Steven Brod, CEO and CIO of Crystal Capital Partners, LLC, a portfolio-centric alternative investment platform for financial advisors.
Artificial intelligence (AI) has moved from the back office into the heart of investment decision-making. From conversations with many of the world’s top hedge funds and private markets managers, I know that they are increasingly using AI to translate novel signals into investable sources of alpha. For financial advisors, understanding how managers are deploying AI in the front office, where investment ideas are formed, portfolios are constructed and clients are advised, is essential for discerning which managers are leveraging innovation most effectively. In this way, advisors can position themselves to safeguard and grow client assets.
There have been several stages in the evolution of managers using AI in the front office. In the 2000s and 2010s, quantitative pioneers were among the first to use sophisticated statistical modeling and machine learning techniques. The global financial crisis drove demand for better risk modeling and scenario planning. Firms expanded AI use into long-term portfolio optimization as data and computing costs improved (e.g., notable asset managers built AI-driven funds aiming to replicate every stage of the investment process using machine learning).
In the 2020s, adoption of AI entered the mainstream, spreading beyond specialist quant funds to mainstream asset managers and banks. For example, JPMorgan’s AI-powered trading system uses reinforcement learning to execute trades, adjusting its strategy based on market conditions and historical data, as reported by Pymnts (paywall).
In hedge funds, use cases for AI include idea generation and research, portfolio construction and risk scenario planning, and trade execution and cost control. AI can help firms scan large quantities of data and lengthy documents to identify patterns before competitors. Some portfolio managers are now using Bloomberg Terminal’s new AI-powered tools to help them filter through documents.
By using machine learning-driven models, firms can better prepare for macroeconomic shocks, sentiment shifts and volatility, as they can run a greater number of more in-depth analyses with greater efficiency. Quantitative hedge funds can also potentially deliver higher net performance by using AI-driven trading execution. They can optimize the timing, size and venues of trades to reduce slippage and costs, thereby minimizing expected return losses in execution.
In private markets, use cases can be expanded to help firms assess deals, speed up the due diligence process and model valuations and exit strategies. AI can help portfolio managers assess targets, wading through data to find undervalued companies. Some managers have embraced this integration by deploying teams to support the firm’s entire investment life cycle, from identifying opportunities to creating value across portfolio companies.
Automated systems can help private market firms evaluate contracts, analyze the competitive landscape and flag anomalies in company data. Generative AI investment analyst models are being used to comb through and analyze large volumes of data and customer documentation, as reported by the Wall Street Journal. Predictive analytics can also help firms assess what to do at the end of the portfolio company’s life cycle, looking into exit possibilities and accurate pricing.
However, advisors need to be aware that there are meaningful practical limits to turning AI into alpha in the front office. Data quality and bias can skew signals, and unclear data rights can stop models from being used. Backtests that look strong often fade in live trading once costs and slippage are included. Complex models are hard to explain, and without clear documentation, it can be very difficult for advisors to separate what the model added from the portfolio manager’s judgment.
To ensure they are fully protecting client portfolios, advisors should be asking every manager for an “AI evidence pack,” covering how AI is integrated into their investment process and risk management, how they measure and evidence AI’s contribution to returns (if they are claiming it is an alpha driver), and whether it has replaced or enhanced a human’s role. They should also be asking for evidence of results attributable to AI, and for answers on how the firm approves AI changes, as well as the governance and kill-switch process for integrating AI into their investment strategy.
By staying practically fluent in how asset managers deploy AI, financial advisors can enhance due diligence, safeguard fiduciary duty and deliver more consistent outcomes for clients by prioritizing live, net-of-cost results over backtests and unprovable AI-washing anecdotes.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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