Capturing the artificial intelligence opportunity in Asia

Chris Salih 10/09/2024 in Asia/Emerging Markets, Investment Trusts

Artificial intelligence (AI) has become a major force in global stock markets, driving significant returns over the past couple of years. Richard Sennitt, manager of the Schroder Oriental Income investment trust, takes a closer look at this theme in the portfolio today.

A key opportunity

Although much of the attention has focused on Nvidia, the US technology company that designs the advanced chips which are essential for AI processing, there is a robust ecosystem of other technology companies that contribute at various stages of the AI value chain. Asia has become a pivotal hub in this AI revolution and whilst the AI related revenues for many of these Asian companies are starting from a low base it is a fast-growing area often utilising leading-edge products and technologies thus enhancing returns for companies that can successfully supply into the space.

These include companies that not only fabricate and package the chips but also those that can supply the high-end servers required or fabricate parts and components to meet the demands of AI. These include items such as the power supply for servers which have to be able to cope with much higher loads than for ordinary applications. Schroder Oriental Income is strategically positioned to capitalise on this growing opportunity and is currently exposed to all of those areas.

It should be remembered that whilst AI should continue to be a positive driver for the IT sector it is not the only driver and the industry should continue to benefit longer term from positive trends around digitisation, cloud and 5G.

With more than 30% of its portfolio allocated to the Information Technology sector, the Schroder Oriental Income Fund is well ahead of its benchmark index (MSCI AC Pacific ex Japan Index, 26.3%). In recent years, this positioning has added value through outperformance and as a strong source of dividends and dividend growth.

Key technology holdings

The portfolio’s largest holding is in Taiwan Semiconductor Manufacturing Company (TSMC)*, which is viewed by many as the bellwether of Asian technology stocks. TSMC has performed well in recent years and strong corporate governance standards in Taiwan mean the company has been keen to ensure shareholders are well-rewarded for its success in terms of dividend income.

TSMC’s global leadership in advanced semiconductor technologies and strong relationships with customers such as Nvidia have seen it become a key player in the AI industry, supplying essential components for AI systems and thriving on growing demand for these burgeoning technologies.

Meanwhile, Samsung Electronics, is the second largest holding in the portfolio*. Key drivers include its continued dominance in semiconductor memory chips. Samsung’s diversified business model also means it has exposure to the mobile, display and foundry sectors.

Elsewhere amongst the portfolio holdings is Hon Hai*, not only a manufacturer of smartphones and other high end consumer products but also a manufacturer of servers key to the growth of AI and MediaTek, which has successfully forged a position as a global leader in mobile chipsets, which have the potential for greater AI-driven applications. As an asset light, cash generative business, it has also been steadily growing its dividend as it returns significant cash to shareholders.

Can the AI boom continue?

Although returns from Asian technology stocks have been strong in recent years, the key question for investors right now is, can the growth continue? Some industry commentators worry that the stock market’s enthusiasm for AI and technology may have fuelled an investment bubble, similar to the one that greeted the internet boom in the late 1990s.

However, there are reasons for cautious optimism. We remain positive about the role that Asian technology companies can play in AI’s continued development. We are still in the early chapters of the AI story, and there is plenty of growth and innovation still to come, with implications for all industries and, indeed, all parts of daily life. This will inevitably drive risk as well as opportunity. However, expectations in parts of the IT sector related to AI are now high and longer-term question marks around the monetisation of the technology remain.

Therefore, one needs to be disciplined when assessing stocks associated with the theme. Whilst Asia remains an interesting way for investors to gain exposure to the AI theme the broader sector also has longer term attractions and on balance, valuations for Asian technology stocks as a whole have not yet responded to the extent that they have in the US.

Discipline is key

Nevertheless, investors should be mindful of potential volatility in the near term. Although Asian technology stocks have not risen as far or as fast as those in the US, they are unlikely to be immune should US technology stocks suffer a correction.

The best protection against this risk is a long-term, disciplined investment approach. We are pragmatic stock pickers and aim to look beyond the day-to-day swings in sentiment to which markets have always been prone. We are looking for the genuine long-term winners across a wide range of sectors, and maintain a strong valuation discipline to ensure that, when we find them, we don’t overpay for them.

We focus on quality companies that have strong management, appropriate balance sheets and sustainable long-term competitive advantages. We also have the ability to draw on Schroders’ extensive research resources in Asia, where on-the-ground analysts engage directly with company management teams, ensuring that the fund remains focused on opportunities that can deliver attractive dividend profiles.

Having grown its dividend every year since its launch, this approach has served Schroder Oriental Income well in the past. We have a robust and repeatable investment process. The disciplined focus on valuation ensures we can adapt to evolving market conditions, allowing the portfolio to deliver its continued focus on income, while still being able to capture some of the best opportunities in Asia, in technology and beyond.

*Source: as at 31 July 2024

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