Tuesday, October 23, 2018

Wealth destroyers

Black boxes, Artificial Intelligence and FinTech - likely a deadly combination that is going to destroy a lot of wealth. We have seen this before - fresh graduates from business schools coupled with mathematicians and physicists, descending on Wall Street to make the world go around in the opposite direction. As they appear on TV after hours - mad and fast - to confuse and pillage small money, ascertaining where every stock is going and even the market, there are 20 million fat fingers across the world chasing the illusion. 

The theory underlying financial markets has been robust in spite of the recent confusion about "behavioral economics." New information moves markets and unless one has insider information, it is impossible to create alpha from fundamental or technical analyses. A lot of careers are made and destroyed on this false idea.  For some of us, theory still matters and it can be shown without any empirical uncertainty that alpha is a white elephant. If an adviser is demonstrating consistent alpha, one has to wonder where the information is coming from. The SEC has gotten a lot more sophisticated lately but a simple heuristic of alpha consistency will tell you that there is something wrong.

Business schools need to rethink their focus. Some even have classes in "trading," and that idea is utterly inconsistent with everything we know. In the presence of uncertainty, it is easy to make returns and lose them quickly. In spite of all the academic literature behind this, not many involved in "money management," really talk about alpha (only returns). Granted, a single factor model is woefully inadequate to measure risk but not considering risk in your returns, like the TV moguls do, is a prescription for disaster. The fact that conventional finance education and even the high-end certifications do not prepare the professionals adequately is symptomatic of education chasing trends and not sticking with what is known.

The financial industry appears to be dominated by engineers and accountants, the former unaware of economics and the later unaware of the fact that we have computers now to count money. Adding mathematicians and physicists on top of this already deadly combination can only result in tears.