This week’s Investment Soundbite Q&A from FundCalibre is with Ian Mortimer, co-manager of the Guinness Global Innovators fund. Ian discusses the recent hype around Artificial Intelligence and covers the pros and cons of the latest developments, before discussing other innovation themes in the portfolio.
(Recorded 14 June 2023)
The fund focuses on finding and investing in innovative and disruptive businesses – how do you actually make money from these types of companies?
The word innovation can sometimes throw people, as I think it can mean different things to different people. We believe the best way to find these companies is to start by looking for secular growth themes, or areas of innovation within the market, and then find companies that have exposure to those themes. The problem is if you just stop your research there, the big risk is you could follow the story or the hype cycle, which could be very exciting, but actually, does it make a very good investment? So, after that initial stage, we apply quality filters to make sure that it is a strong business, it is a business that’s profitable, it’s a business where we can actually understand how the company is making money and what that might look like going forward.
The next stage really – and the bigger risk for investing in growth – is that you pay up too much for the future growth. Growth is pretty uncertain and it mean reverts very quickly. So, what we are then trying to do is apply a valuation discipline ie. buy the interesting areas, buy the good companies where they have long pathways for growth, but be aware you want to limit your risk. That’s ultimately what we’re trying to do within the portfolio.
AI is one of the themes in this fund. Please talk us through that theme with some examples.
AI has very much hit the zeitgeist recently, since ChatGPT hit the headlines and then it really accelerated after Nvidia Corporation posted its results where it demonstrated that it wasn’t necessarily just a good idea, it was actually being seen in company profitability.
We also did some analysis ourselves where we created a kind of ‘artificial intelligence’ basket and we were able to look at how that performed relative to the benchmark and what the benchmark would have delivered without those single stocks. The result was that the benchmark would have been flat and those type of stocks would have been up around 16% – 20%.
The reality is that it does appear to be a very important new technological idea that will have significant impacts across large swathes of both businesses and individuals, whether that’s across jobs, productivity etc. And, like most new technologies, it will have significant benefits and there will also be concerns about how it’s used.
The bigger thing to remember though, is that AI is not a new thing. The ideas and the processes – even if it’s just large language models and so forth – have been around for a long time, it’s the ability to actually execute that and do those computations that is new. And we obviously recognise as much as other people do, the pros and cons.
But from an investment perspective, the first thing to do is to take a step back and remember what I mentioned earlier – don’t buy just the story; it’s important to really understand what this is doing for individual companies.
The way we’ve already had exposure to AI in the portfolio, is ultimately through businesses that are already doing quite well i.e. it’s an additional benefit to what the company is already doing, as opposed to the next big potential thing, such as a startup where that’s very, very uncertain.
Companies like Nvidia, we’ve held in the portfolio for over a decade. We also have a number of semiconductor stocks like Taiwan Semiconductor Manufacturing Company Limited, also equipment manufacturers like Applied Materials, Inc., and Lam Research Corporation. We see the demand drivers for their products increasing and being much broader than they were historically, potentially making these businesses a bit less cyclical.
Obviously, some of the big cap companies like Alphabet and Microsoft are benefiting. A lot of what I’ve just described are the enablers, the picks and shovels or the computational power to provide these services.
On the other side, you’ve got more of the integrators, the Adobes of this world or Salesforce.com, Inc. that we also own, or Intuit Inc., whereby they’re hopefully going to successfully use this new technology to improve their services, grow their revenues and ideally grow their margins alongside.
Tell us more about Meta and some of the opportunities in the metaverse
Clearly Meta has had an extremely strong run this year from a relatively low base, having underperformed quite significantly up to that point. From a metaverse perspective, the way we were looking at it was, that’s an interesting area, but actually its core business remains extremely attractive from an investment perspective, in terms of the advertising revenue and the high margins and low asset requirements that that business likes. That’s really our main reason for holding onto the stock. And then, clearly, they’ve done a good job of listening to the market and focusing more on margins of profitability.
Where that leaves you – in terms of the metaverse – is you have a good optionality on an area that could potentially be very attractive. Clearly, companies such as Apple Inc. coming into that market as well is going to be beneficial. And I think it is trying to understand how that might then play out which is often the case in these types of technologies. It can be quite hard to see in the short term, but for us, in terms of the investment perspective, you’ve got a really great core business that I think is very attractively valued, and now there’s some optionality on some growth areas because they’ve been less profligate in terms of their spending and that carries less risk.
Another theme in this fund is payments and fintech. Tell us a little bit more about this theme and whether the recent banking crisis had any impact on any of your holdings.
When we talk about payments and fintech, we address these themes from a much broader perspective. We’re not putting ourselves out there to be spotting the next big trend before anyone else sees it. For us, it’s all about putting yourself in a position where the companies you’re investing in have good pathways for growth. Often, they’re more established and well-known to many people, particularly on the investment side.
What we’re seeing nowadays is reflecting the change in demographics, which is clearly the change to a cashless society. And it’s also about the plumbing around that. We have avoided any investments in any specific kind of crypto, Bitcoin-type companies or products which we think is questionable both from a regulatory perspective and also the speculative nature of what those business models may look like in the future. We’ve been looking more at areas with companies that are simpler to understand, like PayPal Holdings, Inc., Visa Inc. and MasterCard Inc. Visa and MasterCard are examples where they essentially have an oligopoly on the payment processing ecosystem which clearly makes them a very strong competitor and therefore, an interesting investment.
At the same time, we also own a company called Intercontinental Exchange Inc., which is an exchange group. Exchange groups are interesting investments in general, in terms of their business models – they are difficult to replicate, have quite high barriers to entry but also essentially are very asset light. We think that is attractive. But latterly, those types of businesses have really benefited from essentially owning lots of data. Many of these businesses are providing data sets using that data to make further analysis. And, going back to that first point where we were discussing AI, clearly large data sets are something that could potentially be a lot more attractive going forward.
So, there are many ways to look at the financial space and that’s our perspective. Generally speaking, we carry low exposure to the more traditional banking sector as we don’t see the characteristics that we are looking for in our quality growth portfolio.
Innovation has been a tough place in the last 18 months or so for investors. What’s your long-term outlook for the area?
When people say innovation, I think they often think of disruptive, small companies. Post-pandemic we effectively saw a bubble – I think it would be fair to describe it as that – with many of these early stage, pre-earnings, get-big-quick revenue-type growth companies, really become extremely overvalued, relative to their core businesses. And reverting to that idea of paying up a lot for the prospective growth profiles these companies may have, which clearly then unwound. And we see that across markets again and again, particularly in our areas, like biotech, like 3D printing for example, which have been essentially areas that have got bid up far too far.
And I think it was really those specific areas with more speculative growth companies that really suffered most, particularly last year. I think they had a little bit of a respite as we came into the beginning of this year. And then that quickly unwound once more as we came through some of those trickier markets of February with the Federal Reserve talking about keeping high rates for longer. And then clearly the kind of the worries around the exogenous shock of the US banking crisis.
I think that the changing interest rate regime on a higher duration asset – in terms of those cash flows being much further out – had a big impact. It was a double header; they’d got ahead of themselves in terms of what the market was expecting for their future growth, which then disappointed, followed by the valuation derating, which are the two things that work in combination to fell share prices that have risen too far.
Alongside these companies, are the broader growth companies and they were also affected by that change in interest rate regime and last year the market very much punished growth. This has now changed somewhat. A lot of those quality growth companies, particularly those where one can make the case for secular growth – growth through a kind of lower growth environment and not necessarily affected by any recessionary pressures – have started to be rewarded again.
We think quality growth companies that compound profitably and successfully are those where you are trying to limit your risks – whether that’s on the story or on what you’re paying for the future growth. I think they still offer an attractive investment proposition as part of a client wider portfolio.
Listen to the full interview here:
