📢THE RISE OF ARTIFICIAL INTELLIGENCE IN INVESTMENT FUNDS: OPPORTUNITIES, RISKS & REGULATORY CONSIDERATIONS

The integration of Artificial Intelligence (AI) into the EU investment fund industry is gaining traction as fund managers explore innovative ways to enhance decision-making, optimise portfolios, and improve operational efficiencies.

However, as highlighted in the European Securities and Markets Authority (ESMA) 2025 report, the adoption of AI in investment management remains at an early stage, raising key legal, regulatory, and market considerations that fund managers and investors must carefully assess.

AI in Investment Management: Current Trends and Adoption

Despite the growing enthusiasm for AI-driven innovation, the number of investment funds that explicitly promote their use of AI remains limited. The ESMA report reveals that funds integrating AI into their investment strategies have yet to demonstrate a consistently superior performance compared to traditional funds. Instead, AI tools—particularly large language models (LLMs) and generative AI (GenAI)—are primarily used to support human-driven investment decisions rather than fully automate them.

Several large asset managers have begun experimenting with AI to enhance risk management, compliance, and administrative processes. However, the adoption of fully AI-driven investment models remains marginal due to challenges such as:

Data reliability and biases
Regulatory uncertainty
Systemic risks associated with AI dependencies

Fund Exposure to AI-Related Investments

Beyond operational use, investment funds are increasingly allocating capital toward AI-related companies. Actively managed equity funds have raised their portfolio exposure to AI stocks from 9% to 14% since 2023, reflecting the rapid growth in market capitalisation of AI-driven enterprises. However, this concentration presents risks. The ESMA report warns that the surge in AI-related investments could:

Increase market volatility, given the uncertainty surrounding AI’s long-term profitability
Exacerbate correlated risks, particularly if AI-driven firms face setbacks due to technological, operational, or regulatory challenges
Raise concerns over fair valuation, as investor sentiment fuels inflated expectations around AI-related equities

Regulatory Considerations: The Role of the EU AI Act

As AI adoption expands, regulators have turned their focus to ensuring that AI tools in financial markets adhere to strict compliance frameworks. The EU AI Act, which came into force in August 2024, introduces risk-based classifications for AI applications, requiring fund managers to:

Conduct transparency assessments on AI-driven decision-making models
Implement robust risk management frameworks to mitigate algorithmic biases and feedback loops
Ensure third-party AI vendors comply with EU regulatory standards to avoid over-reliance on concentrated service providers

Key Legal and Compliance Takeaways

For investment funds incorporating AI into their strategies, the following legal considerations should be prioritised:

Regulatory Compliance: Ensuring AI-driven decision-making tools meet MiFID II requirements and align with the EU AI Act to avoid regulatory scrutiny
Investor Protection: Mitigating AI-washing risks, where firms exaggerate the role of AI in their investment strategies, potentially misleading investors
Risk Management: Assessing systemic dependencies on AI service providers and preparing for potential disruptions or cybersecurity vulnerabilities
Governance and Accountability: Establishing clear internal governance structures to oversee AI-driven investments, including board-level AI oversight and internal compliance audits

Looking Ahead: The Future of AI in the Fund Industry

The evolution of AI in investment management will depend on regulatory clarity, technological advancements, and investor sentiment. While AI presents unparalleled opportunities for efficiency and innovation, the ESMA report underscores the need for careful risk assessment, compliance diligence, and regulatory adherence to ensure sustainable integration.

As the AI-driven investment landscape unfolds, law firms specialising in financial services, fund regulation, and AI governance must remain at the forefront of these developments, guiding clients through complex compliance challenges and helping them leverage AI responsibly within the EU’s evolving regulatory framework.

For expert legal guidance on AI regulation and investment fund compliance, contact our team today at info@pelaghiaslaw.com.