The Economist - USA (2019-10-05)

(Antfer) #1

18 TheEconomistOctober 5th 2019


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ifty yearsago investing was a distinct-
ly human affair. “People would have to
take each other out, and dealers would en-
tertain fund managers, and no one would
know what the prices were,” says Ray Dalio,
who worked on the trading floor of the New
York Stock Exchange (nyse) in the early
1970s before founding Bridgewater Asso-
ciates, now the world’s largest hedge fund.
Technology was basic. Kenneth Jacobs, the
boss of Lazard, an investment bank, re-
members using a pocket calculator to ana-
lyse figures gleaned from company reports.
His older colleagues used slide rules. Even
by the 1980s “reading the Wall Street Journal
on your way into work, a television on the
trading floor and a ticker tape” offered a
significant information advantage, recalls
one investor.
Since then the role humans play in trad-
ing has diminished rapidly. In their place
have come computers, algorithms and pas-
sive managers—institutions which offer
an index fund that holds a basket of shares
to match the return of the stockmarket, or
sectors of it, rather than trying to beat it
(see chart 1, on the next page). On Septem-

ber 13th a widely watched barometer pub-
lished by Morningstar, a research firm, re-
ported that last month, for the first time,
the pot of passive equity assets it measures,
at $4.3trn, exceeded that run by humans.
The rise of financial robotisation is not
only changing the speed and makeup of the
stockmarket. It also raises questions about
the function of markets, the impact of mar-
kets on the wider economy, how compa-
nies are governed and financial stability.

America is automating
Investors have always used different kinds
of technology to glean market-moving in-
formation before their competitors. Early
investors in the Dutch East India Company
sought out newsletters about the fortunes
of ships around the Cape of Good Hope be-
fore they arrived in the Netherlands. The
Rothschilds supposedly owe much of their
fortune to a carrier pigeon that brought
news of the French defeat at the Battle of
Waterloo faster than ships.
During the era of red braces and slide
rules, today’s technological advances start-
ed to creep in. Machines took the easier

(and loudest) jobs first. In the 1970s floor
traders bellowing to each other in an ex-
change started to be replaced by electronic
execution, which made it easier for every-
one to gather data on prices and volume.
That, in turn, improved execution by creat-
ing greater certainty about price.
In portfolio management, algorithms
have also been around for decades. In 1975
Jack Bogle founded Vanguard, which
created the first index fund, thus automat-
ing the simplest possible portfolio alloca-
tion. In the 1980s and 1990s fancier auto-
mated products emerged, such as
quantitative hedge funds, known as
“quant” funds, and exchange-traded funds
(etfs), respectively. Some etfs track indi-
ces, but others obey more sophisticated in-
vestment rules by automating decisions
long championed by humans, such as buy-
ing so-called value stocks; which look
cheap compared with the company’s as-
sets. Since their inception many of the
quant funds have designed algorithms that
can scour market data, hunting for stocks
with other appealing, human-chosen
traits, known in the jargon as “factors”.
The idea of factors came from two econ-
omists, Eugene Fama and Kenneth French,
and was put into practice by Cliff Asness, a
student of Mr Fama, who in 1998 founded
aqrCapital Management, now one of the
world’s largest hedge funds. Quant funds
like aqr program algorithms to choose
stocks based on factors that were arrived at
by economic theory and borne out by data
analysis, such as momentum (recent price

March of the machines


NEW YORK
The stockmarket is now run by computers

Briefing Automatic investing

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