AI & ETFs – Myths & Realities

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September 15, 2018 6:31am NYSE:AIEQ

From EquBot, Special to ETF Daily News: From self-driving cars to cognitive robots, artificial intelligence (AI) is seemingly everywhere these days.  It’s increasingly found in the investment world as well, embedded in hedge fund strategies and Exchange Traded Funds (ETFs) among other products.


As these applications spread, inevitably, a number of misconceptions have sprung up about what AI is, how it works, and what it can and can’t do.  A few of the most common ones would include:

It’s a black box

Not really.  True, the algorithms that drive the investment process are proprietary and can be complex, but that’s the case with any number of applications that use higher level mathematics to deliver services or to identify customer needs.  In our case, we employ a multi-stage process that combines fundamental and qualitative analysis with AI in seeking to identify mispriced investments. This includes using the IBM Watson computing platform to sort through millions of millions of articles and massive amounts of unstructured data to build predictive models on over 15,000 globally traded companies.

Effectively, we’re employing artificial intelligence to replace the portfolio manager to process more market data and generate more objective investment decisions given a set of investment criteria.

No one knows how it reaches a decision

This is a frequent criticism of AI – it might deliver the desired outcome but no one knows how it got there. This is particular critical in the investment world, where performance attribution is an important metric.  But systems can be built that allow for sufficient transparency to understand how the algorithms reach a conclusion. Further, the data sets that are acted on by AI are determined by humans; those, in turn, broadly reflect pre-determined investment goals.  The algorithm then advances by uncovering patterns in a kind of trial and error, a reinforced learning process that is directed towards a specific end – outperforming a market index, for example. It may discover things that might elude a traditional portfolio manager – patterns, relationships, and historical anomalies, for example.  Once identified, these patterns can be observed by humans as well, adding transparency.

Most importantly, with an ETF the decisions made by the algorithm are there to be seen every day in the publicly-reported holdings.

The machines are in charge

The goal of any AI system is to combine the best qualities of technology with human experience and insight.  The algorithms themselves are designed by individuals to operate within certain parameters and to achieve well-defined goals – they are essentially recognizing patterns and predicting outcomes.  Adding machine intelligence allows them to learn along the way, and to improve, but it doesn’t alter the fundamental purpose. Algorithms create to enhance the investment process won’t suddenly wander off and start playing chess or Go, for example.  They’ll try to improve the process for which they were designed.

Eliminating bias in the investment process is an important consideration, but it is not the same as eliminating all human input, or forgoing the opportunity for a human portfolio manager to analyze and oversee the results.  Like computers themselves, the algorithms make it possible to do more, faster – well beyond the capability of any individual portfolio manager or team of analysts – both they are subject to human oversight.

It’s going to take over the world

It’s always something.  With advancements in AI the warnings have at times been stark, and some have come from highly respected individuals who have suggested that the technology may eventually pose a threat to human life as we know it.

We’re in the early stages of the AI revolution and, as such, the subject is vulnerable to both unmerited hype and overly ominous warnings.  Since we’re dealing in probabilities, we should look to the most likely outcome as AI evolves. Machines will continue to learn, and learn faster. They will recognize more and deeper patterns, some number of which will be at best unhelpful, at worst meaningless (like many of the patterns discovered by humans).  In the aggregate, they will likely continue to learn and add value, and the applications will continue to expand. Humans will continue to be in charge for the foreseeable future, in how the algorithms are written, in selecting the datasets that are utilized, and in interpreting how the results are applied.

Investing with AI

We introduced the AI Powered Equity ETF (NYSE Arca: AIEQ), the world’s first active AI-powered ETF  in 2017. That was followed earlier this year by the launch of the AI Powered International ETF (NYSE Arca: AIIQ), which brought this same technology to investing outside the US.  Both use quantitative models built by EquBot with IBM Watson artificial intelligence.

With both funds, the EquBot model ranks thousands of stocks based on the probability of each company benefiting from current economic conditions, trends and world events, and identifies companies for inclusion in the portfolio that have the greatest potential for price appreciation over the next twelve months.  With AIIQ, the model also incorporates a volatility screen, with a goal of maintaining portfolio volatility comparable to that of the broader developed markets ex-U.S.

To date, the funds are performing much as we had hoped.  While you can never assume anything in the stock market – and past performance does not predict future returns, as we all know – AIEQ has significantly outperformed its benchmark since launch, returning 19.20% from October 18, 2017 through August 31, 2018, compared to 12.12% for the S&P 500.  AIIQ is much newer – and entered the market at a more volatile time for international stocks. It has returned -2.32% since inception on June 5, 2018 through August 31, matching the -2.32% performance for FTSE Developed All Cap Index over that same time frame.

Conclusion

AI has a sci-fi quality that is both mesmerizing and, to some, a little alarming, but it’s just a technology like any other.  Investors and advisors tend to be a pragmatic group, however, and their criteria for success is a little different: does it help me build a portfolio and meet my long-term investment objectives?  Given the transparency and mark-to-market nature of the investing world, that’s something everyone can see for themselves.

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Click here for AIEQ performance.

https://www.aieqetf.com/fund/#performance

Click here for AIIQ performance.

fund-info

Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Funds may be lower or higher than the performance quoted.

 

Performance data current to the most recent month end may be obtained by calling (650) 451-5497 for AIIQ and  (844) 383 -6477 for AIEQ.

One cannot invest directly in an index. Standard & Poor’s 500 is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. It is not possible to invest directly in an index. The FTSE Developed All Cap ex US Index is a market capitalization-weighted index representing the performance of large-, mid- and small-capitalization stocks in developed markets, excluding the U.S. It is not possible to invest directly in an index.

AIIQ Disclosures

Carefully consider the Fund’s investment objectives, risk factors, charges, and expenses before investing. This and additional information can be found in the Fund’s prospectus, which may be obtained by calling (650) 451 5497, or by visiting www.AIIQetf.com.  Read the prospectus carefully before investing.

The Funds are actively managed and seek to achieve their investment objective by investing primarily in equity securities (or depositary receipts) of companies based on the results of a proprietary, quantitative model (the “EquBot Model”) developed by EquBot Inc. (“EquBot” or the “Adviser”) that runs on the Watson? platform.

Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Narrowly focused investments typically exhibit higher volatility. The equity securities held in the Fund’s portfolio may experience sudden, unpredictable drops in value or long periods of decline in value. This may occur because of factors that affect securities markets generally or factors affecting specific issuers, industries, or sectors in which the Fund invests such as political, market and economic developments, as well as events that impact specific issuers.
The Fund issues and redeems shares on a continuous basis, at NAV, only in blocks of 50,000 shares (“Creation Units”), principally in-kind for securities included in the Fund’s portfolio, and only Authorized Participants (typically, broker-dealers) may purchase or redeem Creation Units.
The Fund is actively-managed and may not meet its investment objective based on the success or failure of the Equbot Model to identify investment opportunities.
The portfolio managers may actively and frequently trade securities or other instruments in the Fund’s portfolio to carry out its investment strategies. A high portfolio turnover rate increases transaction costs, which may increase the Fund’s expenses.
Some of the models used by the Adviser for the Fund are predictive in nature. The use of predictive models has inherent risks. When Models and Data prove to be incorrect or incomplete, any decisions made in reliance thereon expose the Fund to potential risks. For example, by relying on Models and Data, the Adviser may be induced to buy certain investments at prices that are too high, to sell certain other investments at prices that are too low, or to miss favorable opportunities altogether. Similarly, any hedging based on faulty Models and Data may prove to be unsuccessful.

EquBot is the investment adviser to the AI Powered International Equity ETF.

The AI Powered International Equity ETF is distributed by Quasar Distributors LLC, which is not affiliated with EquBot.

AI Powered Equity ETF (AIEQ) Disclosures

Fund holdings and sector allocations are subject to change at any time and should not be considered recommendations to buy or sell any security.

ETF Managers Group, LLC is the investment adviser to the AI Powered Equity ETF.

Carefully consider the Fund’s investment objectives, risk factors, charges, and expenses before investing. This and additional information can be found in the Fund’s prospectus, which may be obtained by calling 1-844-ETF-MGRS (1-844-383-6477), or by visiting www.equbotetf.com. Read the prospectus carefully before investing.

Investing involves risk, including the possible loss of principal. Shares of any ETF are bought and sold at market price (not NAV), may trade at a discount or premium to NAV and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Narrowly focused investments typically exhibit higher volatility. The equity securities held in the Fund’s portfolio may experience sudden, unpredictable drops in value or long periods of decline in value. This may occur because of factors that affect securities markets generally or factors affecting specific issuers, industries, or sectors in which the Fund invests such as political, market and economic developments, as well as events that impact specific issuers.

The Fund issues and redeems shares on a continuous basis, at NAV, only in blocks of 25,000 shares (“Creation Units”), principally in-kind for securities included in the Fund’s portfolio, and only Authorized Participants (typically, broker-dealers) may purchase or redeem Creation Units.

The Fund is actively-managed and may not meet its investment objective based on the success or failure of the Equbot Model to identify investment opportunities.

The portfolio managers may actively and frequently trade securities or other instruments in the Fund’s portfolio to carry out its investment strategies. A high portfolio turnover rate increases transaction costs, which may increase the Fund’s expenses.

Some of the models used by the Adviser for the Fund are predictive in nature. The use of predictive models has inherent risks. When Models and Data prove to be incorrect or incomplete, any decisions made in reliance thereon expose the Fund to potential risks. For example, by relying on Models and Data, the Adviser may be induced to buy certain investments at prices that are too high, to sell certain other investments at prices that are too low, or to miss favorable opportunities altogether. Similarly, any hedging based on faulty Models and Data may prove to be unsuccessful.

The fund is distributed by ETFMG Financial LLC, which is not affiliated with Equbot. ETF Managers Group LLC and ETFMG Financial LLC are wholly owned subsidiaries of Exchange Traded Managers Group LLC (collectively, “ETFMG”).


This article is brought to you courtesy of EquBot.


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