Money management began in India in the sixties with the establishment of Unit Trust of India by far sighted institution builders. However, modern money management in its true sense began with the liberalisation of the Indian economy in the early nineties. The establishment of the Securities and Exchange Board of India and formulation of new regulations saw the advent of the private sector into the money management business. Since then the industry has grown by leaps and bounds with demonetisation giving a huge impetus to the financialisation of savings. From an industry offering limited choice in the early years, investors today are spoilt for choice with a bewildering array of products seemingly meeting every need of investors.
The initial years had their share of challenges. Being a nascent industry, getting the right people to manage money was difficult. The pool of experienced portfolio managers was small and asset management firms had to be creative in recruiting portfolio managers and analysts. Many of us got a start in this industry due to the liberal interpretation of “relevant experience”. This led to a fascinating cast of characters, diverse and eclectic, entering the business. What they lacked in experience, portfolio managers made up by way of imagination, enthusiasm, pioneering spirit and derring-do.
The terrain was virgin and uncharted. Information on companies was sketchy and unreliable. Balance sheets, a key source of information, were eagerly awaited every year and treasured like family heirlooms. Mistakes were made away from the harsh glare of media and the markets/customers were mercifully forgiving. Competition, too, was rudimentary and there was camaraderie all around. The learning curve, however, was steep. Within a few years, a vibrant and modern fund industry was established. Research, in-house and external, improved in quantity and quality. With the Indian economy opening up, companies and industries thus far operating in their own safe cocoons, were suddenly pitted against competition and subject to scrutiny by shareholders/prospective investors. Trading systems, corporate governance, management quality, in short, the entire investment ecosystem improved dramatically. These were exciting times for stock-pickers with research quality improving and investment opportunities abounding. The opportunity set expanded further with new and fledgling businesses being established in information technology, pharmaceuticals, media among many others. The portfolio manager, too, underwent a stunning transformation from the buccaneering Jack Sparrow of the early years to the cold, calculating Spock of today.
In the first decade of the 21st century, the Indian economy grew at a scorching pace. Computing power and the ubiquitous Bloomberg terminal gave the portfolio manager access to unlimited knowledge. They used their superior research and new found access to knowledge to deliver huge outperformance. Soon, research became commoditised, competition intensified and the fund management industry grew in size. This led to a tapering of the outperformance. A new breed of service providers emerged to make sense of fund performance and guide investors/advisors. While the fund manager always took his fiduciary duty seriously, regulatory pressure and adoption of best practices ensured that risk management, repeatability of performance and focus on processes took centre stage.
Meanwhile, momentous changes were taking place in the global money management industry. With the majority of active managers failing to beat benchmarks, a huge shift towards passive funds and ETFs began. This trend continues to gather steam as active managers scramble to cut costs and change business models to stay relevant. Active management strategies such as value investing, small-cap investing and so on which delivered outperformance in the past have now been templatized and so called smart-beta ETFs have been launched to benefit from these strategies. But as these factor investing strategies go mainstream, the outperformance will diminish. While active managers in India still have some years of outperformance left, the move into passive funds and ETFs seems inexorable.
Investing, we all know, is both art and science. Of late, process oriented strategies emphasising quantitative over qualitative aspects are on the ascendant. The situation is tailor-made for computer/algorithm based strategies. The cold, calculating portfolio manager is a myth and will lose out to the rational computer when it’s comes to rule based investment. Nothing illustrates this better than the game of chess. IBM’s Deep Blue defeated the then world’s best chess player Garry Kasparov in 1997. Since then computers have consistently achieved Elo ratings higher than human beings! But can a computer master the qualitative aspects of investing? The answer may well lie in using artificial intelligence/machine learning for making investment decisions. The year 2017 was a watershed for machine learning. AlphaZero, an AI system developed by a Google subsidiary, crushed the world’s computer chess champion, Stockfish, winning 29 out of 100 games and losing none. AlphaZero learnt the game by playing against itself after being taught the rules of chess. It became good enough to beat the world’s top computer chess player after just 4 hours of practice. The use of systems like AlphaZero in fields such as investment management is happening as we speak. The world of robo-investors and robo-advisors is no longer the stuff of science fiction. Fintech upstarts seeking to disrupt the fund management industry are sprouting like weeds across the world. It won’t be long before we see them in India as well.
So, is it curtains for the active investor? There are no easy answers. But my guess is that passive strategies, too, will get their comeuppance. Much like the ‘Masters of the Universe’ brought down to their knees by the global meltdown in 2008, the mad rush into passive strategies will sow the seeds of their destruction. A recent article in the Financial Times explained while computers and AI perform a number of tasks more efficiently than humans, they do not comprehend what they are doing. Therein lies the problem. As algorithms and black boxes become more entrenched, the AlphaZeros of the world will battle each other into a cul-de-sac, a sad state of entropy and ennui. The situation will be redeemed only by human ingenuity, creativity and, yes, perfidy. A million mutinies will erupt to disturb this stasis and a Marie Kondoish counter revolution will sweep the investment landscape. Stock picking in its old fashioned, artisanal, human avatar will make a strong comeback as boutiques, small teams and concentrated strategies beat passive strategies by a mile. The lonely hunter, patiently stalking his prey and biding his time, will have his revenge.