AI - passive active, or active passive?

[GJHarney]

I can't work out whether this new 'active' fund run by 'artificial intelligence' is active at all, surely it is more like a 'smart beta' passive?

http://www.telegraph.co.uk/investing/funds/invest-fund-manager-has-zero-emotion/?WT.mc_id=e_DM474154&WT.tsrc=email&etype=Edi_Inv_New&utm_source=email&utm_medium=Edi_Inv_New_2017_06_22&utm_campaign=DM474154

http://citywire.co.uk/wealth-manager/news/sanlam-puts-ai-in-charge-of-balanced-fund/a1025432

[LongbeardRanger]

Personally I think the concept of "smart beta" is utter nonsense. In my mind the distinction is really simple. A passive fund invests in the entire index by reference to market capitalisation - taking a proportionate stake in each index constituent.

Anything else - from smart beta to traditional stock picking - is an active fund.

The specifics of what this fund is trying to achieve seem quite complex to me - so for that reason it's an easy "no" from me.

[Alaric]

A passive fund invests in the entire index by reference to market capitalisation - taking a proportionate stake in each index constituent.

Anything else - from smart beta to traditional stock picking - is an active fund.

Be careful with that definition. Does choosing to track the FTSE 100 rather than the All Share make the 100 Tracker an active fund?

[Urbandreamer]

In my mind the distinction is really simple. A passive fund invests in the entire index by reference to market capitalisation - taking a proportionate stake in each index constituent.

Anything else - from smart beta to traditional stock picking - is an active fund.

The distinction is remarkably woolly. I see where you are coming from, but as said an active choice has been made as to which index to pick.

Put another way, how is investing in an index, whose components change over time, differ from investing in a "Dogs of the Dow" fund, whose components change every year?

If the approach can be mechanised, does it become passive? Or is a given approach active because, while mechanical, the rules differ from the simple market cap used in the likes of the FTSE100 or FTSE250?

[GJHarney]

Thanks for the replies, I'm glad I'm not the only one who is a bit confuddled by the terminology here!

In relation to 'smart beta' I'm not keen on the name myself (selective index would have perhaps have been better for most of them?), but there is a difference between them and general index trackers in my view. E.g., I hold some of the SPDR 'dividend aristocrat' ETF funds that select holdings in a given geography on the basis of both current dividend level and payment history, there is nothing 'active' around them despite the selective way holdings are chosen from a predefined formula, but they seem little different in theory from what we are told is an 'active' fund run by 'AI' in the case of the new fund in my original post (in fact the only difference it appears to me is that the 'AI' fund has twice the charges of an average 'smart beta' fund).

Perhaps this is all just a question of advertising flannel given the fund in question is from a 'wealth manager'?

[OhNoNotimAgain]

A simple rule of thumb is if that Citywire cover it then it is an active fund.

[hiriskpaul]

In my mind the distinction is really simple. A passive fund invests in the entire index by reference to market capitalisation - taking a proportionate stake in each index constituent.

Anything else - from smart beta to traditional stock picking - is an active fund.

The distinction is remarkably woolly. I see where you are coming from, but as said an active choice has been made as to which index to pick.

Put another way, how is investing in an index, whose components change over time, differ from investing in a "Dogs of the Dow" fund, whose components change every year?

If the approach can be mechanised, does it become passive? Or is a given approach active because, while mechanical, the rules differ from the simple market cap used in the likes of the FTSE100 or FTSE250?

To paraphrase Animal Farm, Some passives are more passive than others.

I mostly agree with LongbeardRanger. No trading is done within a cap weighted fund unless a company leaves or enters the index, or the cap weight changes due to a corporate action. To me the word "passive" implies minimal trading, not any amount of trading as long as it is rules based. The closest match to "passive", but still not completely passive in the sense of no trading at all, is a cap weighted fund. So if anything is deserving of the title "passive", a cap weighted fund is. There are momentum ETFs out there, calling them passive just seems absurd.

An active choice has to be made by an investor over which index(es) to track, but that is of no relevance. Trading in SDY is incredibly active, but SDY is still a passive fund (fairly passive fund).

[OhNoNotimAgain]

Mkt cap trackers are active users of derivatives. What weight do derivatives have in the index?
None.
So don't kid yourselves that mkt cap tracking is entirley passive.

About 3% of the mkt is subject to corporate actions every year so portfolio turnover, even for the least active rules-based fund, is going to be at least 3%. Add in trading to deal with inflows and outflows then any fund with a PTR in low single figures is doing well.

[Lootman]

Mkt cap trackers are active users of derivatives. What weight do derivatives have in the index?
None. So don't kid yourselves that mkt cap tracking is entirely passive.

You are overstating your case. It is true that some trackers use derivatives, but many do not and so using that to criticise them all is a little selective.

More generally you will find that the major market trackers, whether open-ended or ETFs, physically hold the underlying components of the index. Derivatives tend to be used for the more marginal products and can make sense in certain situations, such as where it is difficult to hold the underlying, or where the fund is invested in things like commodities where holding the physical doesn't make much sense. Or in exchange-traded notes which are really not funds at all but rather credit obligations.

About 3% of the mkt is subject to corporate actions every year so portfolio turnover, even for the least active rules-based fund, is going to be at least 3%. Add in trading to deal with inflows and outflows then any fund with a PTR in low single figures is doing well.

Again, that is very selective. Most of the large providers of trackers run many active funds as well. What this means is that much of their trading can be handled by "internal cross trades". As an example, share X may be sold by a tracker if X drops out of the index, but an active fund from that same provider may be buying X. This means that the trade can be done at an effective cost of zero - the holding isn't really sold but rather internally transferred.

When I worked for a very large fund manager, about 80% to 90% of our trading was via internal crosses.

Finally, I think the active versus passive debate is clouded by the use of those terms. A better distinction, in my view, is between rules-based and manager-based. In the latter case, a manager or committee makes buy and sell decisions based on fundamental and technical analyses of the underlying. For rules-based investing, the role of a manager is diminished or extinguished - once you have defined the rules, the fund runs itself.

Whether that rule is based on a market-cap index or some other rule is not that significant. What ETFs, in particular, allow you is the ability to decide what rules you like and then there is a vehicle for implementing those rules. And it seems that many investors feel more comfortable identifying themes and rules they would like to follow, than poring over balance sheets or trusting those who do. The focus is on an investment idea or belief.

[LooseCannon101]

I have read the information given in the links and come to a few conclusions.

The phrase 'Artificial Intelligence' is being used to sell this fund. I assume a considerable amount of money has been spent on advertising and installation of 600+ computers, and so a good story is imperative to make it a profitable venture.

Of course, their marketing department is telling the truth and nothing but the truth like all the financial product providers!

As regards whether a fund is passive or active, I think it is not black and white. A so-called smart-beta fund is somewhere in the middle, and using derivatives further complicates the issue as highly risky strategies can be employed under the guise of 'taking out insurance'.