In this issue, we have reproduced extracts from AIMA’s recent thought leadership study: ‘Perspectives – Industry Leaders on the Future of the Hedge Fund Industry’, which interviewed leading hedge fund managers from North America, Europe, Asia and Australasia. Those interviewed expect lower fee, more scalable, factor-based, alternative risk premia or style premia, strategies will gather more assets. But I’d like to highlight some findings from Chapter 2, entitled ‘Forces of Disruption’.
“On a five to ten-year view, one big trend we expect is growing application of artificial intelligence, machine learning, deep learning and big data techniques. Some firms have now created roles for heads of machine learning,” says AIMA’s Global Head of Research, Tom Kehoe.
Ten of the 19 firms interviewed were systematic and quantitative, but Kehoe stresses that “both systematic and discretionary firms are using these techniques. For example, classic equity long/short strategies, such as Kyle Bass’s, are using big data”. This can be expensive, but Kehoe expects “as technology brings costs down, the majority of managers are likely to adopt these methods.” Technology is also changing human resource needs: “the typical hedge fund analyst profile – of a finance MBA or former prop trader – is shifting towards scientists and engineers,” adds Kehoe.
Still, computers need not displace humans. For a start, “quantitative techniques are more used for shorter term and higher frequency strategies,” points out Kehoe. The report also points out areas where human input is valued. The fact that financial advice is based on trust, limits the extent to which it can be replaced by digital advisers, argues Nobel Prize winner, Robert Merton. One-off events, such as the Swiss Franc de-pegging, can wrong-foot models, observes Tom Hill of Blackstone Alternative Asset Management. And Seth Fischer of Japan-oriented activist manager, Oasis, explains that his strategy, which involves a dialogue with management and other investors, cannot be replicated by machines.
Activism addresses the ‘G’ in ESG, and investing responsibly is the second megatrend identified by AIMA. “Some 55% of firms interviewed are seeing greater interest in adopting forms of responsible investing, partly driven by millennials’ priorities,” says Kehoe.
All firms interviewed are signatories of the UN PRI, but they apply responsible investment differently. For instance, negative screening is one form of responsible investment which is unlikely to be adopted by all managers. When it comes to ESG – environmental, social, and governance considerations – “one manager’s research found that the E and S constraints do not improve risk-adjusted returns, which can create a conflict with fiduciary responsibilities,” explains Kehoe.
More active forms of responsible investment can be undertaken by activist hedge funds, which may invest in companies with low ESG scores and engage with them to improve matters. ‘Impact Investing’ selects companies that have a positive impact on metrics such as the UN Sustainable Development Goals. So far, only a handful of hedge funds, including Avenue and Jana, have publicly announced impact investing strategies, but many more are expected to do so over the coming years.
AIMA will soon unveil another research paper, on responsible investing, and has already received requests to repeat the ‘Perspectives’ study in a few years, Kehoe reveals.