Why physical AI is the next investment frontier

An interesting feature of the AI revolution is how negative we feel about it. When you consider the potential, it is surprising how focused we are on the cloud around the silver lining. It is eating our jobs; the economic benefits will never justify the massive investment; it takes away what makes us truly human. There is nothing new about this. From Luddites smashing looms to red flags in front of cars, people have always leant towards the status quo and worried about the consequences of innovation.

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But investment is the triumph of the optimists. Once you have taken sensible precautions against the unexpected, the best thing an investor can do is put their faith in the new and unproven. My biggest regret in 35 years of investing is a surfeit of caution. And that is why I was gripped by the latest edition of the Barclays Equity Gilt Study which, alongside its annual confirmation of the power of compounded equity market returns, focused on AI’s scarcely tapped potential to produce more with the same - and in doing so, to generate wealth.

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Large scale automation is relatively new. General Motors introduced the world’s first industrial robot as recently as 1961, to weld car parts. It was narrowly focused, and only possible in a highly structured environment, but it was a start. The second wave of automation shifted from physical to cognitive tasks but, similar to factory automation, was essentially an acceleration and expansion of existing human capabilities. Large language models are just an extension, albeit a powerful one, of the productivity improvements that computers have been delivering over the past 60 years or so.

The next stage of the automation journey is different, and potentially more interesting. The creation of humanoid robots, with both physical and AI-powered cognitive capabilities, turns the logic of automation on its head. It will create machines to operate within the human world rather than fitting people into the machine. By enabling them to operate effectively within our messy, unstructured world, it massively broadens AI’s potential to enhance productivity, to earn a return on the required investment, and to free up people for more rewarding activities.

Existing automation has been largely task specific, doing one thing better and faster. The new generation of AI-enabled humanoid robots will be able to perform a variety functions, moving between different human environments and replacing broad sets of low- and mid-skill tasks. They will be able to operate in unstructured workplaces and homes, performing services in hospitality, household work and maintenance. This massively expands the scope of the AI revolution. It is early days, but there is no practical barrier to us getting there.

For investors, there are a few key points to think about. First, the macro-economic implications, then the market impact and finally the asset allocation consequences.

Starting with the macro, the shift from cognitive to physical AI will increase the number of activities able to benefit from the new technology and speed up adoption. This will lead to higher productivity gains for the whole economy. The areas that will benefit most from physical AI are precisely those relatively untouched by today’s digital version.

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A second consequence that is relevant to investors is an acceleration of the shift away from labour to capital. The limiting factor will no longer be finding the right people but the funding for the physical infrastructure (including scarce metals and other rare earth commodities). Putting together the brain (software) with the brawn (mechanics) and batteries will require similar investment to the gargantuan spending on the data centres powering today’s cognitive AI revolution.

That capital requirement has a further economic implication. If capital is scarce and in demand, its cost will rise. The neutral real interest rate will be higher in future than it has been during the capital-light growth of software. Even if more machines and fewer workers reduce inflation, bond yields could be persistently higher in the new world.

A potentially more important investment consideration is the tendency for investors to underestimate the impact of revolutionary new technologies. Barclays points to four recent breakthrough developments that were significantly underplayed, if not outright dismissed, in their early stages. Smartphones, streaming services, cloud computing and electric vehicles saw a similar pattern of early expectations anchored to narrow use-cases that totally underestimated the total addressable market.

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There is a geographical allocation consideration for investors too. Barclays believes the decade of the robot will belong to China. Already it has a considerable lead, installing around half of the industrial robots globally (nearly ten times as many as the US). It also dominates the market for humanoid robots that will drive this next phase of automation, accounting for 85% of those built in 2025. This is not accidental. China has been responsible for 70% of robotic patent filings since 2000, versus 4% for the US. The robotic future is already China’s industrial policy. And don’t forget Japan either, which has deep expertise in this area.

The final investment conclusion for me is an optimistic, contrarian one at a time when anxiety about an AI bubble is prevalent. It is entirely possible that the AI narrative has got ahead of itself in the short run. I do not rule out a painful correction, possibly soon. The transition will not be painless and there will be difficult social questions to address as wealth is concentrated in the hands of dominant firms, key individuals and first-mover countries. But in the end, higher productivity is the only viable path from low skills and poor wages to higher added value and decent incomes. We are on this journey. We must make the best of it.

This article was originally published in The Telegraph

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.