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2039: An investment space odyssey

Still of Hal 9000 from the motion picture 2001: A Space Odyssey
Source: Metro-Goldwyn-Mayer | YouTube
Still of Hal 9000 from the motion picture 2001: A Space Odyssey

Investing was far different in 1989.

American mutual funds managed just $980 billion, about one-fifteenth of their assets today. Index and exchange-traded products didn't exist. Alternatives like hedge, private equity and venture capital funds were relatively secretive, niche vehicles for a privileged group of wealthy individuals and big institutions. Financial advisors charged hefty fees to put clients in a mix of stocks and bonds and mail them monthly progress reports.

In short, a lot has changed.

The next 25 years are likely to prove just as revolutionary, according to leading investment industry experts. Actively managed mutual funds could be a relic thanks to instantaneous access to computer-driven index funds. Algorithms may replace many financial advisors. Once exotic, exclusive "alternative" funds seem poised to go mainstream, often available with the click of a mouse. Call it the robot era of investing.

"In 2039, it will be common for investors to have their portfolios managed by algorithms rather than by humans," said Andrew Lo, a professor of finance and the director of the Laboratory for Financial Engineering at the MIT Sloan School of Management. "The algorithms will incorporate individual or institutional preferences, constraints and lifetime goals in a seamless and optimal fashion to maximize the chances of achieving those goals."

Lo believes that investors will stop choosing between mutual funds that allocate to small- or large-cap stocks, for example, and instead send comprehensive personal data to an online financial management portal. That software will analyze both short- and long-term financial needs and design the most efficient investment plan to meet them. The program robot will then execute the plan automatically, providing updates to the investor and adjustments to the portfolio as needed.

In other words, investors will be offered tools that provide holistic, automated solutions, not do-it-yourself products. Or as Lo puts it, "Meet the financial equivalent of HAL in '2001: A Space Odyssey'!"

Artificial intelligence

"In 2039, it will be common for investors to have their portfolios managed by algorithms rather than by humans." -Andrew Lo, Ph.D., Director of the Laboratory for Financial Engineering,MIT Sloan School

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Lo's robot reference echoes a common belief about the future automation of investing.

"Artificial intelligence-driven client advisors will be mainstream," said Brent Beardsley, a partner at The Boston Consulting Group and global leader of the consulting firm's asset and wealth management unit. "The vast majority of advisors will be focused on risk tolerance and asset allocation ranges; investing and rebalancing will be automated," Beardsley added.

Greg Curtis, chairman of wealth advisory firm Greycourt & Co., agreed. "The vast majority of what most brokers and advisors do today will be handled by technology," he said. "Investment performance will be calculated intraday and will be available in real time. Unexpected performance—good or bad—will be automatically flagged. Portfolios will be automatically rebalanced to predetermined targets and within pre-established ranges."

Just because robots will takeover many retail portfolios doesn't mean all money managers will look like R2D2 in "Star Wars."

"Investors will pay virtually nothing for all this, but will pay for advice," said Curtis. "Most brokers and advisors will disappear, but the best of them—those capable of giving good, honest advice—will flourish."

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No more mutual funds?

The continued rise of passive, index-based investments could mean an end to mutual funds as they are now known.

"We will see mutual funds largely supplanted by ETFs and equivalent synthetics. Although mutual funds won't disappear completely, they will be more purpose-built versus the default investment vehicle," said BCG's Beardsley.

That means, according to Beardsley, that only investment managers who can deliver returns highly uncorrelated to their benchmarks will survive. "Only active management with very strong alpha creation potential will be successful, given that passive vehicles will have become mainstream," he said.

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Not all see such a dramatic decline in human investment direction.

"If you asked me in 25 years will most of the market still be actively managed, I'd say 'yes'," said Brian Reid, chief economist at retail fund trade association Investment Company Institute. "Individuals still want someone to go to and talk to…while there's always a component for the more automated system, that personal interaction really can't be replaced."

Alternatives go mainstream

The rise of liquid alternatives—hedge and other private fund strategies in a retail structure—is another trend experts say is likely to continue.

"Both [hedge and mutual funds] will persist but there will be a larger category of hybrid funds that have elements of both," said MIT's Lo. "We see this trend starting today as mutual fund complexes begin to offer more active and exotic products and hedge funds begin to offer 'liquid alternatives' mutual funds."

"The liquid alts will continue to remain in play as part of the marketplace. I think it's a permanent addition ... as part of a component to many people's financial portfolios," said ICI's Reid. He said the asset class would likely make up between 5 percent and 10 percent of a "modest or large size" retail portfolio.

BCG's Beardsley said that retail investors will have increasing access to private equity and venture capital funds. But he cautioned that regulations, particularlity around liquidity, will make for returns that underperform their original form.

Still, Beardsley predicts that 15 percent to 20 percent of retail investors' asset allocation will go to such alternative products, significantly more than today. He said that new forms could include specific real estate projects (such as jails, universities and hospitals buildings) or investment strategies tied to specific themes (such as insurance risks, population growth or climate change).

Hedge funds, retail or otherwise, seem poised to grow too.

"Hedge funds today are on the same public perception track that mutual funds were, and in 20 years will similarly end up as well-understood investment vehicles—viewed as an essential participant in the global economy," said Richard Baker, president and CEO of hedge fund trade group Managed Funds Association.

Baker said the change in perception will come from continued regulation, institutional use of hedge funds and "years of marketing, disclosures and public competition."

Those factors, he said, "will combine to reverse the mistaken public view of hedge funds as risky, secretive, overleveraged and exclusive to high net-worth investors."

While traditional hedge funds will stick around alongside their retail cousins, fees will decline "dramatically" except for "true out-performance" above a set benchmark, according to Greycourt's Curtis.

More broadly, the labels of today—hedge fund, short-term bond fund, large cap mutual fund—will cease to be useful. Instead, experts say that investment products will be more accurately categorized by risk.

"We will have moved away from the old style boxes, like growth, value, large cap and so forth, and see these replaced by a series of risk factor-related products, like interest-rate sensitive products," said Celia Dallas, chief investment strategist at investment consultant Cambridge Associates. "These could disrupt the conventional market-cap weighted index fund market if implementation becomes cheap enough."

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Hard to predict

To be sure, any 25-year predictions are inherently difficult and overly biased toward trends today.

"Predictions for 25 years out are fun to do, but prone to the typical extrapolations of the present," said Dallas of Cambridge. "We should take heed from the hype regarding Japan in the 1980s, Asian Tigers in the 1990s, and perhaps China in the current decade. Predictions about how the investment landscape will develop over such a long horizon should be reviewed with caution."

"Forecasting investment behavior and conditions a quarter century from now is a risky enterprise," added Beardsley of BCG. "Shifts in global financial architecture and regulations, commodity demand and availability, environmental cataclysm, the fickleness of geopolitics—and, yes, human caprice—will all play a hand, in unexpected ways. You can count on it."

—By CNBC's Lawrence Delevingne.

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