Riding the AI tailwind

By Jayson Forrest

Are you considering an exposure to artificial intelligence (AI) in your portfolio? Cameron Gleeson (Betashares) and Monik Kotecha (Insync Funds Management) discuss how advisers can ride the AI tailwind.

 

As surprising as it may seem, artificial intelligence (AI) machine learning isn’t a recent development, having first emerged in the 1950s. However, it’s only been relatively recently that AI technology, like ChatGPT, has really gained traction, as interest in this technology continues to gain momentum globally.

Put simply, AI is the science of making machines think like humans, by programming them to perform tasks that are considered intelligent. AI technology can process large amounts of data in ways that humans simply are incapable of doing, with the goal of completing tasks, such as recognising patterns, making decisions, and thinking like humans. AI can even be self-aware, learning from experience to improve and adapt, just like humans.

What makes Cameron Gleeson — Senior Investment Strategist at Betashares — excited about AI, are the companies and industries that will materially benefit from this technology in the years ahead.

Speaking at an IMAP webinar on ‘Using AI in investment’ — which was part of an IMAP Specialist Webinar Series on ‘AI and its impact on advice, portfolio management, and investment management’ — Cameron says he is particularly confident of the ability for large technology companies to benefit from the productivity gains that AI will deliver.

“If we consider leading AI venture capital firms — like Nvidia, Microsoft, Salesforce, Google, and Amazon — they all have cornerstone investors within the big tech eco system. And in a symbiotic relationship, those AI companies (like OpenAI, Databricks, and Runway) need the capital and Cloud infrastructure to build out their models,” he says. “Big tech is then able to use these AI tools as bolt-ons or adjuncts to their products and services, allowing them to monetise these solutions.”

However, when considering AI, Cameron concedes there is significant risk in supporting an individual stock, particularly those stocks that are ‘priced for perfection’. Therefore, he believes a less riskier strategy is to hold a basket of stocks — for example, through the Nasdaq 100 index — which can provide investors with an attractive way to invest in the AI thematic.

“AI is the latest area of innovation and development within the growth of Nasdaq companies. In fact, Nasdaq companies invest 7x the amount in R&D and innovation compared to the rest of the U.S. equity market. These companies tend to invest in these new areas of structural change, which drives compounding revenue growth over time,” he says.

According to Cameron, the market is already seeing the impact of AI with large tech companies, most notably in their Cloud businesses, where there is long-term opportunity for Cloud revenue growth as a result of AI.

As an example, he refers to Microsoft’s Cloud businesses, which grew by about 30 per cent in the last quarter (Oct-Dec 23), with 6 per cent of that growth attributed to AI. Cameron believes it’s with these large Cloud platforms — Microsoft Intelligent Cloud, Amazon Web Services, and Google Cloud — that investors will start to see the monetisation of the Cloud.

“For some time now, these platforms have been important growth engines for the likes of Microsoft, Google and Amazon. In fact, the majority of Amazon’s earnings comes from its Cloud business. So, that’s the type of potential we’re looking for in businesses on the Nasdaq, particularly in terms of revenue and earnings growth.”

Discussion on how financial advisers can ride the artificial intelligence (AI) tailwind.
Fifth Logic
Fifth Logic
Viridian Group
Financial Newswire
Cameron Gleeson is Senior Investment Strategist at Betashares
Cameron Gleeson - Betashares
Monik Kotecha is Chief Investment Officer at Insync Funds Management
Monik Kotecha - Insync Funds Management
Mike Taylor — Managing Editor at Financial Newswire.
Mike Taylor - Financial Newswire.

AI is the latest area of innovation and development within the growth of Nasdaq companies. In fact, Nasdaq companies invest 7x the amount in R&D and innovation compared to the rest of the U.S. equity market. These companies tend to invest in these new areas of structural change, which drives compounding revenue growth over time

Cameron Gleeson

Transformative and exciting

Monik Kotecha — Chief Investment Officer at Insync Funds Management — shares Cameron’s excitement of AI, and for good reason. Data from Bloomberg Intelligence reveals that revenue for generative AI (a broad label describing any type of AI that can produce new text, images, video, or audio clips) is on track to become a USD$1.3 trillion market by 2032 (from a market size of just USD$40 billion in 2022). The means generative AI will represent about 12 per cent of total technology spend, compared to the current 3 per cent.

“There’s no doubt there is a significant growth opportunity available for those companies that are well positioned in the AI space,” says Monik. “Interestingly, ChatGPT reached 100 million customers in just two months. This makes ChatGPT the fastest ever growing consumer application.”

However, when considering trends over the last 20 years, Monik says it’s important to remember that the time for market adoption of technology continues to compress significantly. While this creates some interesting opportunities, it also creates threats when picking stocks. This means previous winners can become disrupted and new winners can quickly emerge.

“When investing, it’s important to appreciate that we tend to overestimate the effect of technology  in the short-term, but underestimate its impact over the long-term,” says Monik. “All technology goes through a ‘hype’ cycle.”

Therefore, as an active stock picker, while Insync remains excited about the opportunities of AI, it is also focused on managing the risks of such stocks. Monik says the real skill with investing is knowing when to buy the stock, how much of the portfolio should be exposed to a particular trend, and when to exit or reduce your stock exposure.”

Monik supports the view of Bill Gates — the Co-Founder of Microsoft — who said: “AI has the ability to solve previously intractable problems in health, education, and climate change, as well as its potential to change the way people work, learn, travel, receive healthcare, and communicate with each other.”

Not surprisingly, Monik believes AI not only has the potential to revolutionise various aspects of our lives, but will also significantly impact many industries, including: healthcare, finance, autonomous vehicles, entertainment, and virtual assistants.

For example, within healthcare, AI will play a crucial role in aiding in diagnosis, developing tailored treatment strategies, and accelerating drug exploration. Whilst in the finance industry, AI is enhancing security in transactions, helping to detect fraud, and improving customer experiences by offering personalised services and optimising customer service interactions.

“For businesses to succeed and thrive in the years ahead, it’s important they integrate AI into their respective business models,” says Monik. He believes there are two core reasons for doing this:

  1. AI can process and analyse data more quickly than humans. This provides businesses with insights that gives them a competitive advantage; and
  2. AI provides businesses with an opportunity for genuine innovation. Businesses that embrace and integrate AI, and make it part of their DNA, will enable them to bring new products, services and solutions to customers more quickly than previously.

Our focus at Insync is finding companies that are benefiting from long-term secular mega trends, but which are also highly profitable and cash generative. By having those attributes in place, it enables those companies to deliver sustainable earnings growth

Monik Kotecha

Opportunities in AI

Outside the big technology companies — like Microsoft and Google — Cameron believes there are other areas to invest in AI, which provides additional opportunities for investors who want exposure to AI outside the high valuations of the big technology companies . These include: Cloud computing, cybersecurity, and industrial automation. To this list, Monik also identifies companies with large proprietary data sets — like Adobe, RELX, and Booking Holdings — that heavily rely on AI as part of their business models.

“Our focus at Insync is finding companies that are benefiting from long-term secular mega trends, but which are also highly profitable and cash generative. By having those attributes in place, it enables those companies to deliver sustainable earnings growth,” says Monik. “Over time, what drives good long-term share price returns is the strong correlation between rising share prices and sustainable earnings growth.”

At Insync, Monik says the key to stock selection is picking stocks within mega trends.

“We don’t believe a rising tide lifts all boats,” he says. “Historically, only 4 per cent of all stocks have actually contributed to most of the market returns over the last 100 years. However, investors do get excited by new technologies that emerge. They do create ‘hype’ cycles and significant overvaluations. So, when the bubble bursts, the subsequent falls in stock valuations and earnings can be very significant.”

If I’m thinking about second-order winners, like cybersecurity, they tend to be best used as a satellite. This means it’s a smaller allocation because they tend to have more ‘theme’ specific risk, and they tend to have lower correlation to the core. They can be more volatile but they can also be a great way to potentially add outperformance

Cameron Gleeson

AI exposure in portfolio management

In terms of portfolio diversification, when considering where an exposure to AI sits in a conventional portfolio, Cameron says it’s important to think about a balanced exposure. He says most clients adopt a core-satellite approach to investing.

Betashares thinks carefully about how it builds its core equities sleeve, which includes looking at Australian equities, which are relatively skewed to cyclicals. Cameron adds that when you’re thinking about a growth exposure, it can be very difficult to pick the winners over a long period of time. That’s why he believes a broad market passive approach has performed exceptionally well over a long period.

“You can look to blend in some growth exposure to complement your Australian equities within the core, or potentially combine, for example, quality growth with another factor like value. You need to think about how these types of exposures offset each other and how they behave in different market conditions — like an interest rate hiking cycle or a loose monetary policy environment,” says Cameron.

“Beyond that, if I’m thinking about second-order winners, like cybersecurity, they tend to be best used as a satellite. This means it’s a smaller allocation because they tend to have more ‘theme’ specific risk, and they tend to have lower correlation to the core. They can be more volatile but they can also be a great way to potentially add outperformance, but only in a manner where you’re not adding too many satellite exposures that will increase portfolio volatility as a whole.

“So, when constructing a portfolio, I believe you need to think about what to bring in as core broad diversified exposures, like Betashares Nasdaq 100 ETF, and then think about how to use satellites to add outperformance.”  

Monik remains cautious about having a specific AI exposure, simply because AI will impact every sector and industry. This means that companies that embrace and integrate AI into their DNA as early as possible, are likely to be the winners in this space.    

“Regardless of your style of management — whether growth or value — you need to understand how AI is going to impact the stocks in your portfolio. Obviously, there are companies in this space that are going to be leaders in AI and they will do very well,” says Monik.

“So, I think the important question for advisers to ask fund managers is: ‘How are you thinking about AI in your portfolio?”

Regardless of your style of management — whether growth or value — you need to understand how AI is going to impact the stocks in your portfolio. Obviously, there are companies in this space that are going to be leaders in AI and they will do very well. So, I think the important question for advisers to ask fund managers is: ‘How are you thinking about AI in your portfolio?

Monik Kotecha

AI and geopolitics

And what about geopolitics when investing in AI? Monik acknowledges investors need to consider the effects of geopolitics in areas like computer chips and sovereign intellectual property (IP). He says there is the potential to weaponise AI, which has resulted in many countries seeking to achieve AI dominance. This has already led to the roll out of export restrictions of computer chips used by some countries.

According to Monik, geopolitics will continue to have a profound impact on AI, particularly in terms of how countries respond to protecting their IP. When investing in AI, both geopolitics and sovereign regulations are major factors that need to be carefully considered when deciding on which stocks to invest in.

“In terms of AI and the IP required, China is still considerably behind countries like the U.S.,” says Monik. “It’s going to take a long time for China to achieve the same level of development in AI that’s been achieved in the U.S., particularly considering export restrictions imposed by the U.S. on the sale of some advanced AI chips to China, over concerns they could be used for military development purposes.”

Cameron agrees that the export restriction of chips is a significant challenge China needs to overcome. Other challenges include reduced access to high-quality hardware, requiring China to build its own algorithms — and therefore, AI — to overcome these problems.

“We’re also seeing the emergence of the concept of sovereign AI. Governments are looking to take over greater control of AI, as it becomes more important to national security,” says Cameron. “I think it’s increasingly likely that Governments will begin building their own AI capability, independent of the private sector.”

About

Cameron Gleeson is Senior Investment Strategist at Betashares; and

Monik Kotecha is Chief Investment Officer at Insync Funds Management.

They spoke on ‘Using AI in investment’ as part of an IMAP Specialist Webinar Series on ‘AI and its impact on advice, portfolio management, and investment management’.

The session was moderated by Mike Taylor — Managing Editor at Financial Newswire.

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