2nd June 2023
Rarely a day goes by without hearing or reading something about Artificial Intelligence (AI), usually something terrifying. Only this week, we read that AI could lead to the extinction of humanity, which follows comments from experts and ‘Godfathers’ of the technology that the pace of evolution has even taken them by surprise and could lead to bad actors using AI for nefarious causes. The debate on this is rapidly emerging, and the impact of technology on mankind is absolutely frightening, but it is not something I am qualified to comment on (I can barely use my iPhone!) however regardless of your views, it feels as though it is something that the investment world needs to take very seriously.
We know that AI has been around for years with IBM’s Deep Blue beating Garry Kasparov at chess in 1997, but the main experience I had with it this year was asking ChatGPT to write poems on random subjects such as investment trust discounts. Now, suddenly the end of the world is nigh and every company in the world must seriously consider how to incorporate AI into their business to survive, let alone grow, and every active fund manager needs to build its impact into their fundamental analysis. Quality growth managers will have to reassess the long-established barriers to entry or the deep moats of their chosen companies when those competitive advantages could evaporate overnight. Value managers will have to reassess whether their undervalued companies will revert to their mean valuations if business models are permanently broken. The ranges of potential scenarios when assessing companies’ future growth prospects now seems much wider due to the emergence of AI.
Any current conversation on AI must include Nvidia, the manufacturer of the (supposedly) only chips powerful enough to cope with AI’s huge demands for data processing. Last week, it was reported that Q1 quarterly earnings were down year on year but Q2’s guidance was 44% higher than expected on the back of AI related demand. That news moved the share price up 25% on the day even though the shares were already up 100% in 2023 prior to the announcement. In terms of its valuation, Nvidia was trading at a historic price to earnings ratio of 150 x prior to that announcement and now trades at 200 x. Looking forward, the market is applying an 85 x forward (in the next 12 months) PE ratio which assumes its earnings will be 160% higher this time next year. Is that 160% growth a number the thousands of participants have collectively produced due to forensic analysis on the demand for Nvidia’s products and Nvidia’s ability to manufacture and supply them, or simply extrapolated the 44% quarterly earnings growth for the next year? I suspect it is the latter. There is no doubt that Nvidia is a high-quality company but to us the current valuations seem to reflect its scarcity value given it is the most obvious winner in the scramble for AI exposed companies. We accept that there are more experienced investors in this field that either believe the valuation can be justified, or it might simply be that being underexposed to what is now the fourth biggest company in the US stock market is a risk that most Fund Managers cannot afford to take.
You may be detecting a whiff of cynicism in my Nvidia comments, but it is more to do with our valuation-led investment process that makes it hard to get our heads around these types of numbers. However, that should not stop us investigating these fast-growing investments that might generate attractive returns for our investors, particularly those that have signed up for a higher risk mandate such as our Global Opportunities Fund. That is why we have met with the Managers of the Polar Capital Automation and Artificial Intelligence Fund this week. While this Fund is managed by the same team that manages the highly successful Global Technology Fund and Investment Trust, it has a much broader investment universe that looks beyond technological companies, although it does and will always have a very high allocation to tech companies (Microsoft and Nvidia are the two largest positions). It can invest in any company that is set to benefit from successful adoption of AI into their business. The Fund was launched in October 2017 so has not only been launched to jump on the bandwagon, it focusses on profitable companies and has a bias towards incumbents with deep pockets to continue financing investments into AI and crucially pay for likely significant expenses surrounding inevitable regulation. Apart from Nvidia’s eye-watering valuations on which the Polar Managers take a pragmatic view, the characteristics of the Fund resemble more a growth-style portfolio than a technologically focussed portfolio. If AI is a genuine investment opportunity at an inflection point at the bottom of the technology adoption J-curve, there are likely to be as many losers as there are winners and I think at this stage it pays to outsource the day-to-day management of the theme to experts who have already been on the AI journey for at least six years. If AI turns out to be an overblown fad that we will look back on and wonder what we were all worrying about, I suspect the downside from owning this Fund will be much less painful than owning Nvidia.
We do already have some indirect exposure to this fascinating theme, via our investment in the Bluebox Technology Fund, but have not invested directly yet. If we do, we will be sure to let you know.
Daniel Lockyer – Senior Fund Manager
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