In the world of finance, managing investment portfolios bears a striking resemblance to managing one’s health. Often, individuals discover their financial ailments when it’s too late, mirroring the reluctance many exhibit towards seeking medical help until a condition becomes debilitatingly severe.
Just as preventative healthcare emphasises the importance of proactive measures to maintain well-being, the realm of investment portfolios benefits immensely from automated health checks, carried out by artificial intelligence (AI).
Traditionally, risk management involved laboriously collecting data, manually entering it into cumbersome Excel spreadsheets, often littered with formula errors, and analysing it for potential pitfalls.
This process was time-consuming, prone to human error, and often hindered by data quality issues. The limitations of this historical approach becomes increasingly evident in the face of rapidly changing, volatile market conditions.
In response to these challenges, modern technological solutions are emerging, transforming the landscape of portfolio management. Automated health checks leverage a moving window of data, offering a dynamic and real-time evaluation of the portfolio’s condition. This approach brings several key benefits to the forefront:
- Behavioural Analysis
AI can conduct a behavioural analysis for a given set of market conditions by partitioning historical performance into regimes and determining the expected behaviour in those conditions. This enables a comparison of current performance against expected behaviour in the current set of market conditions, facilitating the detection of anomalies.
- Holding Drifts
Utilising back-tests of the latest rebalance weights, automated health checks can determine the maximum and minimum weight-drifts for every security in a portfolio. This information is crucial in evaluating the current drifts against the established range, alerting investors to potential deviations.
- Stress Tests
Historical portfolio performance is analysed, and future portfolio performance simulated under stressed market conditions, to determine the maximum expected drawdown. This evaluation compares the current portfolio return to the expectation, providing insights into potential losses and prompting proactive measures.
- Returns, Sharpe Ratio, Sortino Ratio, and Volatility metrics
Historical portfolio performance is used to establish the maximum and minimum expected range for key metrics like returns, Sharpe Ratio, Sortino Ratio, and volatility. Current values are then compared to this range, helping investors assess the portfolio’s health and adherence to expected performance.
- Tracking Error
In portfolios tracking against a benchmark, automated health checks calculate a maximum and minimum tracking error. This information, derived from historical data, allows investors to evaluate the current tracking error against the anticipated range, ensuring alignment with benchmark goals.
One of the advantages of automated health checks is the ability to provide real-time notifications to investors. These notifications, often delivered through user-friendly apps leveraging interactions with large language models, explain why a portfolio may be deemed unhealthy and can even suggest remedial actions.
Whether it’s a significant deviation from historical patterns, unexpected drifts in holdings that require a rebalance, or heightened risk levels requiring an urgent change in portfolio shape, investors are promptly informed and equipped with actionable insights to safeguard their portfolios.
In the rapidly evolving landscape of investment management, automated health checks powered by AI and language models will soon become indispensable tools.
These systems offer a proactive approach to risk management by encouraging timely decision-making, helping investors to stay on track with their investments and meet their long-term goals. They help to minimise emotional and impulsive decision-making and help prevent catastrophic (heart-attack inducing) portfolio losses.
So lace up your portfolio’s running shoes and get ready to put a few miles in the bank of endurance.
Article featured in Professional Adviser, 3 October 2024
Real-time evaluation: Let AI be your portfolio’s personal trainer (professionaladviser.com)
