Imran Lakha, Senior Advisor, Vanguard Capital AG & CEO and Founder of Options Insight, Financial Markets Training
What is factor investing?
Factor investing has been around for over a decade and has been especially popular among quantitative equity investors. Essentially, it is a way of filtering stocks based on specific types of factors such as Value, Momentum (both price and earnings), Quality, Riskiness and Size to mention a few. This enables one to explore companies from different industry sectors and regions through an alternative lens and identify relative value trading opportunities. Also known as smart beta, these quantitative styles are supposed to allow investors to extract some risk premium from the market which over time should generate excess returns. Analysing a portfolio in terms of its quant factor exposure can help investors to identify biases or risks that they might have otherwise missed and enables better risk management of their assets.
However, as I mentioned earlier, these are not ground-breaking or new approaches and given the sheer amount of AUM that goes into these strategies nowadays I would argue that their value proposition is becoming less clear. It is often now the case that broad market indices don’t move much but the factors (often referred to as the market internals) are having extremely large moves relative to each other, creating all kinds of pain for quant investors. The defined nature of what they should or shouldn’t be investing in (especially around MSCI index rebalances) leads to position crowding which almost always creates pain and sub-optimal returns.
Why use machine learning?
The leading practitioners in this space, often from hedge funds or maybe more surprisingly pension funds, have realised that to maintain an edge, they need to innovate and find factors that are not so commonly followed. This is where machine learning and artificial intelligence comes in. In this context, ML is basically where a massive amount of past stock return and company data is given to an algorithm, and its job is to use statistical analysis in a looping trial and error process to spot patterns in the data that can be used to make money. With the explosion in data availability and processing power, computers are now able to perform a vast number of trails and finds patterns and dependencies in data relatively quickly, something a human would never be able to do efficiently.
The hunt for alpha has also led some firms to use alternative data sources and NLP (natural language processing) with the most sophisticated deep learning techniques to perform analytics and extract meaningful insights. Deep learning refers to the number of layers in a neural network which makes it possible for an algorithm to learn in an unsupervised manner as opposed to supervised ML where it is given targets to help train and optimise itself. It is the unstructured nature of the data being used which requires the use of ML and extreme computational power.
Combining man and machine
Despite this seeming dependence on artificial intelligence, it is also well understood that market domain knowledge is still crucial and human oversight from experienced professionals must be used to ensure sensible investment strategies are being employed. A machine learning algorithm could find some obscure non-linear relationship in the data, but if it doesn’t make any sense from a rational economic perspective then it shouldn’t get implemented. A common sense approach is key and handing over all the controls to the AI and trusting it blindly is obviously not the way forward.
Also worth considering is the quality of the data source, which is often the determining factor in the success of this type of investment strategy. This is another reason why human intervention makes sense for logically pre-processing the data and spotting any biases that may exist before allowing the model to start training. There is no escaping the fact that the quality of a model is dependent on the quality of the data used to build it.
All the institutions with genuine experience using these technologies, see ML as an addition to the investment toolkit and something that assists them in making their trading decisions rather than making the decisions for them. Whilst the large scale adoption of ML and AI in finance is inevitable, it is clear to me that the winners will be the firms that utilise the technology to augment the human capital they already have which has successfully been generating alpha for many years.
WITHOUT C-SUITE COLLABORATION DIGITAL TRANSFORMATION IS UNLIKELY TO BE SUCCESSFUL WITHIN FINANCIAL SERVICES
By Nick Gold, founder and Chief Executive of Speaker’s Corner
A path to digital transformation
Mapping a clear path is essential for companies undergoing digital transformation. Responsibility for driving digital transformation across the enterprise lies with the C-suite. The CEO, chief marketing officer (CMO), chief human resources officer (CHRO) and chief operations officer (COO), among others, must work together to make the transformation happen. However, this can be difficult to achieve as certain members of the C-Suite are more proficient with technology than others. This article will look at how to overcome resistance/challenges at a senior level to any digital transformation strategy.
Working and evolving alongside the digital revolution
The fourth industrial revolution, where technology meets disruption via the Internet of Things, robotics, virtual reality and artificial intelligence, are fundamentally changing the way we live and work. This journey is taking us further into a world which we are only starting to understand.
We can see this most clearly in the finance sector, where at every stage of this revolution an area of this industry has been targeted and disrupted. As leading thinkers and exponents from the finance sector have shared their stories through their speeches, explaining the current impact and forecasting what will happen next, it is clear that for both the most established companies alongside the new wave of digitally lead fintech companies, change is part of the regular business cycle.
But having the processes and procedure in place to encourage change and be at the forefront of the digital revolution will be critical to the continued survival, let alone success, of companies within this sector.
As such, companies have realised that their processes, their products and even the reason for their entire existence needs to change in order to survive this revolution. However, the C-suite are struggling to adapt because this isn’t a clearly defined problem and there isn’t a historical precedent to follow.
How the finance sector deals with change
In days of old, a business problem would have been identified and a decision would be made to implement a technological solution. With the recommendation approved, the C suite, usually the Chief Technology Officer, would be tasked to deliver the project. This suited all the C suite members as it meant that the expertise of each member of the executive was clear and there was a clear delineation between their roles and responsibilities.
What fascinates me, especially in the finance sector, is for those established companies who historically have dealt with change (especially in the digital or technology space) by acquiring companies to utilise their technological systems and processes, this ‘traditional’ process for dealing with a changing marketplace is no longer as straight forward as it used to be.
Why is this? As I’m sure the reader is aware, the new fintech companies which disrupted the market, with their digital led strategy and processes, need to retain their cultural DNA to keep innovating and growing revenue.
But this doesn’t sit comfortable with the traditional model of acquiring a company and then integrating them into the processes of the buying company. The strengths of the new fintech company are being put at risk by this absorption and integration such that the company is potentially putting at risk the positive benefits for the acquisition.
The question is then posed for the acquirer, how do you integrate the new processes with all their benefits into the existing processes in an environment where the incumbents will be treating both the new company, new processes and new technological with a level of disdain and certainly a high level of suspicion, they are after all companies that have been leading the finance sector for many years
Building a strategic direction lies with the C-Suite
That mission sits squarely at the feet of the C Suite. Their role is to provide strategic direction for the company, understand the opportunities for the business and shape the vision and direction in order for the wonderful people who work for that company to deliver in their specific areas and for these people to see the challenge of change as an opportunity to develop and grow.
This moves the discussion at a C Suite level away from a technological based discussion, away from a place where there might be reticence due to an individual’s relationship with technology to either be part of the discussion or even worse, not commit to their viewpoints as they defer to other who they view as experts. It moves the transformation away from digital to strategic.
But digital transformation is nothing to do with the build and delivery of the systems, it is nothing to do with the evolution of the business processes to work with the new transformed business, but it is everything to do with the strategic path that the company needs to take in this new era.
The fourth industrial revolution, where change is happening at an ever increasing pace, requires the C Suite to have a clear understanding of critical milestones from a business perspective, with diversity of business views based on expertise and experience, to ensure large scale digital transformation programs stay on track to deliver the requirements for the survival, growth and success of their business.
DRIVING DIGITAL: HOW BUILDING SOCIETIES CAN THRIVE IN A NEW DECADE
Simon Healy, Industry Director Financial Services EMEA, Unisys
Building societies have been a feature of the UK’s financial landscape since the late 18th century, and these well-trusted institutions have played a key role in their local communities ever since – particularly when it comes to savings and mortgages. But recent years have presented serious challenges, and not just because of increased competition.
During the 2008 financial crisis, the sector ran into difficulties – often as the result of what proved to be ill-advised business diversification, like venturing into the sub-prime mortgage market, or corporate lending. In 2019, only 43 building societies remained active – and those who have survived have rightfully focused on consolidation, ensuring continuity of service for their valued customers.
Yet, as we enter a new decade, change is in the air. Most building societies are now in a much stronger position, contributing to a general sense that the time is right to start investing in the future. And – as you might imagine, given customer expectations and the focus of modern challenger banks – that future demands a highly digital, personalised approach.
Unfortunately, many building societies still have a reliance on manual processes, and have inherent constraints that limit their ability to innovate. This means that developing and distributing new digital capabilities can be challenging, with many feeling unsure of where to start.
So, what sort of digital offering should building societies spend their time developing – and how should they approach the process?
Belief in building societies: understanding the desire for digital
You only have to look at the rapid uptake of app-based banks like Monzo to understand that digital is desirable. But people aren’t seeking cutting-edge innovation in and of itself, which is good news for building societies. Instead, as Unisys’ recent research shows, customers are primarily motivated by fairly straightforward capabilities.
Our respondents claimed that convenience is one of the key drivers for choosing an account. So, in today’s digital world, it is perhaps no surprise that half say that online opening is important when they’re thinking about a new savings account, and 43% want online account management. A third would like access to a mobile app, and 34% are seeking omni-channel service, so that the service they receive in branch or on the phone is seamlessly integrated with their mobile, tablet or computer experience.
Nearly two in three customers feel that building societies should leverage the opportunities presented by the new Open Banking framework, with a third believing this would positively impact their personal finance management. And although not a traditional market for building societies, 86% of under 35s would be interested in a simple, intuitive digital current account from them.
Interestingly, and perhaps counter-intuitively, Unisys’ research shows that consumers are nearly seven times more likely to open a digital account with a building society than a digital bank, showing there is plenty of appetite – if only building societies are ready to take advantage.
Knowing this is one thing, of course, and building these capabilities in an environment that has traditionally relied on manual processes is quite another. Because while customer appetite for digital is high, delivering on it requires careful planning, not to mention a fundamental shift in mind-set.
Building societies should start by forensically understanding and assessing the actual wants and needs of their target customers. As we’ve already seen, the requirements of most are quite straightforward at a high level – so by taking the time to thoroughly understand digital drivers, building societies can segment customers more effectively, and gain a focused understanding of the features and services most valuable to them.
Once this has been established, they should be prepared to move in small, incremental steps. This might seem counterintuitive for a digital transformation project, especially since innovation teams are usually under pressure to show the ROI of their efforts. But moving too quickly can lead organisations to build capabilities that customers don’t actually want, squandering capital and resources.
A few years ago, after all, it was widely expected that tablets would be the primary method of accessing online banking. Now, it’s generally accepted that mobile-first is the strategy to focus on – and those who invested heavily in an experience optimised for tablet may feel they’ve wasted their resources somewhat. By moving incrementally, building societies will have the freedom to flex and pivot as market shifts like this occur.
A top-down change
This phased approach will also allow building societies to drive innovation across the entire organisation, rather than focusing on one particular area – like customer experience. Given the choice, most would prioritise a customer-facing app over investing in the employee experience. But while this works as a means of getting to market quickly, any digital innovation focused solely on the customer experience will soon fall down if it’s relying on paper-based, clunky or manual processes behind the scenes.
This is also tied to the need for a wider cultural mind-set shift, which necessitates buy-in from the top down. Senior stakeholders play an important role in influencing cultural change and moving transformation forward. And just as importantly, they can also overcome financial objections. The reality is, traditional revenue models aren’t particularly helpful for analysing the value of digital investment. An engaged stakeholder can ensure that the project isn’t derailed by objections on this front.
Innovation is by no means an easy process for building societies. But as we head into a new decade, the need for developing digital capabilities is clear. Consumers are keen to continue supporting their local building societies – but to build on this sentiment, organisations must take the time and the resource to build out their digital offering. If they can do so successfully, they’ll be well placed to thrive on the UK high street for many years to come.
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