One of the most significant forces of change in the global alternatives industry over the last five to ten years has been the plethora of technological advances. Never has Moore's Law, which argues that the processing power of computers doubles every two years, been more evident. This has come at a time when the gravitational pull of market regulation has stretched fund managers to breaking point, not just operationally but from a cost of compliance perspective.
Technology has been a saviour, allowing fund managers to effectively outsource all non-core investment functions as software providers have developed comprehensive cloud platform solutions; indeed, non-financial institutions such as Microsoft and Amazon have been integral to this development with their Azure and Amazon Web Service platforms, respectively, fundamentally changing the way that managers set-up funds today.
The power of transformation that technology offers was a key theme at CAIS 2017. It served to underscore the need for fund managers to embrace digital models, new ways of communicating and re-writing trust contracts with investors, becoming altogether more transparent and responsive to reflect the way we all live our lives today.
Whether one could argue that technology has the capacity to generate alpha is very much open to debate. As Darsh Singh, Co-Portfolio Manager, Satori Alpha Capital, observed: "Alpha is not immutable. The way we define alpha is innovative: perhaps relationship or technology-driven strategies that have yet to be defined by the marketplace."
The progress of digital technology is dazzling. From the customer's perspective, said KPMG's Cowell, "We've had the first wave of change as the human touch has gone digital and robo advisers are reaching and delivering to a growing population of savers. Factor investing, artificial Intelligence and machine learning are evolving and moving further into our industry."
The robo adviser phenomenon is an interesting one. According to Business Intelligence, robo advisers will manage around 10 per cent of total global assets under management (AUM) by 2020; approximately USD8 trillion. That is a significant number and not one that alternative fund managers can turn a blind eye to.
"If hedge funds are to continue delivering value they might have to start thinking about upping their game," said Tarun Ramadorai of Imperial College London. "Look at wealth management start-ups offering robo advisory solutions at a lower cost to investors. These might not yet be much of a direct threat to hedge funds but that's because they have, to date, only been going after retail investor capital. This is classic disruptive innovation in action."
It will be interesting to see how quantitative, machine-learning hedge fund strategies shake up the natural order of the industry in the coming years. Ramadorai, and many others, think that artificial intelligence will be increasingly levered by more innovative, forward-thinking fund management groups.
"There is increasing competition from Silicon Valley with respect to asset management. The big firms there are getting involved in the provision of direct credit and thinking about technology pretty seriously.
"Those managers who are building good models are going to find it increasingly easy to make money in the short run. However, I think over the long run it will become harder to generate alpha using machine learning strategies," opined Ramadorai.
Ramadorai chaired a panel at CAIS 2017 entitled "Alternative Investments: Advancing in the Digital Age". One of the panellists, Raoul Pal of The Global Macro Investor was in no doubt that some of the best hedge funds could be replaced by machines. "I do think the huge bulk of the alternatives industry will become systems-based," he said.
Which begs the question: Where does the human role come into play?
"Humans are really good at time horizon, generating longer-term plays and determining a strategic vision of the world. Computers are terrible at looking into the future," added Pal, no doubt reassuring many of the fund managers in the audience.
Recently, Elon Musk spoke of his concerns over the machines taking over in a film by Werner Herzog called Lo and Behold, Reveries of the Connected World (2016). He gives an example of what could happen were a hedge fund to leave it up to AI to maximise the returns of a portfolio. The AI system might determine that the best way to do that would be to short consumer stocks, go long defensive stocks and start a war.
This is just one example of where AI could create inadvertent crises, whether planned or otherwise, if unplugged entirely from man.
However, there is no reason to fear that the machines will take over in the guise of HAL 9000, the malign machine in 2001: A Space Odyssey. The man/machine relationship will likely flourish than flounder.
Bettina Warburg (pictured) is a Blockchain expert and co-founder of San Francisco-based Animal Ventures, a venture studio focused on helping clients best adapt to the changing technological landscape. She explained to the CAIS audience that technology is facilitating `intelligence augmentation'. "Machine-learning algorithms are producing great advances that are combining to augment different human experiences. Machines should do what they do well, humans should do what they do well, combining those forces to create a new human/machine symbiosis. Those that can adapt to that will be successful," commented Warburg.
Warburg pays a lot of attention to the intersection of Blockchain, AI and the Internet of Things, helping companies come up with strategies that can combine synergies of different technologies.
Algorithms are going to be part of the global fabric, including financial services. As such, it is incumbent upon fund managers of all shapes and sizes to embrace technology, as Warburg alludes to above, and optimise the way they deploy it.
Suryanshu Mishra is Director, Head of Hedge Fund Administration, Deutsche Bank Fund Services. In his view, there is an increasing focus on the interoperability of technologies. How does one make software built for one platform, work across a variety of different platforms for tools that are doing different tasks?
"Large quantitative funds are building teams to address this interoperability challenge for their front to back systems. That interoperability between a manager's platform and its service providers – prime brokers, fund administrators – using the same underlying coding language, is an interesting trend," said Mishra.
Blockchain
Blockchain is generating considerable interest from firms and regulators alike. If the internet was the exchange of information, then blockchain is the exchange of value and will, according to KPMG's Cowell, "revolutionise trust".
There is still much debate, however, about its potential to fundamentally change dealing, settlement, custody and transfer agency operations and take out significant costs.
Outside of Blockchain, one of the most significant technological changes is taking place in India, which has, seemingly overnight, moved almost entirely to a digital currency system, with the Reserve Bank of India confident that blockchain has "matured enough" to be the core technology to support the digitisation of India's fiat currency, the rupee. Last November, Prime Minister Narendra Modi banned 500-rupee and 1,000-rupee notes, wiping out 86% of total currency in circulation.
This is a fundamental decision and could lead to other nations doing away with physical currencies. Dr Pippa Malmgren is Founder of DPRM and a leading UK-based economist. She predicts that inflation will return to the economic landscape in 2017. In Europe, this could create a source of profound social conflict. "In Germany, there is a commitment to never again using inflation to solve a debt problem whereas in the rest of Europe, inflation is the only means of dealing with the debt problem," said Malmgren.
Imagination, she said, is a crucial part of the fund industry's toolkit. To that end, she believes that rather than try and inflate their way out of the debt burden, western governments might just well take a leap of imagination and take India's lead.
"It is possible that governments will abandon the current systems of accounting and introduce an entirely new one. It has happened before in the early 1800s, when the British abandoned a system that had been used for centuries and all the tally sticks were destroyed.
"I can tell you the name of such a new accounting system: blockchain. It is able to assess every single transaction without an intermediary and triangulates everything, making it a highly efficient system. This could profoundly change the asset management world," remarked Malmgren in her keynote presentation.
Speaking on Ramadorai's panel, Richard Scott-Hopkins, Director at KPMG (Cayman), said that there is already a blockchain solution available for OTC contracts that cuts out the intermediary that some fund managers are using. He noted that smart contracts allow for settlement on a real-time basis, which can improve margin management.
"Compliance professionals are having to become technologists ie apply rules and put them into code such that systems can monitor trade flow, allocations and so on," said Scott-Hopkins.
By 2020, it is expected that there will be USD5 billion spent on blockchain. "I think it will be used fundamentally in a lot of applications on people's computers and mobile phones without us really knowing about it," added Scott-Hopkins.
Warburg explained that one can think about the breadth of blockchain technology in three main areas. The first, she said, is that we are moving away from an internet of information to an internet of value: "With blockchain, we are able to use technology to do transfers of trades across large distances without the need for any intermediary.
"Secondly, we're not just going to see one or two blockchains. There are many kinds being developed for privacy law, governance structures and so. We will see a world of thousands blockchains that will be interoperable," said Warburg, echoing the point made earlier by Mishra.
Thirdly, blockchain is a gateway drug to new assets. Through smart contracts and blockchain technology, it is facilitating the invention, not just of new products, but new markets: i.e. driverless vehicles that pay out every time they are used in an Uber-like model.
The possibilities are endless. This is why, as Cowell said earlier, fund managers will need to become dreamers and explorers of new worlds of opportunity, as blockchain and the rising sophistication of AI re-writes the rules of what it means to do business in a hyper-connected world.
