Can learning help you beat the markets?
Moore's Law (named after Intel co-founder Gordon Moore in 1965) is one of those amazing rules that seems to defy logic. Essentially the rule states that computers become twice as powerful and half the price every year.
The original observation noted that every year since circuit boards were invented the number of transistors per square inch on a circuit board had doubled. This increasing power led to Moore’s Second Law which notes that as the cost of computer power falls, the cost to producers rises as they strive to fulfil Moore’s law. In other words the pressure on R&D, manufacturing and testing rises in line with speed and falling consumer prices.
The last implication to consider is that as technology speeds up and becomes capable of achieving more results in less time, the users that are benefiting from this power must find ways to keep up with the power on offer! This can, and often does, lead to people having a feeling of being overwhelmed at the pace of change.
One area that increasing computing power has been able to drive forwards is Artificial Intelligence (AI). This is where computers are able to undertake tasks that require high level cognition. The term AI is actually used to cover a wide range of 'intelligence' and is probably most familiar in the guise of such areas as online Chess or handwriting recognition or voice controlled applications such as Siri, Google Now or Microsoft Cortana.
AI also plays an important role in the economic hypothesis of 'efficient market theory'. This concept (developed in 1965 by Nobel Laureate Eugene Fama) proposes that prices of stocks reflect all of the available information and as such investors can’t beat market indexes by stock picking. There is a problem with this concept of course: people aren’t perfect! Therefore markets won’t have the complete information...
However, what if we remove people from the equation and replace them with AI? As the use of algorithms and AI based trading increases, so the markets become more efficient. That’s the theory anyway.
So, do you believe that its impossible to beat the market because prices will always reflect all available information?
Investors at the Renaissance Hedge Fund (RenTec)(please watch the excellent TED talk with Renaissance founder Jim Simons below) would certainly disagree with that supposition. They would argue that 'value investing' is possible and that computers can help their cause by accelerating learning and uncovering imperfections in the markets.
With average annual returns exceeding 35% after fees (they have the highest fees in the market of 5 and 44 - vs the industry norm of 2 and 20 (i.e., 2% management fee and 20% share of profits)) the managers are well qualified to show that there is always ‘another way’ if you’re willing to do the research.
As a last thought, there is a quote from Warren Buffett that resonates on this topic, “Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.”