All you want to know before investing in the AI boom

Once the province of science fiction, artificial intelligence is today widely employed by businesses and tech start-ups. The power of AI - which include subfields like machine learning, natural language digesting and computer vision - means it can be utilised by companies to obtain a huge competitive advantage, whether it’s discovering a new medicine or suggesting new products for customers to get or movies to stream.

The impact can be seen in the market, where even amid the heady growth of tech stocks in 2020, the performance of AI companies and some AI-focused investment funds stand out. And with McKinsey estimating that the monetary benefit of AI for the global economy could be as high as $15 trillion over the next decade, there’s no reason to trust the party has ended - even while some analysts question sky-high valuations of tech stocks.

“Every industry has been transformed by AI, which will only accelerate in today's monetary environment as companies turn to improve productivity, reduce costs, and enhance human-machine collaboration,” Masroor Batin, leader of wealth management for the Middle East and Africa at BNP Paribas, says.

The need for AI has been confirmed across multiple regions of the economy in a Covid-19 dominated 2020. Not merely are major corporations upping their investments in IT, incorporating AI, cloud and cybersecurity, AI has also played a crucial role in accelerating the expansion of technologies to combat the Covid-19 pandemic.

Nevertheless, investing in AI is less clear cut than buying, say, solar technology producers or e-sports companies. For just one, there is absolutely no firm definition of what constitutes an AI company.

And with so much hype around AI, investors ought to be able to separate the wheat from the chaff, “For [AI] to end up being meaningful, it must produce an exponential benefit, not just get marketing hype,” says Matt Ocko, co-managing partner at capital raising firm DCVC.

What’s an AI company?

The good thing for investors is that people that have diversified equity portfolios will already have exposure to some of the world’s virtually all successful AI companies - in the United States, that’s familiar big cap names like Google, Amazon, Microsoft, Apple, Tesla and Nvidia.

Voice assistants such as for example Siri and Alexa employ AI to electricity conversations; Google, Amazon and Microsoft give machine-learning-as-a-service to many others; and Google and Amazon make use of AI to serve customised advertisings and generate product suggestions.

AI companies could be put into two groups: large companies and consultant niche players, according to Michael Topley, head of sustainable portfolio management at Barclays Private Bank.

Large cap technology stocks already enjoy strong cash generation, market leadership and frequently a good history of capital allocation through acquiring emerging technologies, while as providers of AI services they'll enjoy classic network effects because they attract more users, he believes.

“This AI will be something akin to the web - an omnipresent service that one could access for all your cognification needs. The companies offering these services will likely enjoy raising rates of go back to scale and strong barriers to entry,” he says.

Meanwhile, niche players may prove to be attractive investments, investors could be taking on “idiosyncratic risk around the efficacy of their algorithms, the size of their addressable markets and their capability to fight competition”, Mr Topley says.

Although some elements of the technology space seem overheated, “there is a very justification for the price appreciation several names have enjoyed, and my conviction in the ability of these companies to create cash flow later on has further increased because the start of year”, Mr Topley says.

Looking beyond large caps

For investors convinced of AI’s transformational capabilities, there are many of thematic investment funds that provides broader contact with the sector.

Actively managed funds include Allianz Global Artificial Intelligence fund, which includes returned around 64 % year to date. Another actively managed fund is usually ARK Innovation ETF, which covers a wide technology swathe such as for example AI, autonomous vehicles and robotics, and can be up around 83 % so far this season.

One element that both funds have in common is usually that their single most significant holding is going to be Tesla, which, at its peak in December, was up a lot more than 600 per cent since January 1.

Jeremy Zhou, vice president and brain of indexing solutions at FactSet, says they typically search for “pure play” firms that generate about 50 % of revenue from a particular industry or technology when constructing an index related to a style like artificial intelligence.

“When you are working with pure play firms, usually the likes of Google, Amazon, and Facebook are likely to receive kicked out [of the index], or in least will retain an extremely small weight as a result of broad nature of their businesses,” he says.

FactSet has constructed several indices round AI, including the one that is tracked by the iShares Robotics and Artificial Intelligence Multisector ETF, which includes returned above 40 % this year.

With regards to thematic funds, many incorporate AI with verticals including robotics, manufacturing and healthcare - Mr Zhou says these sectors have already been the first adopters of AI.

But adoption is speeding up, and AI is increasingly playing a job in consumer sectors. In May, ROBO Global, an index and study company, launched a new pure play AI ETF, following on from two existing ETFs covering AI in robotics and in healthcare.

"The timing was right because of this fund because we see an inflection point in artificial intelligence. We believe it will likely be a major driver of advancement and growth across various sectors,” says Lisa Chai, senior exploration analyst at ROBO Global.

Ultimately, the worthiness of AI lies not really in the technology and algorithms themselves, however in organisations' capabilities to harness them, says Ms Chai. “Investors should pay attention to the innovation influence that AI is making ­- we feel that there will be clear winners in this space as adoption of AI matures over the next decade.”

Despite the optimism, Ms Chai says it’s vital that you dig deeply right into a company to observe how it’s using AI, and the investments it’s building, such as for example hiring data scientists, since some companies play up the role that AI has of their organization to take good thing about the hype.

That view is echoed by Mr Ocko, who says that some companies utilise AI in a way that’s performative, applied to older undifferentiated technology, and even “just cynical marketing”.

Could a backlash hit valuations?

While the organization outlook for AI might seem to be to be an open-and-shut-case, it continues to be questionable just how much of AI’s impact will be positive and how much will be negative - something that could spark a backlash against AI companies. Contentious areas involve facial recognition, racial biases, deep fakes, and the amplification of disinformation via social media networks, like the rise in conspiracy theories such as anti-vaccination.

On the positive side, the impacts of AI-driven technology are vast, such as detecting criminality or automating risky and dangerous jobs. With the necessity to reduce human get in touch with amid the pandemic, many of these techniques have multiplied. “Corporations have been forced to adopt smarter, faster, less expensive, more human beneficial methods. And if there's any silver lining for the pandemic it’s that society-wide good provides been accelerated,” says Mr Ocko.

But as well the pandemic has highlighted the dangers of the spread of disinformation.

Companies already are seeing a good backlash against AI, but that is leading tech corporations to self-regulate, Ms Chai says.

Funds also have ESG screens set up, while regulators have a job to play, she adds.

“It’s a small amount of a good wild west currently concerning how these technologies are actually being used. But at the moment we're starting to see a large amount of the consortiums, and academia and technology companies and policy-led players doing work along [to develop standards],” she says.