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The Investment Service Using AI to Help Fund Managers Make More Lucrative Decisions

Clare Flynn Levy, founder and CEO of Essentia Analytics, discusses how COVID is taking Essentia from a “nice-to-have product to being a must-have product” for asset managers.

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COVID has changed a lot about the world this year, but one positive we’ve seen is how businesses, including asset managers, are using this time to reevaluate their strategies. Essentia Analytics is here to help fund managers break old habits and establish new ones in order to improve their performance by utilizing data and AI. Founded by Clare Flynn Levy, a former, highly acclaimed fund manager and hedge fund owner specializing in tech stocks, who after 9/11 started asking questions about how she could improve her work.

“It was a very different market for a good couple of years there than the one that preceded it,” Flynn Levy says. “What I knew how to do as a fund manager stopped working. It wasn’t making money anymore. And so I had to take a step back and say, ‘Alright, what is it that I’m doing that is helping and what is it that I’m doing that is not helping because I have control over my own energy and that’s kind of it.’”

Clare Flynn Levy

It was in asking herself these questions and questions like it that led her to founding Essentia to help other investors and fund managers achieve better performance through better discipline.

“What we do is we say, let’s look at all the different types of decisions you make, you know as an investor, you buy a stock, you’re making a decision to pick that stock and not a different stock—that’s a picking decision; you’re making a decision when to buy it—that’s an entry timing decision; you’re making a decision about how much to buy—that’s a sizing decision; you might take multiple days to get up to your full size position—that’s a scaling decision, and then you have adding, trimming, scaling out and exit timing decisions,” she says. “So, let’s look at each one of these types of decisions. And then, let’s look at all the different characteristics of the stocks in question that might be relevant, like what sector is it in, what country, what’s the price doing at the time that you made the decision, how big of a position was this for you, how long have you held on to it? These are all things that we know from experience can have a bearing on the quality of your decision. And then we put all of that into a machine learning hopper and say, ‘Alright, machine learning, you cut to the chase—what’s the answer to the question? Where’s there a statistically significant pattern in this person’s trimming decisions, and where is there a statistically significant pattern in their adding decisions?’ And out the other end comes these insights. And so, we’ve used AI…in a very specific part of what we’re doing as opposed to saying AI’s going to solve this problem because what humans are good for, still, is judgment calls and critical thinking and the ability to know what question to ask in the first place.”

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Flynn Levy explains that on the spectrum of artificial intelligence (AI), there’s smart AI like driverless cars and then there’s more baseline assisted intelligence, like the oil light in your car turning on when oil is low. She says Essentia’s programming falls essentially midline on that spectrum with augmented intelligence, which she equates is closer to the dinging noise you’d hear in a car if you’re beginning to swerve into the other lane.

“It’s still leaving the power of decision-making in the hands of the driver.” And that’s a very important aspect of the way Essentia Analytics uses AI. The ability to decide always remains in the driver’s hands, not with the computer.

“There’s a lot, a lot, a lot of data out there that analysts who would be working for fund managers would be trying to crunch themselves, and AI can help them not have to do the crunching and just know what question to ask and then figure out what you’re going to do with the answer to that question,” she says.

It’s clear that Flynn Levy sees AI adding value to the asset management industry, but the aspect she’s most interested in seeing evolve is the user experience.

“The part that I get the most excited about is around the user experience,” she says. “A lot of banks and wealth managers have invested a lot of money in fintech and have come up with new applications and new types of accounts and things like that. And it’s early days, but AI stands to help these firms make their customers happier by learning what the customer wants and likes and does and then catering to that in the same way that you can see AI is what sits behind all those Facebook algorithms that cause you to get ads for, you know, whatever it is and you think, ‘Oh, I was just looking for that.’ On the one hand, you could be scared of that and think that’s evil. On the other hand, you could say, ‘Well actually, I wanted that, so I’m glad that it found me.’”

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When it comes down to it, Essentia is all about behavioral alpha and supplying analytics to help firms peg the skills and biases of their fund managers.

“It’s the alpha that you can earn by getting out of your own way and not making the same mistakes over and over again that humans make because we’re biased and too human,” she says. “It’s about seeing yourself—about knowing thyself, if you like—seeing yourself in the mirror and recognizing what you see, and thinking, ‘Oh, gosh, I can see in my data that I have a tendency to hold on to my losers for too long. And I know that that is a natural bias called loss aversion, and it’s just what people do so I’m not going to take it personally. However, I can stop myself from doing that.’ And what Essentia does is help people stop themselves from doing that by analyzing their portfolios and then sending them what we call nudges that are texts or emails that say, ‘Heads up, this position in your portfolio needs your attention because you’re doing it again. You know, that pattern that you said of holding on to your losers for too long or whatever, it looks like that may be happening again.’…Not telling you what you have to do, just saying concentrate a little bit of energy here and apply your brain here. And what happens when you do that is that people will more often than not make a good decision.”

“You know, it’s very easy to get yourself into a situation where you’re not being productive anymore. And so, if at that moment, a piece of technology can give you a little tap on the shoulder and say, ‘OK, there was a moment where you need to be objective. Here are three questions that you said you want me to ask you the next time you were in this situation.’ You decide what the questions are, but it’s making it possible for the fund manager to talk to themself, you know, self is talking to them now and saying, ‘Alright, you said, would you be a buyer today?’ And for fund managers, it’s like he knows that if the answer to that is no, then why are you not a seller? It’s about empowering them to follow the process that they want to follow but at the moment when historically they’ve not been following it,” Flynn Levy says. “And that results in 150 basis points of average performance improvement. That’s behavioral alpha and the alpha they could get from knowing themselves better, and then stopping themselves from making the same mistakes over and over again.”

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And this kind of technology could help to not only improve fund managers’ performances, but it very well could be the way of the future—especially with the changes COVID has brought about.

“We’re at the stage where we’re going from being a nice-to-have product to being a must-have product, and we can see that tipping point. You know, it’s coming. I [can] see it there at the end of the tunnel, where you know we’ve been doing this for seven years, so it’s not always been visible in the distance,” she says. “There was always this theoretical idea that that would someday be the case, but thanks, in some part I suppose, to COVID, asset managers who were already under-the-gun around performance and really being told by investors, ‘you better prove that you’re worth these fees I’m paying you because otherwise I’m going to stop paying you them and I’m going to buy an index fund.’ Now [with] COVID, it threw everybody for a loop, and it’s causing them to do massive briefings of their own structures, you know, what products they offer, who runs them, all that kind of stuff. And a new generation of leadership is being put in place in a lot of firms, which is good news for us because the younger generation, the sort of next generation fund managers who are in their 30s, let’s say, they totally get it, and they see what we do, and they’re like why would anyone not do that? You know, we have to have this…These companies are making strategic decisions that are playing to our favor, that are making what we do become a must-have. And if the world could just get back to a point where people feel like they can make their own forecasts reliably, then they can make decisions and then this all starts to result in very high growth for us. So that’s what we’re playing for, that’s been the dream this whole time, and I can see it’s not that far away.”

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