AI - Opportunity or Bubble?
Artificial intelligence has rapidly moved from the realm of science fiction into everyday life.
From the way businesses analyse data and develop new products to healthcare, manufacturing and financial services, AI has the potential to transform large parts of the global economy.
For investors, that creates considerable opportunity. However, history also reminds us that genuinely transformative technologies can attract excessive enthusiasm and valuations. The challenge is therefore not simply identifying an exciting long-term trend, but deciding how much to pay for it and what risks are present.
The investment case for AI
The potential economic impact of AI is enormous. Businesses are investing heavily in the infrastructure required to develop and operate increasingly sophisticated AI models. This has already created significant demand for semiconductors, data centres, cloud computing, networking equipment and electricity generation.
Over the longer term, however, the opportunity could extend much further. If AI allows businesses to automate repetitive tasks, analyse information more effectively and increase the productivity of their employees, the beneficiaries may eventually be found throughout the economy rather than solely among today's technology leaders.
Healthcare companies may use AI to accelerate drug discovery. Manufacturers can use it to optimise production. Financial companies can improve fraud detection and data analysis. Retailers can manage inventories and understand customers more effectively.
We may therefore still be relatively early in understanding the ultimate economic consequences of the technology.
Not every AI winner will be an AI company
An important distinction for investors is between the companies developing AI and those which ultimately benefit from using it.
During the internet boom of the late 1990s, investors correctly recognised that the internet would transform the world. What proved considerably more difficult was determining which companies would ultimately capture the economic benefits. Some companies, such as Amazon, Ebay, Google etc, experienced huge growth whilst many other companies eventually failed.
The same could prove true of AI.
Today's dominant technology businesses have enormous advantages, including financial resources, data, computing infrastructure and established customer relationships. Nevertheless, technological leadership can change remarkably quickly.
Some of the greatest investment opportunities may ultimately emerge among businesses that use AI to lower costs, increase revenues or develop products that previously weren't possible.
At the same time, many companies may suffer as a result of AI, as their products or services are replaced by the Technology.
This is one reason why diversification remains important even when the long-term investment theme appears compelling.
Could AI be a bubble?
Possibly – and this does not necessarily mean that AI itself is overhyped.
History contains numerous examples of transformative technologies producing investment bubbles. Railways, electricity, automobiles and the internet all fundamentally changed society. Yet investors still suffered substantial losses when expectations and valuations became detached from economic reality.
The dot-com boom is perhaps the clearest modern example. The internet ultimately became even more important than many optimists imagined, but numerous internet-related shares nevertheless collapsed when the bubble burst.
AI could potentially experience something similar.
Investors are currently assigning very high values to some companies expected to benefit from AI. Those valuations often assume substantial future growth. If revenues or profits fail to grow as quickly as expected, share prices can fall significantly even if the underlying businesses remain successful. A wonderful company can still prove to be a poor investment if too high a price is paid for it.
The concentration risk
Another consideration is how much AI exposure investors already have without deliberately seeking it.
The world's largest technology companies now represent a significant proportion of major global and US stock-market indices. Consequently, an investor holding a conventional global equity fund may already have substantial exposure to companies such as Microsoft, Nvidia, Alphabet, Amazon and Meta.
Adding specialist technology or AI investments can therefore increase concentration considerably.
That isn't necessarily wrong, but investors should understand the overall exposure across their portfolio rather than considering each investment in isolation.
Investment beyond the obvious winners
AI may also create opportunities in less obvious areas.
Data centres require enormous quantities of electricity, creating investment requirements across power generation, electricity networks and energy infrastructure.
Semiconductor manufacturing requires highly specialised equipment and materials. Data centres require cooling systems, networking equipment and physical infrastructure. Cybersecurity requirements are also likely to increase as AI becomes more widely adopted.
The investment opportunity surrounding AI may therefore ultimately prove considerably broader than simply owning a handful of US technology companies.
Managing the risks
For long-term investors, diversification remains one of the most effective ways of managing uncertainty.
Rather than attempting to predict precisely which companies will dominate AI ten or twenty years from now, a diversified portfolio can provide exposure to technological progress while also investing in other sectors, countries and investment themes.
Periods of excitement can also be a useful reminder of the importance of rebalancing. If one part of a portfolio rises dramatically, it can become a much larger proportion of the overall investment than originally intended.
Periodically restoring a portfolio to its chosen asset allocation can therefore reduce the risk of inadvertently making an increasingly concentrated bet.
Opportunity without losing sight of risk
AI may prove to be one of the most important technological developments of our lifetime. It has the potential to create new industries, improve productivity and generate significant wealth.
That makes it difficult for long-term investors to ignore.
But investment history teaches an equally important lesson: transformative technology does not remove the importance of valuation, diversification and risk management.
There is no contradiction in believing that AI has extraordinary long-term potential while also recognising that some AI-related investments may currently be expensive and that periods of substantial volatility are inevitable.
For investors, the objective should not necessarily be to identify the next technological winner. It is to participate in long-term economic growth while maintaining a portfolio capable of weathering the inevitable periods when markets become considerably less enthusiastic.
The growth of AI, and its implications for companies, makes active investment management all the more important. Rest assured that our investment partners and fund managers are closely monitoring this new technology and its potential implications for company profits and valuations.
The value of investments can fall as well as rise and investors may not receive back the amount originally invested. Past performance is not a reliable indicator of future results. This article is for general information only and does not constitute personal financial advice.