Artificial intelligence, or AI, has been a presence for almost 75 years, but since the recent emergence of platforms capable of generating essays, coding websites, and creating images in response to human prompts, widespread interest has peaked in the past six months. This has led many investors to question – should I be investing in AI?
In this article, we have explored the origins of AI, how viable is AI investing and what considerations should you make before getting started.
What is artificial intelligence?
AI, in its simplest form, refers to the ability of computers to think and learn. It encompasses various forms, but it commonly involves simulating human intelligence in machines. Complex computers can be trained to process and analyse vast amounts of data, recognising patterns within it.
The foundational work on AI came from British mathematician Alan Turing, renowned for his contributions to cracking the Enigma code. Turing proposed that computers should be capable of utilising available information and reasoning to solve problems and make decisions, much like humans do.
In a 1950 paper, Turing posed the question, “Can machines think?”. He then introduced the Turing test, an experiment in which a human interrogator attempts to distinguish between a computer and a human based on text responses.
Since then, AI has made steady but gradual advances. In 1997, IBM’s Deep Blue defeated reigning chess champion Garry Kasparov in a multi-day rematch. In 2011, IBM’s Watson computer system won $1 million by outperforming human champions on the US game show Jeopardy!
However, it was the recent release of ChatGPT, a free AI bot, and its competitors that truly brought AI into the public consciousness. Many anticipate that this technology will transform or even replace jobs across various industries.
The previous “brief sparks” of AI emergence and promise ultimately fizzled out due to cycles of overpromising and under delivering. This narrative is changing primarily due to the reduced cost of accessing AI for both businesses and consumers.
When Turing initially proposed AI, leasing a computer could cost up to £70,000 per month, limiting its utilisation to prestigious universities and major technology companies. Just 30 years ago, owning a digital camera with a 10-megapixel sensor could cost over £1,000. Today, most people carry a smartphone in their pocket equipped with three 10-megapixel sensors.
Storing and processing large volumes of data have also become much more affordable, for instance, the basic version of ChatGPT is freely available for use.
Growing AI stock prices
Nvidia, a world leader in Artificial Intelligence Computing, saw its stock price soar by approximately 160% this year alone. The company announced last week that the demand for its graphics processors, essential for training AI systems, would generate $11 billion in revenue in the three months leading up to the end of July, exceeding the $7.2 billion expected by Wall Street analysts.
AI has become a major topic of discussion among American businesses. According to data from FactSet, 110 companies on the S&P 500 index (the largest US companies), mentioned AI in their calls with Wall Street analysts following their Q1 2023 results. This represents nearly three times the number of mentions compared to the same period in 2020.
As stocks of companies benefiting from the AI boom have surged, so have the funds that track them. The L&G Artificial Intelligence exchange-traded fund (ETF) has risen by 24% this year, outperforming the 9.3% increase in the S&P 500. The top holdings of the ETF include Microsoft, Alphabet (Google’s parent company), and Nvidia.
Is AI investing viable long-term?
Investors are becoming increasingly excited about AI investing. However, it is crucial not to let enthusiasm for a theme dictate investment decisions or abandon caution. There is a deluge of AI investing related hype driving the financial markets, with many tech companies eager to emphasise their involvement in AI to capitalise on the trend.
This trend has drawn comparisons to the late 1990s dotcom boom when companies sprouted seemingly out of nowhere, mentioned their website launches, and experienced surges in their stock prices. Many firms even rebranded with “.com” in their names to take advantage of the trend.
The notable winners in 1999 included AOL, Time Warner, Lucent, and Nortel, all of which eventually lost their dominant market positions to other companies. Similarly, there will be significant winners and losers in the AI space, but at this moment, it remains uncertain who they will be.
What are the positives of AI investing?
While it is hard to ignore the parallels between the current AI boom and the late 1990s dotcom bubble, many companies that were expected to become leaders back then didn’t exist just five years prior.
In contrast, Nvidia celebrated its 30th anniversary in April, Microsoft is nearly 50 years old, and China’s Baidu was founded at the turn of the century. These are massive, well-established businesses with substantial cash flows and some of the most robust business models worldwide.
Some argue that Nvidia’s stock is overpriced, given its price-to-earnings ratio of around 200, compared to the S&P 500’s average ratio of 18.5. However, looking at Nvidia’s forward price-to-earnings ratio, which considers expected future earnings, provides a more favourable perspective. Wall Street estimates anticipate earnings per share of $9 this year, resulting in a forward price-to-earnings ratio of approximately 44.
Recent developments have transformed Nvidia into a completely different business, it’s in a completely different space than it was three months ago, let alone a year ago. This rapid change shows the opportunities inherent to AI investing.
There is still much progress to come in the field of AI also, the breakthroughs witnessed this year suggest that we might be at the beginning of another computing paradigm comparable to the PC, internet, or smartphone.
What are the risks of AI investing?
Specific investments, including AI investing, carry higher risks compared to diversified global stock portfolios. A specific theme is inherently less diversified than a fund holding over 3,000 stocks across multiple sectors.
Specific funds also tend to be more expensive than index trackers. For instance, the L&G Artificial Intelligence ETF has an ongoing annual charge of 0.49%, while the Vanguard FTSE All-World ETF charges 0.22%.
Furthermore, the chances of correctly selecting the stocks that emerge as the major winners are slim. If there had been a mobile phone ETF in the early 2000s, it would likely have included Nokia, Motorola, and Blackberry as top holdings. These companies were not the ones that ultimately capitalised on the widespread adoption of mobile phones.
It is also worth noting that an AI ETF will likely overlap with other funds in which one invests. The four largest holdings of the L&G fund, Microsoft, Alphabet, Nvidia, and Amazon, are also among the top five holdings of the Vanguard Total US Stock Market ETF.
Moreover, AI investing may not unfold as expected. Concerns regarding regulation pose a significant threat. For example, Italy temporarily banned access to ChatGPT due to privacy concerns, while the European Union is working on an AI Act to protect citizens’ rights.
While AI presents incredible possibilities, there are reasons for caution. Governance challenges arising from AI-generated student essays are just one minor example of the issues these systems can create.
AI Investing may not be as straightforward as it seems, before diving headlong into any investment, it is essential to take a step back, take a deep breath, and evaluate the risks. While the potential pay-offs are significant, thematic investing is speculative.
AI Investing – What you should do
As with any investment, diversification is essential. While one can select individual stocks, predicting the winners and losersin the AI space is challenging. A more prudent approach would be to invest in a fund that provides diversified exposure to the AI theme.
The Global X Robotics & Artificial Intelligence ETF is an option that includes robotics alongside AI. Its top holdings include Nvidia, Keyence (a Japanese automation specialist), and Intuitive (a robotics products manufacturer used in surgery procedures).
Broader technology funds can also capture AI investing while providing exposure to other tech trends.
AI Investing and specific stocks
Companies involved in AI infrastructure encompass chip designers, manufacturers, as well as providers of servers, networking, and cloud computing solutions. Alongside Nvidia, consider companies like Advanced Micro Devices, ASML, Arista Networks, Taiwan Semiconductor, Cisco, and Microsoft.
These companies are analogous to the “picks and shovels” sellers during the 19th-century US gold rush, who often made more money than individual gold prospectors.
Nvidia, in particular, plays a crucial role due to its chip technology, which has proven highly suitable for AI computation. Around 90% of generative AI programs are trained using Nvidia chips.
Investing in Amazon already provides exposure to AI investing, as most AI computing is done using its Web Services cloud platform. Alternatives to Amazon include Cloudflare and Snowflake, which are also viable AI investing paths as well.
Is AI investing just a tech story?
AI’s impact extends beyond the technology sector. It is poised to disrupt various industries. AI could well be a global phenomenon, transcending sectors and regions.
A prime example of AI disruption is Thomas Cook, the bankrupt travel agent. Its downfall was largely due to management’s failure to recognise the threat posed by online booking platforms like Priceline, Expedia, and booking.com. These platforms leverage AI to offer personalised recommendations and competitive pricing.
In the future, leading companies in all industries will be determined by their ability to engage with and utilise AI effectively. Firms such as John Deere, which is developing driverless tractors and AI-powered weed detection systems, exemplify this shift. Upstart, a lender utilising AI to assess creditworthiness, is providing better loan access to disadvantaged communities.
Recursion Pharmaceuticals, Duolingo, Roblox, and Tesla are other notable examples of companies leveraging AI to innovate across various sectors. AI investing might not end up being a niche sector of the stock market, considering AI’s application in a range of industries.
AI Investing – Should I go for it?
If you believe that AI will play a significant role in our lives, AI investing can be worth considering. However, it would be prudent to exercise caution amid the increasing number of companies using AI as a buzzword to boost their stock prices.
Focus on companies that genuinely enhance their products, services, and business models through AI, rather than those merely mentioning AI to attract investors amidst all the hype.
Picking winners in the AI space is challenging even for professional investors, and valuations continue to rise. There is a possibility of a new tech bubble emerging, particularly as interest rates increase, which historically poses challenges for growth stocks.
While the rally may continue, high US interest rates or further increases could potentially lead to a decline in company valuations.
AI Investing & Brite
As for Brite, our investment philosophy is based on taking the long view and focusing on protection first, as nobody knows what’s around the corner.
Our investment platform lets you decide your investment approach based on your goals and attitude to risk. We then do all the hard work using our asset management professionals and technology to execute portfolio solution trading. Therefore if AI investing is something that interests you, we will do our best to ensure you get the most of your investments in that sector.
Market volatility is a normal occurrence, however, over the long term, the stock market has always proved to be the best way of growing your money and maintaining your purchasing power.
Contact Brite here if you want to learn more about how we invest, especially in the world of AI.