July 2023 Happy Summer, a month away in Africa was long enough to make me feel like I’ve lived under a rock. Since my return, the media and many of my clients have been all over the topic of Artificial Intelligence. Is this going to be the next monumental shift? How can investors benefit from it? Should investors be worried about the influence of AI on markets?  On a personal level, I’m fascinated and impressed by Generative AI. Like most, I’m trying to wrap my head around its implications for me personally, professionally, as an investor, consumer, and citizen.  When I have questions related to new trends that hit the Wall Street hype machine, I go for answers to the collective brilliance of the Dimensional team, my trusted source. Gerard O’Reilly, the company’s CIO, explained in a recent discussion that AI aims to work very much like markets do — processing vast amounts of information. In other words, the Market is our super AI. Below is a more detailed answer to the AI question.

Can AI Identify Mispriced Securities? Active investors have long attempted to get an informational edge on markets by using artificial intelligence (AI) processes to retrieve and process data. For example, tools that gauge sentiment from social media or scrape text from company financial reports predate ChatGPT by many years.   Material information gleaned from running AI processes is very likely a subset of the vast information set known by the market in aggregate and reflected in market prices. If new information is obtained, the process of acting on that information incorporates it into market prices.   Another reason to question AI’s role in helping with market timing is limitations with its predictions. AI’s forecasting ability fares well when assessing patterns that are relatively stable. The market is fantastically complex. So much so that no one knows exactly how much a particular piece of information impacts a price, because there are so many other simultaneous inputs. AI trying to predict market prices is like self-piloting cars trying to read stop signs with words, shapes, and colors that differ every day.   As an example, consider the AI-Powered Equity ETF, launched in 2017. It employs IBM Watson AI to analyze publicly available information to pick US stocks that will outperform the US market (Exhibit 1).

Exhibit 1: AI Powered Equity ETF vs. Russell 3000 Index and S&P Technology Select Sector Index Cumulative returns, November 1, 2017–May 26, 2023

While Watson can outwit an individual, its intelligence pales in comparison to the aggregate wisdom of the millions of individuals trading in stock markets each day. It is perhaps unsurprising then that the Watson-powered ETF has lagged the broad US market and, by a wide margin, the US technology sector since its inception. Sure, AI can help the execution of trades. But the market is powerful and ensures a price is the most accurate current representation of the value of a stock or bond. There is no reason to think that AI should fundamentally influence the way people think about stock prices anytime soon. I look forward to learning about your experience with AI and invite any of your questions, comments, and insights.  I trust you have something fun planned for this summer. Warmly,

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