One Trend I Don’t Like

You know me. I’m all about innovation and the next-generation way of doing things better, faster, cheaper and smarter. Well, most of the time anyway. I’ve come across an exception, one that I think could cost investors money.

One week ago today, a new exchange-traded fund (ETF) was launched called the AI Powered Equity ETF (AIEQ). The AI stands for artificial intelligence, which is definitely NexGen.

Now many of you know that I happen to love ETFs, which are also a newer and often great way to invest.

So what’s the problem?

The problem is that this particular ETF is managed by a computer. In fact, AIEQ uses IBM’s Watson to pick stocks. Watson may have been able to beat a couple of the all-time great Jeopardy! champions, but I’m not convinced it will do as well with stocks. Yes, it wouldn’t take much to beat Wall Street, but I expect it will have a hard time even matching our 80%+ success rate.

If a computer is picking stocks, its strategy has to be based on algorithms that are programmed into it. There are already funds out there that use algorithms to try and beat the market, but this one claims to be different because of the “built-in AI and machine learning.” The strategy for this particular model includes technical, fundamental and proprietary information. Sound familiar? That’s exactly what we do in our NexGen investing.

One advantage I will give algorithm-based investing like AIEQ is the amount of information that can be processed. A computer can obviously process much more and much faster than a mere mortal like you or me. I will even give it a second advantage in that it removes all human emotions, which for most investors is a good thing.

But honestly, removing the human element is one of my big fears about all of this. There are a lot of unknowns every single day, and you still need that human touch, experience and perspective that simply can’t be programmed. If you owned the Dodgers or Astros, the teams playing in the World Series right now, would you want a computer as your manager? Sure, it could tell you the best hitter vs. pitcher matchups, or which player plays better in the sixth inning with two outs and the wind blowing in from the west. However, it cannot walk out to the pitcher’s mound and look the pitcher in the eye when determining whether he should stay in the game.

Another fear I have is that what little diversity Wall Street gives investors now – most funds own a lot of the same stocks – could get even worse if everyone starts going into algorithms that are programmed to follow similar trends. It might all work great when stocks are going up, as buyers would generate more buyers, but that’s already the case – we use technical analysis to determine that. However, down days, technical pullbacks and even bear markets are going to occur, and if investors own the same stocks and all pull money out at the same time, it would have a huge effect on prices. Selling would lead to sell signals in the algorithms, which would lead to more selling.

I saw a great quote from noted investor Jeffrey Gundlach, who also agrees that you can’t replace the human element. He put it this way in an interview with Bloomberg News: “It’s a one-size-fits-all financial solution. Everybody gets the same portfolio, which means everybody owns the same stock, which means when they all decide to get out you cause a crash.”

The same is true of so-called robo advisors, which are also based on math and algorithms with very little in the way of human experience, context or perception. This low-cost alternative is being embraced by the younger generation, and while it is great for them to get exposure to stocks, these algorithms are all new and have never been tested in a bear market. It has also been shown that the passive investing approach taken by robo advisors has investors of all types in the same mega-cap stocks. The way of getting there may be different, but the result is likely to be the same unacceptable performance we see so often in Old Wall Street.

The AI Powered Equity ETF isn’t off to the best start, despite its goal of building the “perfect portfolio” of 30-70 stocks at any given time. It has actually underperformed the S&P 500 by about 1% in its first week. I’m willing to cut it some slack since it has been around such a short time, but there are many negatives with computer advisors and stock pickers, and that won’t change. They may save money, but what’s true in every industry is true in the investment world as well – you get what you pay for.

For my money – and the money of my clients and subscribers – I’ll stick with using our NexGen system to profit from the digital age. There will be plenty of opportunities to profit from robots, but I will never turn my investing decisions over to one.

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