Can AI Replace Human Discretion in Executive Decision-Making?

1. Can AI Replace HumanDiscretion? Implications for executive decision-makers Damir Tokic Professor of Finance International University of Monaco October 29, 2018

2. Motivation • My professional background: trading/investing (Series 3, Series 7) • Recently, the largest investment management firm Blackrock announced that it will start replacing human stock pickers with Artificial Intelligence.

3. Motivation • My professional background: trading/investing (Series 3, Series 7). • Recently, the largest investment management firm Blackrock announced that it will start replacing human stock pickers with Artificial Intelligence. • Questions: • Can AI replace human discretion in investing?

4. Motivation • My professional background: trading/investing (Series 3, Series 7). • Recently, the largest investment management firm Blackrock announced that it will start replacing human stock pickers with Artificial Intelligence. • Questions: • Can AI replace human discretion in investing? • If so, can AI replace human discretion in strategic planning?

5. Motivation • My professional background: trading/investing (Series 3, Series 7). • Recently, the largest investment management firm Blackrock announced that it will start replacing human stock pickers with Artificial Intelligence. • Questions: • Can AI replace human discretion in investing? • If so, can AI replace human discretion in strategic planning? • What are the implications for executive decision-makers?

6. Background Investing Active Passive Systematic Discretionary

7. Passive investing and AI • Passive investing – long termstrategy. • Believes in marketefficiency. • Early-version Robo-advisors (AI) used to automatically profile the clients and allocate the funds to appropriateinvestments, as programmed by the human. • Key attraction: cost saving

8. Active Systematic Trading and AI • Active systematictrading – market timing based on technical analysis. • Believes in market inefficiency. • Systematic Robo-traders (AI) used to automatically execute the trading rule, as programmed by the human. • Key attraction: discipline

9. Active Systematic Trading and AI

10. Discretionaryinvesting • Believes markets are inefficient, information is not properly priced. • So, investor can find opportunities to time the market, or find undervalued assets, based on fundamental analysis.

11. Discretionaryinvesting – two approches Discretionary investing Bottoms-up Top-down

12. Discretionaryinvesting – two approches

13. Discretionaryinvesting – top down approach • Also known as Global Macro analysis (systematic risk). • Primarilybased on analysis of: • global monetary policy • global fiscal policy • geopolitical events • Example: George Soros

14. Discretionaryinvesting – bottoms up approach • Also known as Stock Picking. • Primarilybased on fundamentalanalysis (firm-specific risk): • Financial statements • Ratio analysis • Company news • Example: Warren Buffet

15. Stock Picking and AI • Blackrock is attempting to replace human Stock Pickers with the ArtificialIntelligence program (the bottoms-up approach).

16. Stock Picking and AI • Blackrock is attempting to replace human Stock Pickers with the ArtificialIntelligence program (the bottoms-up approach). • Why?

17. Stock Picking and AI • Blackrock is attempting to replace human Stock Pickers with the ArtificialIntelligence program (the bottoms-up approach). • Why? • To lower the fees in the active trading division (and prevent the fund outflows to less profitable divisions). • To improve the performance – AI can outperform the human discretion.

18. Stock Picking and AI • Blackrock is attempting to replace human Stock Pickers with the ArtificialIntelligence program (the bottoms-up approach). • Why? • To lower the fees in the active trading division (and prevent the fund outflows to less profitable divisions). • To improve the performance – AI can outperform the human discretion. • Justification: BIG DATA

19. Stock Picking and Big Data • The AI Stock Picker is essentially a sophisticated Stock Screener. • The AI Stock Picker is able to instantaneously analyse: • Thousands of financial statements and financial ratios. • Published company news • Social media posts • Satellite images • Real time web-page traffic • Other. • Thus, iteliminates the need for human financial analysts (decision-makers).

20. Stock Picking and Big Data • The role of human: • Program the AI Stock Picker with the corporate finance theory and financial analysis. • Program the decision making rule or the parameters for desired stock pick. • Example: AI Powered Equity ETF (AIEQ)

21. Can AI replace the human discretion in top-down approach? • Technically, YES. • The AI program can use econometric methods to extrapolatehistorical data. • Also, the AI program can interpret economic forecastembedded in financial assets (for example yield curve). • The AI program can also use as input the public economic forecast (for example IMF). • In addition, an AI program can use as inputs major predictable trends and themes, such as demographics.

22. Top-down approach and AI (example)

23. Can AI replace the human discretion in top-down approach? • An AI-powered Global Macro fund reduces the need for human economists and statisticians. • The role of the human: • Feed the AI program with econometrics, macroeconomics, and otherPh.D. levelknowledge. • Feed the AI program with data.

24. Strategic management and AI • The strategic management process combines the bottoms-up and the top-down approaches. • Executive decision-makers have to be able to foresee the business cycle (systematic), and the specific business fundamentals (firm specific). • Note: Profitable business opportunity is also due to market inefficiency.

25. Can AI replace executive decision-makers? • YES, an AI-powered Strategic Manager can more efficientlydetect the supply/demand inefficiencieswithin the business cycle context. • Also, iteliminates the agency costs(conflicts between shareholders, managers, and bondholders). • An AI-powered Strategic Manager reduces the need for human executive decision-makers. • The role of the human: • Feed the AI program with the knowledge and data. • Implement the strategy.

26. Strategic planning and AI • Capital budgetingexamples where an AI program could replace the human discretion: • New productdevelopment • New markets • New plant/factory • Machinery replacement • Thesedecisions also affect: • Dividend policy • Capital structure

27. The rise of Robo-Bosses • Early-version Robo-advisors, were designed to improveefficiency, lower costs, and implement discipline. • Human still retained the decision-making power. • The new-versions of the AI powered Robo-advisors are designed to improve and possibly replace human decision-making. • The role of human is reduced to feeding the AI program with data and knowledge.

28. Step forward: the rise of Robo-Policymakers • An ArtificialIntelligence Powered Central-Banker? • Central bankers use the same fundamental data, macroeconomictheories, and econometric models to set the monetary policy. • 100% guaranteedCentralBank independence?

29. Imagine this:

30. Critical Analysis • An AI-powered decision-maker is essentiallya Rational Arbitrageur. (In investing, a rational arbitrageurestimates the intrinsic value and buys/sells when the market value differs from the intrinsic value, and thus, ensures Market Efficiency.)

31. Critical Analysis • Thus, the systematic use the AI-powered decision-makers, would make all markets completelyefficient. • There would be no trading opportunities. • There would be no profitable business opportunities.

32. Elements that will prevent the rise of Robo decision-makers: • Legislation and lobbying • Unpredictablegeopolitics • Corruption • Justice system • The rise of Robo-predators (fake data manufacturers, hackers)

33. Conclusion • The machine can be fed with all possible human knowledge and all available data, but the machine can never consistently model human imperfections and inefficiencies. • Thus, as long as the human imperfections are preserved, an AI-powered machine will not be able to replace the Human Discretion.