When we first put the computer on the air, we asked it what it wanted to buy and we couldn’t wait to see what it reached for. It said, “Treasury bills and cash.” We couldn’t get it to buy anything. So we checked out the program again, and while we were checking out the program, the markets went down. Then we asked it again. The computer insisted on staying in cash. The market went down some more. We begged it to buy something. “There must be ONE stock somewhere that’s a buy,” we said. You see, even computer people are victims of these old atavistic instincts from the pre-computer days. The computer just folded its arms. It wouldn’t buy anything. Then, just when we were worried that it would never buy anything, right at the bottom it stepped in and started buying. The market started going up, and the computer kept on buying. Pretty soon the computer was fully invested and the market was still going up.
“What did it do then?” I asked. “The market was still going up,” Irwin said, “and then one day it came AND ASKED US FOR MARGIN. It wanted to keep buying. So we gave it margin. After the market went up some more it sold out of a bit, but came back to being fully invested; right now it has still got buying power.” “Irwin,” I said, “tell the truth now. If all these computers go on air, as you say, does an individual investor have a chance?” “There’s always luck,” Irwin said. “Luck — which is to say a serial run of random numbers – can happen any time. And the computer is out for really aggressive performance. An individual, with a longer time horizon, might be able to do passably.”
— Adam Smith, “The Money Game” (1968)
We have used the aforementioned quip from our departed friend Jerry Goodman (aka Adam Smith) a number of times over the past 47 years because of the wisdom it imparts. We dredged it up this morning after reading an article in Barron’s over the weekend titled, “Man and Machine,” which was an interview with Omar Selim, the CEO of Arabesque Asset Management, a quantitative and sustainable investment management firm. In a quantitative investment fund, customized computer models are built using software programs to determine the fund’s investments. Over the past number of years there has been an increasing move by firms to build investment management software and to turn over the management of money to the “machines.” We remember the first quantitative investor, namely Dean Lebaron, who founded Batterymarch in 1969. Dean hired computer “rocket scientists” from NASA to build the models that guided the investments of Batterymarch, and it worked. However, Dean made some VERY key macro decisions on what said computers were supposed to look for in an investment. For example, in the early 1980s Dean “told” his computers to stop looking for investments in “hard assets” and switch to looking for companies that play to financial investments. That was a pretty key macro shift as short-term interest rates were set to collapse, causing financial assets to soar. So it begs the questions, “Do machines, in and of themselves, really have intelligence?” We think the answer is no, although they are certainly a great tool in aiding in the investment process.