Written by Daniel Broby and William Smyth.
The purpose of this article is to highlight an example of world-class research taking pace in fintech, right here on our doorstep.
Perhaps, the greatest misconception about fintech is that it is a niche field. This could hardly be farther from the truth. Fintech can be defined as the use of technology to enhance existing ways, or to enable new ways to move, raise or invest money and capital. It is difficult to think of a single aspect of our everyday lives that does not involve moving, raising, or investing money or capital, either directly or indirectly. And as for the technology part of fintech, the relevance of technology requires no elaboration.
It’s not every day you get official confirmation that your research has enhanced and advanced the work of some of the best in your field. Even less so when one of them is a Nobel laureate. That is what I and my co-author Professor Daniel Broby have received via our recent publication in one of the world’s top finance journals.
I have an advanced degree in mathematics and a PhD in theoretical physics. I am proud to say I completed both of these at Queen’s University Belfast, right here in Northern Ireland. An early career researcher, I have published 14 peer reviewed papers in leading scholarly journals. I am familiar with many techniques of machine learning (a trendy synonym for modern statistical analysis) and have a strong mathematics and coding background. This combined with Professor Broby’s C-level finance industry expertise and experience has enabled us to form a formidable research partnership. In his industry career, Professor Broby was the Chief Investment Officer of several asset managers, responsible for the discretionary management of billions of pounds. One of the flagship global funds that he was directly responsible for was rated five-star by the global rating agency Morningstar, placing him as a fund manager in the top performance decile.
A team comprising leading US finance academics, industry experts, and one of the country’s top data scientists recently proposed a statistical co-movement metric, the Gerber statistic, which is able to cut through the high levels of noise which often obfuscate analyses of financial market data. Its use gets to the underlying connection between assets. In other words, to ascertain the true relationship between the financial returns of various assets.
Understanding the way stocks vary and co-move with each other is a problem which has challenged practitioners and academics alike since the introduction of modern portfolio theory. The first breakthrough in this earned Harry Markowitz the Nobel prize for Economics (along with Merton Miller and William Sharpe, the latter another household name from the field of finance). Professor Markowitz is a co-author of the work we improved and we use the Sharpe ratio, proposed by Professor Sharpe, to demonstrate our results.
The concept is mathematical, but can be thought of as accurately establishing the connection (think correlation or co-movement) between two statistical variables. In this case these are a series of asset price returns which facilitate the construction of diversified portfolios. The purpose of this is optimal portfolio diversification, and the process can be used to control the risk of mutual funds and suchlike. The Gerber statistic does this better than other common methods such as historic covariance or shrinkage. This gives a fund manager or investment analyst a potential edge when it comes to building large investment portfolios where literally billions of pounds are at stake.
Having analysed the work of Gerber, Markowitz et al., we identified two ways in which we believed the Gerber statistic could be improved. After developing the necessary mathematical representation, the associated statistical theory, and coding it up for testing, both these modifications turned out to be effective. The Smyth-Broby enhancement, to which the modified statistic is being referred, outperforms the Gerber statistic a significant majority of the time. This result is exceptionally pleasing. To think that your research, the unseen part of which takes you into the small hours on very many occasions, has enhanced the work of giants in your field is a great source of pride and vindication.
An especially pleasing aspect of our work is that the co-movement statistic we have developed has applications beyond the field of finance. It is not practical to list the full range of applications but there is a highly transferrable principle which clarifies its applicability across research fields and industries alike. Many variables of interest in industry projects and academic studies are intrinsically difficult to measure, or indeed may not be directly observable at all. However, what can be done to address this problem, is to establish a connection between the variable of interest and another variable which can be measured. Thus, critically, if the co-movement connection has between accurately identified, a measurement of the variable which is observable can be used to provide insight into the likely value for the variable which cannot be observed.
The Smyth-Broby enhancement fits squarely in the investing money and capital branch of fintech. Classic InvestTech applications such as robo-advisors aspire to democratise investment. They take something that, until very recently, was the preserve of the wealthy few and make it accessible to billions of ordinary people worldwide. The algorithms underpinning robo-advisory apps rely heavily on the ability to correctly identify the co-movement connection between financial assets.
We feel sure the Smyth-Broby enhancement to the Gerber statistic will have a real and lasting impact in the investment management industry. In fact, we have commenced collaboration with some of the original team involved in the Gerber statistic work to investigate if together we can answer one of the longest-standing unanswered questions in finance. Watch this space!
Our work strengthens Northern Ireland’s standing in Financial Technology. The applications of FinTech are growing rapidly. Locally, thanks to the efforts of a wide range of stakeholders, including the FinTech NI Association we are changing perceptions about Belfast’s role in global finance.
FinTech NI Board Member Alex Lee said: “The pattern of growth within FinTech in Northern Ireland is largely a result of the dynamic and collaborative ecosystem we have here. Our world-class universities are a key element of this. The high calibre research being carried out by academics at Ulster University plays a significant role in helping us maintain our position as one of UK’s leading FinTech clusters. The Smyth-Broby enhancement brings specific value by improving investment portfolio optimisation and will go a long way in overcoming long-standing challenges and questions within the sector. This work strengthens our position in Financial Technology and is one of the key supporting factors that keep Northern Ireland competitive and in fact often rivalling some of the world’s leading FinTech hubs.”
