The Revolution of Active Management Through AI: A Paradigm Shift

This article is extracted from “Ensemble Active Management – AI’s Transformation of Active Management” and “Methodology, Design, and Data Integrity Validation Study of Turing Technology’s 2024 Ensemble Active Management” white paper.

Several studies have analyzed the performance of active US equity managers against index funds and ETFs. The consensus is clear: active managers struggle to outperform benchmarks. In addition, active management incurs higher costs than passive investing, leading to net outflows from actively managed funds. This trend has persisted for over 18 years, amounting to more than $2.5 trillion in outflows by the end of 2023, according to Morningstar Direct.

For active management to regain its edge, it needs more than incremental improvements. A transformative shift driven by new technologies and methodologies is essential to bridge the performance gap.

Enter Ensemble Active Management (EAM), a cutting-edge approach leveraging advanced technologies and a multi-manager model to redefine the active management landscape. EAM is not just a concept; it has been operational since 2018, with a track record of successful portfolios spanning two to five years.

This paper dives into the mechanics of EAM and highlights three essential pillars validating EAM’s performance and potential for the future.

By the end of 2023, live EAM portfolios were positioned as the most robust lineup of actively managed US equity portfolios in the market.

The Essence of Ensemble Active Management

EAM aims to capture significant alpha to surpass traditional active and passive management strategies. Through the application of Ensemble Methods, EAM utilizes a multi-expert system to enhance predictive algorithms in portfolio management. By consolidating the insights of multiple models into a stronger predictive engine, Ensemble Methods epitomize the concept of collective wisdom.

EAM’s innovation lies in utilizing a multi-manager platform rather than enhancing an individual manager’s capabilities. By integrating a variety of predictive engines extracted from actively managed funds, EAM constructs a diversified portfolio of up to 50 stocks, devoid of derivatives or leverage but fully aligned with benchmark holdings.

To create EAM portfolios, quality mutual funds are carefully selected, and their predictive engines are harnessed through a mathematical engine powered by Ensemble Methods. This meticulous process ensures that EAM embodies the collaborative wisdom of a dozen top-quality managers.

Unleashing the Power of Ensemble Methods

Ensemble Methods stand at the forefront of generating new sources of alpha. Hailed as the most influential development in Data Mining and Machine Learning in recent years, Ensemble Methods have found application in various real-world challenges, from facial recognition to cyber threat detection. The power lies in integrating multiple predictive models to create a more reliable and accurate predictive engine.

In-Depth Analysis: 2024 EAM White Paper

The monumental study detailed in “Ensemble Active Management – AI’s Transformation of Active Management” breaks new ground in measuring EAM’s potential. With 60,000 EAM portfolios constructed and evaluated, using 333 underlying funds from over 140 fund companies, the study encompasses a significant portion of the active US equity universe. The results, validated through an independent academic review, demonstrate EAM’s prowess in outperforming benchmarks across various style boxes.

• 60,000 portfolios analyzed for performance over a 6-year period
• Utilized data from 333 funds representing over $3 trillion in AUM
• Covered a broad range of investment styles

The detailed analysis provides compelling evidence of EAM’s superiority, with an expected performance benefit of 400 to 500 bps compared to industry benchmarks. The rigorous methodology and statistical significance of the findings validate EAM’s transformative impact on the active management landscape.

Performance Evaluation: EAM vs. Benchmark

The performance comparison of EAM portfolios against standard benchmarks unveils a consistent pattern of success rates exceeding expectations. Across all evaluated style boxes, EAM portfolios displayed a remarkable success rate, outperforming benchmarks and delivering robust annual excess returns.

EAM Success Rates vs. Benchmark, Average of All Style Boxes

Notably, EAM succeeded across all style boxes, consistently surpassing benchmarks to deliver impressive excess returns. The relentless pursuit of performance excellence across various investment styles underscores EAM’s adaptability and resilience in today’s dynamic market environment. EAM’s systematic approach leverages cutting-edge technologies and collaborative expertise to outshine traditional active management strategies.

Independent Validation and Review

David Goldsman, a distinguished academic from the Georgia Institute of Technology, lauded EAM’s methodology and precision in generating substantial alpha. The comprehensive review validated EAM’s performance benefits, highlighting its capacity to elevate active management practices and yield significant excess returns.

The exemplary performance of EAM portfolios, coupled with a meticulous review process, attests to the transformative power of AI in reshaping active management strategies and delivering superior results for investors.

Harnessing the Potential of Fees

EAM portfolios exhibit strength and resilience even when subjected to maximum fees, emphasizing their ability to outperform benchmarks consistently. The robust success rates highlight EAM’s competitive edge and adaptability in various market conditions, reinforcing their value proposition to investors seeking superior performance.

EAM’s Market Impact: A Glimpse into the Future

Through a rigorous performance evaluation, EAM portfolios have established a formidable track record of success, consistently outperforming benchmarks and delivering exceptional excess returns. The strategic alignment with benchmark holdings and diversified stock selection underscore EAM’s potential to redefine the landscape of active management, setting a new standard for performance excellence.

Epilogue

The era of underperformance in active management has reached a turning point with the emergence of EAM and its transformative impact on industry standards.