Go to Jeff Salisbury LWGate Home Page.From: maness@sdcoe.k12.ca.us (Jay Maness)
Subject: neural networks
Date: Fri, 7 Aug 1998 05:02:56 -0700 (PDT)
Previous Article (by Author): capital gains tax, renting vs. owning ldavis@ix.netcom.com (Lynn R Davis)
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<Memills@aol.com> asked: Subject: Artificial Intelligence/Neural Net based mutual funds Does any know of a mutual fund that makes it stock selections based solely on a neural network (artificial intelligence) analysis of a historical database? I'm familiar with James O'Shaughnessy's work, but I don't think he used neural network software. Thanks, -- Mike Mills <reply> Mike, I have some interest in this field also. Here is a lightly edited copy of a posting from MONEY that I kept. <begin quote> Date: Fri, 8 May 1998 20:13:27 EST Reply-To: dailymail@LISTSERV.PATHFINDER.COM Sender: Money Daily <MONEYDAILY@LISTSERV.PATHFINDER.COM> From: MONEY Daily <moneyadm@PATHFINDER.COM> Subject: How one fund capitalizes on market inefficiency To: MONEYDAILY@LISTSERV.PATHFINDER.COM For an enhanced HTML version of the Money Daily, visit http://moneydaily.com. Weekend, May 9-10, 1998 How one fund capitalizes on market inefficiency The new N/I Larger Cap Value Fund trades hard and fast on a fair value model that's recalculated hundreds of times a day - and so far, it's working By Michael Brush In business school, they teach you that the stock markets are completely efficient. All public information about a company, the professors tell you, is fully reflected in a stock's price at all times. Rubbish, say many seasoned investors. They know that stock prices often bounce around maddeningly, even when there is no news. And when there is news, look out! Investors are prone to overreact, driving prices to extremes. Capitalizing on these temporary price anomalies would seem like a winning strategy. A relatively new mutual fund that tries to do just that is the Larger Cap Value Fund (NILVX), launched by N/I Family of Funds (800- NUMERIC) last December. The fund is based on the premise that when it comes to the stock markets, business school professors have it all wrong. "The markets are not efficient. They are partially efficient," says Langdon Wheeler, who founded N/I in 1989, and helped develop the computer programs behind the Larger Cap fund. "It is not all machines yet. The markets are people and people get carried away. They are out there saying `I have to buy because he is buying.' Or `I have to sell because he is selling.'" And that kind of emotion often helps drive down prices of good stocks to attractive levels. "Prices slosh around quite a bit," notes Wheeler, an former engineer who became fascinated by financial markets and changed careers. "Just look at a price chart. You see all kinds of ups and downs when the fundamentals did not change that much." To take advantage of buying opportunities caused by market inefficiencies, the Cambridge, Mass.-based N/I has developed a `fair value model' which tries to "mathematically model the excesses of human behavior in the market," says Wheeler. The first step is to figure out the `fair value' -- or how much the market is usually willing to pay -- for certain qualities of stocks. These include things like book value, expected earnings, the growth rate, the quality or consistency of earnings, and the number of analysts covering a stock. The market, for example, tends to pay less for volatile earnings as opposed to more predictable earnings. And it pays more for companies that are followed by more analysts. "You figure out how the market prices all these factors each day," says Wheeler. "Then you go back and assign each factor a weight for each stock, and bingo! You have a theoretical price." The computers at N/I x- ray the stock market about once every 90 seconds to see if investors are underpricing any aspects of a company, like its earnings growth or book value. If so, portfolio manager Arup Datta and N/I traders pounce on the stock. As you might suspect, such a portfolio management style leads to heavy trading. The fund has about a 250% annual turnover -- way above what many fund advisors believe is an acceptable level. Two factors, however, make this high turnover rate palatable. First, the fair market value strategy creates a good enough return to offset the cost of all that trading. As of March 31, the Larger Cap Value Fund had a return of 16% since it was started at the beginning of December, compared to a Russell 1000 return of 11.6%. And over a full year, use of a similar model in private accounts has produced the same kind of edge. Second, N/I has a record of keeping down other costs. Like other mutual funds at the group, the Larger Cap Value fund has annual expenses capped at 1% -- below average for an actively managed fund. And there is no load or 12(b)-1 fee. Sometimes, of course, the model leads fund managers in the wrong direction. Stocks, after all, do sometimes go down in value because of bad news that is not yet out. "You know you are going to be wrong on some of them," admits Wheeler. "But you have to follow the discipline, if you have a discipline that works most of the time. A relatively small informational advantage applied over a large number of trials will get you a persistent outcome." One of the advantages of the system is that it leads the fund to low valuations "in stocks that most value investors would not understand," says Wheeler. By that he means that it finds bargains not only among the typical down and dirty value stocks, but among quality growth stocks as well. If you are interested in the fund, don't wait too long to look it over. To date, it only has about $15 million in assets. But N/I, which has about $5 billion in assets under management, has a habit of shutting down funds to keep them manageable -- and this one is scheduled to close at $500 million. <end quote> - -
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