Previously, we explored if Meta’s Prophet library could be used to drive a momentum portfolio (Prophet for Momentum, Prophet for Momentum, Part II). We found that a simple (naïve) momentum strategy outperformed whatever we did with Prophet.
More generally, using a Neural Network or an SVM to drive portfolios have been a disappointment in live scenarios (Machine Learning Themes). Their after cost performance trail benchmarks.
Moreover, a big problem with these models is that there are a million different ways to specify them and a few of them will go on to outperform in a forward-test simply because they load on a factor that is working for that moment in time. So, you never know if you found the “right” set of specs (because there is none) and if you are not careful, you will forever be tuning the model based on what worked in the recent past.
Even simple SVMs come with so many different ways to specify them: classification vs. regression, polynomial degree, cost (static vs. auto-tune), feature selection, feature tuning, etc. And, since we don’t know which ones work beforehand, we try most of them and settle on those specs that output the results we wanted.
For example, an SVM can be trained with a time-series of previous month’s returns to predict the next month’s returns. A momentum portfolio can be created by ranking these predictions. Rebalance every month and you have something that works.
The problem is that to arrive at this model, we went through a fair amount of parameter and feature tweaking/tuning which may or may not work in the future.
Here, we published the charts of an SVM that uses a 5th degree polynomial kernel because it worked (higher Sharpe!) and not because there is a strong theoretical reason why 5 is better than 1.
For every model that is published, be rest assured that there are thousands hidden away in a drawer.
This is why we remain skeptical of “A.I.” investment strategies.
Code and charts on github.
