Some fund managers are looking to provide AI exposure beyond the mega-cap stocks and index funds.sorbetto/iStockPhoto / Getty Images
As the first bloom of artificial intelligence euphoria focused on the Magnificent Seven stocks begins to fade, some investors are looking beyond these hyperscalers to play the AI theme.
The average investor defines AI as the “Mag 7,” says Sri Iyer, managing director and head of i3 Investments at Guardian Capital LP, and those stocks are represented heavily in major stock market indexes.
To that end, Mr. Iyer and his team is looking to provide exposure beyond the mega-cap stocks and index funds, focusing on AI subcategories, subindustries and subsectors with an actively managed investment fund launched last month.
Guardian i3 AI Technology and Innovation Fund GIAI-T uses AI agents to help find companies deriving significant revenue from AI or investing heavily in the technology.
The fund, with about 50 holdings, covers 11 subcategories, including cybersecurity, robotics, health care, consumer technology and cloud platforms, with a 70-per-cent tilt toward large-cap companies in power generation, AI infrastructure, quantum computing, semiconductors and software subsectors.
Mr. Iyer says AI companies can be divided into two buckets: enablers and adopters.
Enablers are building the infrastructure and platforms to deploy and protect AI solutions. Beyond the Mag 7 companies such as Nvidia Corp. NVDA-Q and Microsoft Corp. MSFT-Q are a broad range of companies, including memory and storage provider Micron Technology Inc. MU-Q, power company Vistra Corp. VST-N and cybersecurity company CrowdStrike Holdings Inc. CRWD-Q.
The adopters, such as cloud computing company ServiceNow Inc. NOW-N, can leverage AI technology in their products, services and operations to enhance operational efficiencies, improve customer experience and drive product and service innovation in a range of sectors including retail, finance and health care.
Mr. Iyer says that as “productivity layers start to show up in free cash flow,” stocks in the adopter bucket may come to represent up to half the fund.
Paul Moroz, lead portfolio manager of Mawer Global Equity Fund at Mawer Investment Management Ltd., uses a zoological analogy to parse potential AI winners and losers, breaking companies down into three categories: dinosaurs, rats and ants.
“The dinosaurs are big and slow, and they don’t evolve very fast,” he says.
Mr. Moroz points to obstacles such as company culture, regulation and governance structures that could hinder these companies’ ability to leverage AI fully. He cites the banking sector as an example in which regulatory and governance structures restrict AI adoption.
The second category is rats. These are companies that are willing to implement AI tools, but don’t have an enduring competitive advantage.
Mr. Moroz says a law firm with a large staff billing by the hour at the senior partners’ hourly rate could use AI tools to replace most of the paralegals and associates, but the excess profit margin may soon be competed away as other firms do the same.
The final category is ants, which can lift 10 to 50 times their weight.
“Companies that are willing to reorganize and restructure are the ants,” Mr. Moroz says. “They can carry a lot more business with fewer people and they can be wildly profitable.”
He cites Visa Inc. V-N as an example, which recently laid off 7 per cent of its workforce.
“My hunch is they’re reorganizing and evolving with technology to scale differently for both revenue and cost opportunities,” he says.
Mr. Moroz also cites Airbnb Inc. ABNB-Q, a company in an industry with a fragmented base of supply (rentals) and demand (renters).
“Whether it’s using AI to create and adjust listings, scan photos and match them to search terms, or make listing recommendations, they have the data, website and interactions and can use AI to create a better value proposition to monetize the business,” he says.
Similarly, a company such as S&P Global Inc., with business units that include a credit rating agency, market indexes and financial data and analytics, can embed AI into its processes to improve pricing power and gain a competitive advantage.
Mr. Moroz says trying to pick AI winners and losers is fraught.
“Sometimes, the key to good stock picking is less stock picking and more diversification,” he says. “There will be inventions out of the blue. Maybe we won’t need so much memory or so many data centres, or power generation. That’s why diversification pays off.”