INSIGHT

Investing in AI

August 2018

Investing in Artificial Intelligence

By Simson Sanaphay

Fear and anxiety are contagious. If markets become volatile from issues like “Trade Wars” and it spooks an investor to liquidate investments and hoard cash you can be sure that action will spread to someone else they know, and so the contagion begins. It is why portfolio management is about looking at the long term, so as to smooth out the impact of short lived volatility. However, there is another aspect not as often discussed – and that is having the conviction to follow a thematic.

A thematic can be forward looking, track current events or be based on past events. It generally tracks structural changes or macroeconomic trends. Without doubt one of the greatest structural changes occurring currently arises from the looming impacts of Artificial Intelligence (AI).

It throws up terms like disruptive technologies but it is about leap frogging a current impediment to delivering a result to consumers. It may be a medical breakthrough, new payment system or new form of transport. Investing in the future requires an investor to not just research a technology but also how it relates to the broader environment.

On the face of it, an investment in driverless cars would be considered as taking a position in the automobile industry. But for a thematic investor it could just be an aspect of an energy play, with other parts of the thematic invested in solar cell technology, logistics specialists and networking solutions – why? – because cars of the future will likely be self-sustaining for fuel needs and require massive interconnected networks to be on-demand where consumers need transport and arrive safely by communicating with all parts of the transport network. Designing such a portfolio would require geographical diversification.

With its global footprint Citi scours the planet for companies positively exposed to investment themes that we believe will represent the future corporate landscape. Out of 82 wide-ranging themes that we assess from “clean water” to “climate change” and “top brands” to “urbanisation”, an investment thematic that scores well in our investment screening process is AI.

In essence the AI theme is driven by the development of computing technology being able to perform tasks typically requiring human intelligence, such as speech recognition, visualisation, decision-making, translation between languages and automated categorisation and many investors should be familiar with these applications, simply take a close look at your smartphone.

In fact, AI is a diversified technology thematic that is correlated to Citi’s other investable tech themes such as data storage (Big Data), cloud computing, smart mobile devices demand, video games, patents and intellectual property and the internet of things (IOT).

We find that picking a particular niche within tech can sometimes mean investors are concentrated in the one technology, platform or solution, much like betting on Window or MacOS. However, the broad nature of AI allows investors to diversify as the applications are varied and numerous. AI is not confined to one part of the technology value chain but represents tech in general.

AI is being viewed across all sectors and industries as a potential competitive advantage. For example, financial services and banks are deploying AI to counter the threat of Fintech, pharmaceutical firms are deploying AI to develop new and effective drugs and improve health outcomes. In manufacturing AI is being deployed to automate the supply chain and in logistics its transforming how product will be delivered.

Citi estimates outside the tech sector itself, financial services are one of the leading early adopters of AI in terms of spending. We expect Global Banks are set to spend USD$8bn on AI in 2019, that’s the size of the entire AI market in 2016.

The impact of these disruptive technologies is evident in company reporting. In 2017, nearly 66 per cent of companies in the S&P 500 discussed an emerging disruptive technology in US Securities and Exchange Commission (SEC) filings. It is also now evident that perceptions of corporate innovativeness are correlated with equity market returns. The top innovators outperformed the S&P500 by an annualised 8.3 per cent.

Artificial intelligence themed stocks are on average buy rated by the street. This is important as on balance the buy-rated constituents have positive price to growth and therefore expected positive returns. Artificial Intelligence buy rated rankings are a lot closer to Buy/Strong Buy than 80 per cent of other investment thematic that Citi monitors. The street and Citi are not half-convicted in this arena.

Putting that into context the tech sector now comprises 25 per cent of both S&P 500 market cap and earnings per share (EPS). So valuation does look reasonably priced, however, when we compare IT to the broader market and take into account strong growth expectations the price premium is below the average.

That means at 19x times next year’s earnings, Tech’s 13 per cent valuation premium relative to the market is low compared with the long-run average premium of 22 per cent.

A final thought, ask yourself is your investment portfolio subject to the whims of monetary policy, short term issues like trade wars or even a past thematic like taking positions in the big four banks to get an exposure to a past “hey day” of credit growth in Australia.

Enduring portfolios need asset class and geographical diversification but in the age of technology an investment in the future also requires close attention.

Simson is a strategist for Citi’s wealth business

Important Information:

Disclaimer: This document has been prepared for general information purposes only. Any advice contained in this document has been prepared without taking into account your objectives, financial situation or needs. Before acting on any advice in this document, Citi recommends that you consider if it's appropriate for your particular circumstances. Investors are advised to obtain independent legal, financial, and taxation advice prior to investing.

All opinions and estimates constitute Citigroup Pty Limited AFSL No: 238098 ("CIti") judgement as of the date of this report and are subject to change without notice.