Wall St. stock pickers shift to machines

Wall Street’s shift from man to machine is moving deeper into the realm of stock picking, a profession once viewed as more art than science.

But powerful computers that can crunch data cheaper and faster than humans are spurring the nation’s biggest money management firm to rely more on machines to help pick winning stocks and build more profitable portfolios. And all at a price investors won’t balk at.

It is the latest salvo in the war between “actively managed” funds, or those run by portfolio managers who use their own brains, investment strategy and company analysis to decide which shares to buy or sell, and “passive” funds that simply mimic the performance of a stock index or base buy-and-sell decisions on rules-driven computer algorithms.

The evolution of funds goes like this: First there was the star mutual fund manager. Then came low-cost index funds whose goal was to match the  returns of indexes like the Standard & Poor’s 500. Next came cheap ETFs, or funds that trade like stocks.

The latest shift in the cost-conscious, performance-driven money management industry is a move to place more stock picking responsibility on computers. BlackRock, the world’s biggest money manager with $5.1 billion in assets under management, said recently it would make changes to its actively-managed fund business. They include the launch of nine funds giving investors access to a team of investment pros that incorporate big data analysis and computer algorithms into their stock selection process -- and with lower fees.

Mark Wiseman, global head of active equities at BlackRock, said the company is “harnessing the power of ‘human and machine.’” The company's changes will result in roughly $30 million a year in annualized savings to clients, the firm said.

The decision is due to two key trends, says Dan Culloton, director of equity manager research at fund tracker Morningstar.

“It’s cost and performance,” he says. Fees for funds run by managers are higher than those of index funds and ETFs. The average annual expense ratio for all actively managed funds is 1.2%, Morningstar says, more than double the average 0.51% expense ratio for passive funds that track the S&P 500 and far more pricey than the 0.09% charged for Schwab's S&P 500 index fund and the SPDR S&P 500 ETF.

Higher fees bite into long-term returns. A $100,000 investment with a 4% annual rate of return and an ongoing fee of 0.25% would be worth nearly $210,000 in 20 years, according to the Securities and Exchange Commission’s Office of Investor Education and Advocacy. By contrast, if the investor paid 1% each year in fees, the portfolio would be worth about $180,000, or $30,000 less, two decades later.

What’s more, returns from funds run by stock pickers have badly lagged the benchmark indexes they are measured against for years. Nearly 70% of mutual fund managers that run U.S. equity funds did not beat their benchmark in the past year, and that number rises to more than 83% in the past five years, Morningstar data show. BlackRock has not been immune to the difficulty faced by other actively managed funds. “They’ve long struggled to build a competitive lineup of equity funds,” Culloton says.

Traditional fund managers, Culloton explains, incorporate technology into their investment process, but most often come up with stock ideas by dialing into earnings calls led by executives, or reading their transcripts. They also scour regulatory filings  or meet with a company’s suppliers or customers.

The old-school fund manager was more like “a green eyeshade-wearing accountant sitting at a desk crunching numbers or the private investigator out gathering information in order to come up with a better understanding of a stock, or a better piece of information that others on Wall Street don’t see,” Culloton says.

By contrast, he says, computer-driven investment methods “sweep in everything” to improve stock-picking performance.

They use “satellite imagery”  to see how many shoppers are parked outside stores or how many ships are squeezing into ports, or how full grain silos or gas storage tanks are. They use “electronic scraping” techniques to search through transcripts of corporate conference calls for words that denote positive or negative outlooks. They can plug in social media.

If the use of technology in the stock-picking process grows, as many analysts expect, it could  force down the fees investors pay for actively managed funds, says Nathan Flanders, managing director of non-bank financial institutions at Fitch Ratings. “That is certainly a win for investors.”

And while BlackRock is an early leader in that area, Neal Epstein, VP and senior credit officer at Moody’s,  expects "other firms will feel pressure to follow them."

Analysts stress that human money managers are not in danger of extinction. But they say it is likely that more stock funds in the future will be hybrid in nature, as investment firms merge the best of both computer-driven strategies and human portfolio.

The marriage of computer-driven strategies with more traditionally run mutual funds could expand the list of funds investors can choose from.