solid growth companies try using m1 finance (you’ll get an extra $50 dollars with the referral link) it’s a great platform for long term investing. And finally, if you’re looking for further ways to enhance returns check out our high risk and ultra-high risk newsletter.

Have you made money stock picking? Or has your AI powered mutual fund returned you more than the market has this year? Comment down below and let me know!

Note: the m1 referral link gives the reader $50 extra dollars to invest with if they choose to fund a taxable with $100 dollars within 30 days of opening the account or fund an IRA with $500 within 30 days of opening an account. The author of this article will receive a $10 dollar compensation as a result of the reader opening an account. The compensation for both parties occurs 30 days after the deposit occurs and assumes the full amount is retained in the account until the end of 30 days from the deposit day.

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