Artificial Intelligence (AI) has introduced major breakthroughs as fintech solutions in the finance industry. Risk management, customer segmentation, credit scoring, personalized banking, process automation, etc. are some of the advantages of AI and its technologies that are leveraged by the finance sector.
Another important area of finance where AI has a significant role to play is asset, portfolio, and wealth management. In this blog post, we will discuss the applications of AI technologies in intelligent portfolio management.
A portfolio comprises several financial assets including stocks, mutual funds, commodities, exchange-traded funds, etc. Different asset classes can involve the risk of diversification, which may impact the decisions to buy, hold, and sell the assets at the most profitable time. A portfolio management software can help to deal with the limitations of this kind by analyzing and optimizing assets at regular time intervals. The software helps portfolio managers in analyzing strengths, weaknesses, threats, and opportunities (SWOT) to make optimum choices for maximum profits.
Artificial Intelligence to Manage Portfolios
AI can help investors or portfolio management firms in asset allocation, risk management, trading processes, etc. Here are some use cases discussed in detail.
1) Fundamental Analysis: AI technologies such as Machine Learning can be used for text analysis of data and to generate reports or other actionable insights. Text analysis is a technique to automatically extract insights from unstructured data sets. In addition to this, ML models can help to identify correlations between the different asset classes. This can help investors to identify the outperforming or underperforming assets in their portfolios.
2) Risk Management: There are different types of risks that a portfolio is exposed to. This includes operational risk, technology risk, liquidity risk, credit risk, market risk, etc. AI and its technologies can help to overcome these risks. For example, machine learning models can play a critical role in analyzing historical trade patterns and point outperforming inquiries.
3) Portfolio Optimization: AI helps in optimizing the time to enter and exit the market to increase returns and reduce loss. By using ML algorithms (especially the Genetic algorithm), some of the complex optimization issues can be resolved by adding constraints. These constraints can include a restriction on a number of assets or a minimum holding threshold.
Genetic algorithms are inspired by Darwin’s theory of evolution. By examining factors like natural selection, reproduction & mutation, these ML algorithms help in resolving complex problems such as search and optimization.
Customer Success Story: Explore how Daffodil helps an asset management firm to build a portfolio management application
4) Trade Management: Algorithmic trading is another use case of AI in finance. This method of executing orders utilizes pre-programmed trading instructions that help in making relevant predictions. Trade using AI is use variables such as time, volume, and price to determine the best trading options. AI-powered trading techniques assist in analyzing transaction costs and executing large trades.
5) Robo-advisors: Robo-advisors are changing how portfolios are managed. They start by understanding an investor's risk tolerance and financial goals. Then, AI algorithms craft diverse portfolios matching the investor's profile. What's distinctive is their adaptability; they monitor markets and automatically adjust portfolios to maintain the desired balance. These platforms also optimize taxes by strategically managing assets.
Robo-advisors offer cost-effective alternatives to traditional advisors by automating key tasks, reducing fees, and providing 24/7 accessibility through user-friendly interfaces. In essence, they bring efficient, personalized, and data-driven portfolio management to a wider audience.
AI in Portfolio Management: Risks Involved
Artificial Intelligence solutions are all about data. The different decision-making algorithms like genetic algorithms, neural networks, etc. are dependent upon data to analyze the data and make predictions. Some of the data related challenges include:
Incomplete Data Set: The quality of input to an algorithm determines the quality of the output- ‘Garbage In Garbage Out’. Any gaps in the quality of the data set can turn profits into losses, thereby reversing the impact of technology. An incomplete or improper data set can lead to incorrect predictions or assessments.
A Large Data Set to Train: For a machine to cognitively learn, it needs a large-sized data set. The bigger the data set, the better it would be for an ML model to understand the trends and patterns to make predictions. A relevant data set is the key to the most suitable output.
Bias: The quality and availability of the data set have a direct impact on the algorithm’s bias. You can read about examples of Biased AI in this article about Ethical AI.
Black Swan: An inappropriate data set can lead to unexpected events called Black Swan. However, for an ML model to learn from its experiences and deal with unexpected scenarios in the future, it is important that such scenarios are encountered. However, they can lead to some severe consequences that lead to loss.
Technology breaches are unavoidable. However, with the right set of precautions and measures to improve the quality of output (especially with the data set), AI technology can be best utilized for managing financial assets and portfolios.
Read More: How to tackle bias in AI: An Ultimate Guide
AI Portfolio Bot vs. Traditional Fund Manager
1) Data-Driven Decisions
AI Portfolio: AI portfolios base their decisions on advanced algorithms and data analysis. They can process vast amounts of data from various sources, identifying patterns and correlations that might elude human fund managers. This data-centric approach ensures that investment choices remain grounded in objective analysis.
Traditional Fund Manager: Human fund managers, on the other hand, rely on their experience and expertise to make investment decisions. While their knowledge can be valuable, it's subject to human emotions and biases, which can influence their choices. They may make decisions based on intuition and judgment developed over their career.
AI Portfolio: AI portfolios are highly consistent in their approach. They strictly adhere to predefined rules and algorithms, ensuring that investment strategies remain unchanged regardless of market conditions. This consistency can be reassuring for investors seeking a disciplined approach.
Traditional Fund Manager: The consistency of traditional fund managers can fluctuate. Their strategies may adapt to evolving market sentiments or personal judgments, resulting in variability over time. While adaptability can be an asset, it can also introduce inconsistency.
3) Speed of Execution
AI Portfolio: AI portfolios can execute trades rapidly, often within milliseconds. This swift execution is particularly advantageous in fast-paced markets, where timely decisions can make a significant difference in returns.
Traditional Fund Manager: Human fund managers typically require more time for research, analysis, and execution. This slower response can lead to missed opportunities or delayed reactions to rapidly evolving market conditions.
Wealthy investors who invest in hedge funds often give away 20% of their earnings and an annual fee based on how much they invest.
4) Risk Management
AI Portfolio: AI portfolios incorporate advanced risk management techniques, automatically adjusting portfolio allocations based on predefined risk thresholds or market volatility indicators. This proactive approach can help protect investments during market downturns.
Traditional Fund Manager: Risk management by traditional fund managers is often manual and may not be as responsive to rapidly changing market conditions. It can be influenced by the manager's individual judgment.
5) Management Fees
AI Portfolio: AI portfolios typically come with lower management fees compared to traditional fund managers. These cost savings can result in higher net returns for investors over the long term.
Traditional Fund Manager: Traditional fund managers usually charge higher management fees, which can impact overall returns. These fees cover the costs of human expertise and personalized service.
6) Learning and Adaptation
AI Portfolio: AI algorithms can continuously learn and adapt from new market data. They engage in extensive backtesting to identify optimal strategies. This capacity for self-improvement means that AI portfolios can potentially become more effective over time.
Traditional Fund Manager: The performance of traditional fund managers can vary, and their ability to adapt to changing market conditions may be influenced by their individual experiences and expertise.
AI Portfolio: AI portfolios operate 24/7, monitoring global markets and reacting to news and events in real-time, even outside of human working hours.
Traditional Fund Manager: Traditional fund managers are typically limited to working hours and may not be available to respond to market developments that occur outside of those hours.
The choice between an AI portfolio and a traditional fund manager depends on an investor's specific goals, preferences, and risk tolerance. Many investors find that a combination of both approaches can be a balanced strategy to achieve their financial objectives.
Choosing the Right AI Portfolio: Key Considerations
1) Transparency and Explainability: Seek transparency in the AI's decision-making process. The algorithms should be explainable, meaning they can provide clear reasoning behind their investment choices. Understanding how the AI makes decisions is crucial for investors.
2) Track Record and Performance: Assess the AI portfolio's historical performance. Look for a track record of consistent, positive returns over an extended period. Analyze how the portfolio has performed in various market conditions, including bull and bear markets.
3) Risk Management Strategies: Examine the AI's risk management techniques. A robust AI portfolio should have built-in risk controls and mechanisms to mitigate losses during market downturns. It's essential to understand how the AI handles risk.
4) Customization Options: Determine if the AI portfolio offers customization options. Investors may have different risk tolerances and investment objectives. Look for AI solutions that can tailor the portfolio to meet your specific needs.
5) Fees and Costs: Consider the fees associated with the AI portfolio. While AI solutions often have lower management fees compared to traditional fund managers, it's essential to understand the fee structure and how it may impact your overall returns.
6) Diversification: Ensure sure the AI portfolio prioritizes diversification by selecting a wide range of assets, including stocks, bonds, ETFs, and various securities. Portfolios with a broad array of assets are better positioned to withstand challenging investment environments.
7) Exit Strategy: Understand the process for exiting or making changes to your investment in the AI portfolio. Whether you want to withdraw funds or adjust your strategy, the platform should offer a clear and efficient exit strategy.
Asset and Portfolio Management with AI: Getting Started
Artificial Intelligence and its technologies have broad use cases in the finance industry. With deep learning, big data, and GPU processing capabilities, fintech organizations are achieving better results in various areas including asset and portfolio management.
If you are a startup or a Fortune 500 company with an idea for asset and portfolio management, our fintech specialists can help you to get started. For more detail on how our experts can be a help to you, check out more about our fintech services or book a free consultation.