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Are human active investors becoming obsolete?

Like most sectors, funds management and investing is an industry which is undoubtedly being impacted by technology. These computers are cheaper and don't talk back. This is both in the form of passive strategies which mimic an index or performance of an industry (exchange traded funds). It also relates to quant funds which use powerful computers to collect an enormous amount of information in live time and uses this information to unemotionally make investment decisions.

The question we need to ask ourselves is: Are human active investors becoming obsolete?

Being a human active investor, I obviously have my biases, but I firmly believe there is a future for human active investors.

Undoubtedly, 'gaining an edge' as a fundamental investor has become more difficult. Information is disseminated globally in live time and with powerful computers being able to gather and interpret this information much quicker than the human brain, the ability to pick short-term earnings changes and share price movements has become increasingly more difficult.

In fact, even the best human fundamental investors are at a comparative disadvantage when it comes to predicting how new information about a company (like earnings releases) is going to impact the short-term share price movements of a company. It is important for any fundamental investor to read and analyse the underlying company's earnings release as a minimum.

However, interpreting an earnings result and how it compares to consensus forecasts in itself is no longer terribly useful in predicting short-term share price movements. Computers will always be able to do this better and quicker than humans. While good human analysts can still gain some edge by identifying accounting tricks used to inflate the core earnings metrics, it will only be a matter of time before computers are going to be able to do this, so I don't believe that this is a sustainable competitive advantage.

All is not doomed for the human race. Ironically, it is the frailties of human psychology as it pertains to investing which gives humans a significant advantage. At the end of the day it is humans who program the computers and humans which structure passive products. The biggest frailty of human investing psychology is the desire to always look smart and the short termism that this breeds. Whether that be an investment manager wanting to beat the index every quarter or a retail investor chatting at a dinner party. This drives humans to want to own what is popular at any given moment (stock with positive share price or earnings momentum) and steer clear of any company which is not going so well. A strong share price tends to make investors feel more confident about buying shares in a company and vice versa.

This behaviour of buying what is loved and selling what is unloved is alive and well in computers. Passive strategies which mimic an index tend to buy companies when they are a bigger part of the index which is typically when the share price is higher. Sector ETFs are forced to buy the companies which they represent when the funds under management (FUM) grows. This tends to occur when the sector which they represent is popular, which in turn is when the underlying securities have, in recent history, performed well.

Generally quant funds (and there are exceptions), tend to buy companies which have positive earnings forecasts revisions and strong share price momentum. Hence as mentioned before, computers generally suffer from the same frailties as human investors. That is an intense focus on the short term and an underlying program to buy what is popular and sell what is unpopular (some people call this buy high and sell low).

In our opinion this creates longer term opportunities to buy high quality companies which are unloved by both humans and computers. This could be because the companies are at the lower end of their respective cycles, have negative broker recommendations or are just simply out of favour because they do not fit the popular thematic of the day.

Written by Anthony Aboud, Perpetual, portfolio manager

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