Technology is Shifting the Balance of Power to Asset Owners

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Active investment management will only become more scientific as time goes on. This is ultimately to the benefit of asset owners both large and small.

The Information Age has transformed and brought spectacular advances to a wide range of industries, from medicine to transportation and beyond. Investment management has been by some measures slower to evolve, but it, too, is changing.

The explosion of data is widely discussed as a major driver of this disruption, but it’s hard to fully grasp the scale this exponential growth has reached. Today the world creates about an exabyte of data every hour—that’s a billion gigabytes, or 213 million Star Wars DVDs. This data, much of it unstructured information, comes from an immense diversity of sources, and information gets absorbed by markets more efficiently than ever. While there is now exponentially more data than in the past, the value of each unit of data is individually worth less, and for a shorter period.

Fueling both the phenomenal growth of data and significant advances in various fields of artificial intelligence (including machine learning, natural language processing, and image processing) are exponential advances in computing power. Embracing these advances in engineering and data science techniques is imperative to finding signals in this ocean of data, but doing so requires smart and significant investments in technology and R&D.

Given the pace of these related developments, it is safe to say that active investment management will only become more scientific as time goes on, at least in areas where there is sufficient data and liquidity. This is ultimately to the benefit of asset owners both large and small.

Innovations in portfolio construction

Alpha, meanwhile, remains fundamentally scarce, and is not sufficient to achieve investors’ objectives. Most asset owners need solutions that impact their whole portfolios. We believe that the most efficient way to construct portfolios is through a combination of discrete alpha exposure, compensated style factors (e.g., risk premia), and pure beta factors. Few pure expressions of these investment building blocks exist today. Instead, asset owners are confronted with tens of thousands of investment options (across tens of seemingly arbitrary categories) that often consist of different mixtures of alpha, risk premia, and beta. And more than a few managers are selling what is essentially a package of risk premia and beta, while charging alpha fees. Investors wind up overpaying for opaque products with mediocre results, but properly designed investment solutions and more analytical investors can help close the gap between what is and what should be.

It stands to reason that investors will also need solutions that more clearly demarcate the lines between alpha, risk premia, and beta. Technology will help asset owners, be they retail or institutional, to better understand their current exposures and create fairly priced, custom portfolios that are more responsive to their unique multi-horizon goals, liabilities, financial profiles, risk tolerance, and utility functions. By enabling advanced portfolio analysis and optimization, technology is shifting the balance of power from asset managers to asset owners.

The asset managers of tomorrow

Moving forward, durable advantages will to accrue to those building a substantial platform based on massive amounts of data, along with the technology and institutional expertise to use it. Building such a platform requires significant and ongoing investment in R & D, and a fundamentally different culture and mindset to apply a scientific approach to the data-rich world of today.

Major, positive changes are in store for investors. By necessity, the future of asset management will be highly scientific and empirical in nature, and there’s no going back. The winners are clear: innovation will continue to empower investors and help asset owners—whether they are individuals or institutions—reach their objectives.

I recently spoke on this topic at the Milken Global Conference. To see the full panel, watch the video below.

A version of this article previously appeared on LinkedIn.

This article is not an endorsement by Two Sigma of the papers discussed, their viewpoints or the companies discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma Investments, LP or any of its affiliates (collectively, “Two Sigma”). The information presented above is only for informational and educational purposes and is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. Additionally, the above information is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice. Two Sigma makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever. Click here for other important disclaimers and disclosures.

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