Change is considered the only constant in investing – is it?

Published in The Sunday Times on 13th October 2024.

The winner of the 2024 Olympic marathon in Paris ran it in two hours and six minutes. Had he been racing against the winner of the 1904 Olympic marathon, he would have won by nearly an hour and a half. In 1954, Sir Roger Bannister became the first man to run under four minutes in the mile. 82 college kids did that in the 2021/22 track and field season. In 1972, Eddy Merckx set the record for the longest distance cycled in one hour at just over 30 miles. In 1996, a cyclist went nearly five miles farther than Eddy Merckx. 

There’s more to this than simply human progress

The 1904 Olympic marathon winner, Thomas Hicks, was drinking rat poison, brandy, and raw eggs while he ran along the course. Roger Bannister ran on soft cinders that stole far more energy from his legs than the synthetic tracks of today. In 2000, the International Cycling Union decreed that anyone who wanted to hold the cycling record had to do so with the same equipment that Eddy Merckx used in 1972. Where does the record stand today? A mere 883 feet farther than Merckx cycled more than four decades ago. Essentially the vast bulk of the improvement in this record was due to technology.

According to author David Epstein, improvements in technology isn’t the only reason behind the progression. Innovation in sports training and the spread of sport to new populations around the world, have conspired to make athletes stronger, faster, and better than ever. 

What’s more, the results have become more uniform. Absolute results (winning times) have improved, and relative results (gaps between best and worst finishers) have narrowed. The time gap between 1st and 20th place in the Olympic marathon in Paris was under 4 minutes. A hundred years ago that gap was 33 minutes. In other words, today’s best marathoner is better than ever, but only a little faster than the competition.

The relevance of this for investing

I’m struck by the relevance of this to the profession of investing. Investors have also become more skilful as a collective group over time. Information from companies, analysts, and the media has never been so abundant. Advances in technology, access to data and computing power make it far easier to process this information and distil useful intelligence. 

And much like sport, the profession has attracted hordes. The potential rewards of market-beating investment results are so high that many of the best and brightest are attracted to the investment business. With so many capable, well-informed, and highly incentivised investors trading each day, market prices quickly reflect all known information. Results for active managers have followed a similar path to Olympic marathon runners in that they are much more uniform – there’s little that separates the best from the worst. 

We may be on the cusp of significant change

If we are to believe the artificial intelligence hype, we are on the cusp of even greater technological change. It’s important to ask how this might impact financial markets and the profession of investing. On the face of it, you’d be inclined to think it’s likely to be profound. However, there’s a critical difference between sport and investing which has important implications for the answer to this question. 

The marathon hasn’t changed in response to its competitors or technology. It’s still 26.2 miles. Equally, a mile is still a mile, notwithstanding improvements in the running surface. The same cannot be said for financial markets. Participants in markets adapt, adjusting their strategies based on evolving trends and past experiences, contributing to the complexity of the financial system. There are no constants. The interconnectedness of global financial markets adds another layer of complexity. Whether it’s stock and bond correlations, return premia for style factors or even the existence of an equity premium – capital markets are constantly evolving.

Given the complex nature of financial markets, understanding them requires a multidisciplinary approach, integrating economics, finance, and psychology to grasp their non-linear and unpredictable nature. It’s fairly uncontroversial to say that it’s likely AI will change the investing profession. But given the interconnectedness and feedback loops, it’s very difficult to say how this change will manifest itself. 

Finding an edge and betting on it

Investing involves finding an edge and figuring out how to bet on that edge. If the edge you’re exploiting is an analytical one, I think it’s reasonable to believe that AI will figure this out pretty quickly and compete that away. 

It’s less clear to me whether AI will impact the psychology of markets in the same way. It may be that the edge you need to exploit is a behavioural one. Understanding the common biases we all tend to fall for and weaving that into the process and methods to mitigate and manage those. On the wealth advice side of the investing business, I see even greater opportunity. 

AI will change the investment profession, in ways that are not easy to comprehend. Human behaviour hasn’t changed much through the millennia. There’s an edge in that constant.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on twitter @gconno1.