AI investing and where to find the next generation of winners

You’d have to be unusually self-confident to emulate Nick Train’s investment approach. The manager of the Lindsell Train UK Equity Fund has stuck with an almost recklessly concentrated portfolio, just 21 shares that might best be described as an anti-AI fund. You’d struggle to put together a collection of stocks apparently less likely to thrive in a market fixated on the artificial intelligence boom.

The fund’s top ten holdings include five shares that scream AI disruption: RELX, Sage, London Stock Exchange, Experian and Rightmove. The other two shares in his top seven, which accounts for 60% of the value of the fund, are unexciting consumer stocks - Diageo and Unilever. Train has not been drinking the AI Kool Aid.

Well, the charismatic fund manager has finally had his moment. Since the beginning of October, six weeks in which investors have fallen spectacularly out of love with the AI boom, he has enjoyed his best performance in a quarter of a century. Those seven shares have delivered an average gain of 18%. The tech-heavy Nasdaq index has fallen over the same period by 6%.

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I take my hat off to Train. Not many fund managers would possess the self-belief to stick with such a defiantly unfashionable set of shares long enough to have the last laugh. Most of us would have thrown in the towel long ago.

But the most interesting aspect of his approach is that it is less anti-AI than it seems. Rather, it recognises what I have suspected for some time - that the next big opportunity from artificial intelligence could lie not with the companies building the infrastructure but with those that ultimately capture the economic value created by the new technology. Especially if they have already been written off as victims.

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We have been here before with previous technological revolutions. The best historical parallel to AI is electricity. Like AI, it was in its time a general-purpose, enabling technology. The initial investment opportunity in electricity was generation, building power stations and distributing power. But the seismic transformation came when businesses redesigned their operations to take advantage of cheap and reliable energy. Not just using electricity to do existing things better. A complete rethink. AI will follow a similar template.

There will be a few different ways to the top of the AI mountain. The first will be companies that use AI to reduce their costs. Businesses with high labour costs, repetitive processes and plenty of scope for automation - think banks, insurers, logistics and industrial companies.

The scope for established, low margin businesses to be transformed is substantial. A company with sales of £10bn, costs of £9bn and operating profits of £1bn could increase its profits by 45% simply by cutting out 5% of its costs. Even if everyone else is doing the same, and the business is forced to pass on half the gain to its customers, it would represent a meaningful increase in value.

The second type of winner will be the owners of scarce assets. Companies with proprietary data, or trusted customer relationships, regulatory permission or brands that AI cannot replicate. This is where Nick Train has been fishing - RELX and the London Stock Exchange both fit in this category. It has taken the market a while to catch up.

The third group of beneficiaries will be companies that use AI to do things that just weren’t possible before. Drug discovery and diagnostics are good examples. Companies like AstraZeneca or Roche could be winners here, although faster research does not necessarily translate into commercial products.

The fourth category is also square in Nick Train’s sights. Experian and Sage are good examples of established businesses that can integrate AI into workflows on which customers already depend. These kinds of companies may be able to charge for new capabilities or deepen their relationships with customers.

There is a catch, however. AI might make a company’s services cheaper to deliver but it could also make them easier to replicate. The competitive advantages of established businesses will matter more than ever.

The final set of winners is the most exciting but the hardest to predict in advance. These will be companies that can create entirely new products or services. Areas where this might be possible include healthcare, education and financial advice.

The biggest beneficiaries from AI could well be the companies that can both increase margins on their existing customer base by cutting costs but also increase their addressable market. In financial advice this might be through reducing the cost of personalised advice to wealthy clients who are already on the books while simultaneously providing advice more economically to people who cannot currently afford it.

In healthcare, the cost benefits may come in the form of faster diagnosis or reduced administration. The bigger opportunity may be in finding new treatments or better prevention.

What is interesting for an investor today is that there are different ways to tap into AI that will survive the current turmoil in the sector. The opportunity in infrastructure and enabling technology will not disappear even if political opposition to data centre construction slows the pace of investment. But crucially, this is not the whole story - which is why the turbulence in some corners of the AI theme has failed to really dent the market’s resilience.

That doesn’t make it an easier investment landscape to navigate. It makes it less predictable, but also potentially rewarding for investors who can think outside the box and have the courage to stick to their convictions.

The internet transformed many areas of the economy. It created wealth for the owners of a relatively small number of companies and destroyed the economics of others while at the same time transferring value to consumers. AI will do the same.

We are not moving from one set of winners to another in a predictable sequence, tempting as it is to frame it in this way. Rather we are moving from a concentrated investment story to a more diverse and uncertain one.

Nick Train’s experience is that finding the eventual winners is only half the battle. Having the courage to stick with them while everyone else is looking away is a bigger challenge.

This article was originally published in The Telegraph.

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