We have discussed portfolio replication or cloning in past blog posts.
We’ve covered the definition, the uses, the benefits, and detailed a case study complete with the study’s favorable findings for using the replication tool as a solution to your client’s investment needs.
We mentioned that portfolio replication is based upon the same technologies used to clone DNA. Makes sense. Right?
Perhaps a bit of an introduction to the technology would be helpful, but no one wants to get lost in the weeds. Fair enough.
As you might expect, the replication process is grounded in math. ( I can hear the collective groans, but stay with me.) Granted the math is complex and a bit complicated at times, but together we can decode it a bit for the purposes of this blog.
We base the technology on predictive analytics. Predictive analytics includes statistical techniques, modeling, data mining, game theory, and optimization theory to take historical facts and make predictions regarding future events.
Complex algorithmic equations seek to identify time series observations.
In our case, those time series observations would be daily closing prices on a registered mutual fund. Once these observations are identified, the algorithms then begin to look for patterns in those closing prices. The technology actually “teaches” itself to identify, study, and draw conclusions regarding these pricing patterns.
The next step is to rake what it’s learned, and actually predict future pricing movements based upon what the technology has learned.
Remember the phrase, “History has a way of repeating itself?” The technology understands that concept.
The best part of the whole process is that the technology actually measures its predictive effectiveness, and corrects itself to make future predictions more accurate.
It’s a concept commonly referred to as Machine Based Learning. Not a bad AutoCorrect function!
It all goes into making the replication process more accurate as time elapses.
A mathematical process that continually corrects its errors, who wouldn’t have wanted that while taking a high school algebra test?