Lessons from three great investors on how to ride the AI boom

The extraordinary performance of SpaceX during its first week as a listed company confirms that we have reached the ‘cake and eat it’ phase of the AI boom/bubble. This is the part of the cycle when investors want to continue enjoying the market’s gains and to bank what they’ve already got. Being on the sidelines is too painful but being fully invested is too fraught. You don’t want to miss out; and you want to avoid being carried out.

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An obvious question to ask today is what would and would not have worked 25 years ago during the dot.com bubble and how that might map onto today’s rhyming but not repeating re-run. With the benefit of hindsight, a sensible strategy was to: progressively rebalance away from technology as valuations became ever more extreme; to shift from growth to value; to gradually reduce exposure to the US in favour of a more internationally diversified portfolio; to cut the equity weighting in favour of bonds and cash; to focus on quality and sustainable earnings growth; and to adopt an equal- not capitalisation-weighted approach.

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Essentially you were looking to ride the end of the wave but to minimise the crunch when the board inevitably slipped away from under your feet. Obviously, you didn’t have a crystal ball while doing this, so the scale and timing of each of those moves was inexact. Just as it is today.

A further complication now is that the AI boom is subtly different from its dot.com predecessor. Even more than the internet, AI is a general-purpose technology that has the potential to transform every corner of the global economy. From more efficient manufacturing to the automation of routine administrative tasks, from accelerated scientific research to improved customer service, it is hard to think of an area of life that will not be revolutionised in the years to come.

To pursue the surfing analogy, it feels like we are riding just the first of a set of waves that could prolong the cycle much longer than was the case 25 years ago. The opportunity cost of sitting it out on the beach might be even greater this time.

All the more reason, then, to think about how to retain an exposure to the AI story without betting the farm on one single trend, company or outcome.

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The initial ‘picks and shovels’ phase of the AI boom is well under way and the risks of investing in the companies building the infrastructure are much greater than they were a couple of years ago. The investment case is well-understood and priced in for the first wave of winners: the semiconductor designers (Nvidia, Broadcom); the companies making the chips (Taiwan Semiconductor); and the memory (SK Hynix, Micron). Korea and Taiwan now account for more of the MSCI Asia index than China and Hong Kong.

Given the strong earnings underpinning these businesses, I would not bet against them. But equally I would not want to put all my eggs in this basket. Given their dominance of the indices, a sensible question is how much hidden exposure you already have to this story? It is almost certainly more than you think.

At the very least, it is time to look beyond the initial winners. An interesting parallel with the internet boom is the way in which the real beneficiaries of artificial intelligence may not be the companies that build the AI infrastructure but those that work out how to use it to best effect. So, I want to direct at least as much of the AI-related part of my portfolio to the users of the picks and shovels as to the businesses providing them. The software companies using AI to be more productive, the financial companies like my own using it to automate research, the healthcare companies making giant leaps towards life-changing drug discoveries, the industrial companies doing more with less.

At times like these, I ask what better and more successful investors than I would do. Crucially, there isn’t a right or a wrong answer and someone looking after their own money can mix and match the best approaches.

Someone like the legendary Fidelity investor Peter Lynch would, I suspect, be comfortable sticking with the obvious winners. His focus was on where earnings were growing and why. He was not particularly concerned with finding hidden gems. He looked for businesses that kept surprising on the upside. He would probably be happy continuing to own Amazon and Taiwan Semiconductor. He liked obvious stories that you can ‘illustrate with a crayon’.

Were his UK counterpart Anthony Bolton still investing other people’s money today, he would I suspect be more circumspect about the picks and shovels winners and more interested in the second-line beneficiaries. His question would be more like ‘where is the unrecognised earnings growth that AI is going to create?’ I think we might be moving out of a Lynch and into a Bolton market, one in which the challenge is not identifying the broad changes that AI will effect, but in finding the businesses that will benefit more from them than the market already expects.

The investor I knew best was Jim Slater, and his approach would have been different again. Unshackled by the need to justify his performance against a market benchmark, he would undoubtedly have ridden the AI wave with enthusiasm and got out altogether when his acute market antennae twitched close to the top. Slater is best known for a Lynch-like growth-at-a-reasonable-price approach. But in my view that was really an after-the-fact rationalisation of a much more instinctive investment style. He once said to me ‘I just know when something’s going to go up.’ He usually did.

I am not Lynch, Bolton or Slater. But my approach to the unfolding AI boom/bubble will be informed by all of them. Like Lynch, I will trust that sometimes the obvious story is the right one. Like Bolton, I will look for where the market may have got it wrong. And like Slater, I will try to trust my gut - and to act on it.

This article was originally published in The Telegraph.

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