Six specialist areas to add sparkle to your portfolio
While diversified bond and equity funds sit at the heart of most investment portfolios, there is a...
In capturing the AI trend, most investors haven’t looked much further than the world’s largest technology stocks. Amazon, Microsoft, Meta, Alphabet or Nvidia all have a significant stake in the future of AI, but, if the optimists are to be believed, AI is a revolution as powerful and far-reaching as the internet. Where else might investors look to reap the inherent opportunities in AI?
Four semiconductor stocks have proven the major winners of the AI boom: Advanced Micro Devices, Broadcom, Marvell Technology and Nvidia – also known as the ‘four horseman of AI’**.
Among those, Nvidia has the strongest position in the continually expanding AI market. This type of company provides the building blocks for AI. Abrie Pretorius, portfolio manager at Ninety One, says “we will need to upgrade the existing infrastructure to support generative AI for it to scale properly. We need more computing power that needs to run more efficiently on a common technology stack in the cloud. This is where we have seen some of the biggest near-term opportunities – Nvidia leading the market with graphical processing units (GPUs) for example. These are an essential foundation layer.*”
The problem with targeting the most obvious AI beneficiaries is that everyone already knows about them. So where do investors turn to next?
However, the key is to look beyond the most obvious companies in the most obvious market. Looking outside the US brings in equally important companies, but at lower valuations – notably, Netherlands-based ASML, Taiwan-based TSMC or South Korea-based Samsung. None of them attract the same attention as, say, Nvidia, yet TSMC supplies Nvidia’s computer chips and ASML supplies crucial equipment that helps TSMC to make its advanced computer chips.
It is an opportunity spotted by a number of fund managers. For example, BlackRock European Dynamic has a significant weighting in European semiconductor stocks, including 5.6% in ASML***. The Ninety One Asia Pacific Franchise fund has 18.4% of its portfolio in TSMC and Samsung, representing the top two holdings in the fund***.
There are also opportunities in digital infrastructure – the building blocks for the building blocks. To realise the opportunity in AI, there needs to be data, and that data needs to be gathered and stored. Funds such as Schroder Digital Infrastructure are aiming to harness this opportunity by investing in macro towers, fibre optic cables and data centres. The fund has been hit hard by rising interest rates, but valuations have started to stabilise and an opportunity may be emerging.
The potential size of the opportunity remains subject to fierce debate, but forecasters estimate that total demand for data centres, as defined by power consumption, could hit 35 gigawatts (GW) by 2030 in the US market alone, up from 17 GW in 2022.
Equinix, a top holding in Schroder Digital Infrastructure***, is a leading player in the global data centre industry, owning a portfolio of 248 multi-tenant data centres across 32 countries, that host 10,000+ companies, with 450,000+ inter-connections between these customers.
Jeremy Gleeson, manager of AXA Framlington Global Technology, owns three of the four horseman (with the exception of Nvidia****) but told us in a recent interview, “we’re also in design software companies that are helping engineers design the semiconductors and systems to make these chips work perfectly for their intended use. And we own companies who are making the equipment, which make those semiconductor chips, and companies that actually manufacture those chips as well.”
There are also companies on the other side of AI – not creating it, but using it. This is also a relatively under-explored opportunity. Chris Ford, manager of the Sanlam Global Artificial Intelligence fund, says certain companies are uniquely placed to benefit from the growth of AI: “The most important thing about AI, in our opinion, is that companies that have large and high quality datasets, the skill and cultural ability and dexterity to deploy AI effectively across their business and existing moats, will end up in an almost unassailable position, and that is why we have investments in sectors like industrials, consumer discretionary and healthcare.”
Adoption of AI within companies is clearly accelerating. For example, ChatGPT achieving 100m users in just three months***** – has got the attention of almost every CEO. Abrie adds: “We have seen organisations move from being very sceptical, to adopting it at pace.” Companies can build faster revenue growth, a bigger addressable market, or drive efficiency gains to improve margins.
Where might those gains be realised? Jeremy Gleeson told us, gaming companies may also be a key beneficiary of AI. It can enhance the algorithms embedded in games to influence behaviour and decision-making. Behaviour systems can create human-like responses, adjust difficulty based on player performance or create interactive dialogue. AI also creates the potential to personalise the user experience.
Maneesh Bajaj, manager of the Brown Advisory US Flexible Equity fund, explains how the managers are seeing AI in the healthcare space. He cites its usage in the diagnosis of tumours, analysing clinical trial data, or for improving operational efficiency of healthcare providers.
It is also possible to see opportunities in insurance, where AI can lead to a better understanding of risk, improvements in pricing and to devise new ways to distribute insurance products. However, one of the unintended consequences of increased computing power and AI becoming more widespread, is cyber-crime. Alessandro Dicorrado, co-manager of the Ninety One UK Special Situations fund, told us how the fund has been adding to cyber-insurance over the last 18 months as a cross section of this AI trend developing.
Then there is investment management itself. The major investment managers are employing AI to help them understand companies better. BlackRock set up the BlackRock Lab for Artificial Intelligence in Palo Alto, California in 2018^, while Schroders, Goldman Sachs and BNY Mellon also have major technology programmes.
Schroders explains its approach: “What we don’t do is use AI to build models and algorithms to trade. Instead, we use the datasets we have and AI techniques to enhance our investors’ views so that they can make better investment decisions. Rather than using AI to replace people, we use AI to provide an information edge in investment decisions.^^”
Researchers at the University of Florida found that ChatGPT could pick up market sentiment indicators and, to some extent, predict stock price performance, particularly among less liquid small caps^^^. The finance industry is already experimenting with baskets of stocks selected by ChatGPT and has found that they outperform some of the leading UK investment funds^^^^. However, time scales are short and the algorithm tended to gravitate to larger companies, but this should not rule out a future role for AI in portfolio creation.
There are opportunities in the software layer, but these remain in the germination stage. Jeremy says: “What we’re not trying to do in the AXA Framlington Global Technology fund is find AI-only companies that are completely dependent on the success of AI for their near-term, mid-term and long-term futures. What we’re trying to find is companies who have good exposure to AI and therefore good exposure to this good medium and long-term opportunity, but have also got other areas of business, which will keep them ticking over quite nicely and quite comfortably in the short term, just in case we have any of those speed bumps that quite often come along with new technology.”
Investors should watch this space, or – even better – get a skilled fund manager to do it for them. Chris Ford, for example, uses privileged language to mitigate the risk of investing in commoditised or ‘me too’ companies whose claims to be involved in AI may be overblown. The problem with all AI investment is that it is vulnerable to hype. As with all new technology innovation, excitement over potential growth can outpace real growth. Active fund managers are well-versed in making these judgements.
AI is exciting – and could be revolutionary. However, it is nascent technology and it will take time for the winners to emerge and evolve. In the meantime, it is easy for investors to get caught up in the hype cycle. Looking beyond the most obvious AI beneficiaries may be a good place to start.
*Source: Ninety One Big Picture podcast, October 2023
**Source: Investor’s Business Daily, June 2023
***Source: Fund factsheet, 30 September 2023
****Source: FE Analytics, full fund holdings, 31 August 2023
*****Source: Reuters, February 2023
^Source: FT, February 2018
^^Source: Schroders, June 2023
^^^Source: Lombard Odier, June 2023
^^^^Source: CNN, May 2023