Embracing Uncertainty

by Plotinus

Perhaps the most resounding investment theme thus far for 2022 is uncertainty. Concern regarding this uncertainty has been amplified by the faltering start to the year in the broad US stock market, emphasized in particular by, for example, the tech sector’s performance thus far.

There are some obvious headwinds that are cause for concern, but there is no clarity as to whether these will create some inconvenient resistance or if they might combine to whip up a storm. Simultaneously there is no air of confidence to be found in what would traditionally be considered the safe havens in times of trouble. In fact these “safer” investments themselves have the prospect of being more of a hinderance than a help, risking further disappointment.

In a way, perhaps unsurprisingly, Wall Street’s investment banks reflect the uncertainty in their opinions on how 2022 will be. The range of forecast estimates for the S&P 500 from Goldman Sachs to Morgan Stanley, for instance, is separated by 15 percentage points, approximately the five-year annualized volatility figure of the index.

Yet regardless of the concern and the less than perfect stumble out of the blocks of 2022, the resilience of US equities cannot be underestimated. In the last decade the S&P 500 has only had two losing years and the last three years have seen average returns of 24.0%, well above the average for the decade of 14.8%. So, whilst caution is often the recommended course of action when faced with uncertainty, this weighs heavily against the potential cost of missing out on possible strong equity returns due to over cautiousness.

This poses a reallocation dilemma for many investors, as they attempt to assess how and where they might achieve an acceptable risk/return profile given these conditions.

A Problem in Need of a Solution

We find it very interesting that this dilemma occurs at the very moment when the cost and viability of traditionally more cautious approaches are under question and the problem needs a different answer. It can be very hard, though, to break from traditional thinking particularly when looking at a longstanding problem, like achieving a well-balanced portfolio. In the current conditions, however, with potential slowing growth, inflation, unattractive yields, monetary policy, possible over valuation and the illiquidity of many alternatives all being cause for concern, perhaps this lack of clarity may encourage investors to seek out a new approach.

These are the very types of issues and unclarities that our firm considered when, several years ago we posed ourselves the following question:

Could a new AI-based, technological approach be applied to investment management such that it would provide a new way to hedge US equities without needing to leave the asset class?

In other words, by using AI-based trading could we generate a non-conventional way of obtaining a better risk/return than a pure US stock market investment, but with the characteristics of a portfolio that was diversifying away from that same exposure. In effect, this is a way to have your cake and eat it.

By building an artificial intelligence-based approach from the ground-up, from concept through to execution, we were able to confront the problem from a unique angle rather, than simply applying the straight jacket of conventional thinking. Thus, we have avoided condemning the result to becoming just another tackling of an old problem in an old way.

Our own experience has been that we have been successfully able to answer the question we posed, by achieving our desired better risk-adjusted return than the S&P 500 over the past 3.5 years. This has strengthened our confidence that AI-based trading, if properly deployed, is a resource that has only begun to be tapped and is one that has the ability to provide investors with many new solutions to their investment management problems. The uncertainty of 2022 should not be feared. AI-based approaches give investors a new means to grapple with it.

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