With megatrends, new investors often go for the largest potential winners, even though these stocks might be badly overhyped or overvalued. Thanks to Fear of Missing Out (FOMO), they latch on to rising stocks, hoping a hot trend will keep going. More often than not, this perceived ‘hot hand’ burns investors who buy into the trend too late or are seduced by hype.
Artificial Intelligence (AI) investing will follow a similar path to other megatrends, burning investors and also creating long-term opportunity.
There’s a recurring pattern in megatrend investing. Novices buy into the initial phase of a hot trend too late when media and market hype is rife. They confuse investing with speculating, unaware that there are many more losers than winners in newer megatrends, such as AI, and the uncertainty involved.
Then, having suffered heavy losses, they vow never to invest in AI stocks again. The media is full of negative stories about the investment trend and brokers publish less research on companies exposed to the trend because there are fewer capital-raising opportunities. The hype fades.
In turn, investor interest in the trend wanes because fewer people are looking, just as company valuations become seriously interesting. I suspect this trend is in play in clean-energy stocks that have been battered in recent years.
Back to AI. This week’s The Australian had a front-page story on a tech company paying $100,000 sign-on bonuses to recruit software engineers, such is the soaring demand for tech experts with AI skills. The story was another indication of the ‘AI rush’ underway and the money being thrown around.
There are four main investment considerations for prospective investors in AI,
First, beware chasing megatrends higher after stocks initially soar. For example, I have liked the global semiconductor sector as a play on AI for some time, having identified the Global X Semiconductor ETF (ASX: SEMI) a few times in this column since 2021. More AI means more semiconductors required.
SEMI provides exposure to 30 of the world’s largest semiconductor stocks. The ETF is up 69% over one year to 18 June 2024, thanks largely to its 12.1% holding in NVIDIA, the global posterchild of AI-related software stocks.
I can’t. however, buy SEMI at these levels. The ETF is up around 90% from its 52-week low and has more than doubled since the start of 2023. I’ll watch and wait for better value as steam finally comes out of NVIDIA’s valuation.
Chart 1: Global X Semi-Conductor Index
Source: Google Finance
Second, understand the importance of having diversified exposure to megatrends. Inexperienced investors often try to pinpoint one or two big winners from a trend – an exercise often challenging for even the market’s best asset managers.
Instead, they should aim to ‘buy the sector’ through Exchange Traded Funds (ETFs). In the initial stage of a hot trend, a lot of stocks can rise as the market speculates about potential winners and losers. Diversified exposure through a fund reduces the risk of some AI stocks inevitably failing.
Third, consider companies that provide the ‘picks and shovels’ for the AI megatrend, not only the AI companies. Semiconductor stocks are an obvious beneficiary. But the market is well aware of this and semiconductor stocks, as mentioned, collectively look expensive.
Cloud computing and cybersecurity are other beneficiaries of the AI boom. More AI will mean more video, audio and text created and stored. That’s good for cloud-computing companies and data-centre companies.
AI also means heightened online security risks – witness recent scandals around deep-fake imaging and other cyber hacks. That’s good for cybersecurity providers whose products and services are needed to protect online data more than ever.
Finally, recognise that the best time to invest in a megatrend is often after the initial hype fades, valuations tank and burnt investors lose interest. We might be some way off that, but with NVIDIA up almost tenfold since September 2022, that point is getting closer.
Here are two ways to play the AI trend by investing in global companies that provide the ‘picks and shovels’ for the AI boom:
- BetaShares Cloud Computing ETF (ASX: CLDD)
CLDD tracks an index holding 36 global cloud-computing companies with an average market capitalisation of US$220 billion. Key holdings include Wix.com, a website builder that uses AI tools; SPS Commerce Inc, a provider of supply-chain management; and C3.ai Inc, a leading enterprise AI software provider.
CLDD has had less attention than other AI-related ETFs in the past year, despite the benefits of the AI boom for cloud-computing providers. SPS Commerce, for example, should benefit given the effect AI will have on global supply chains. Almost half of CLDD is held in application software stocks.
Cloud computing stocks have underperformed this year. It’s hard to pinpoint the exact reason, other than high interest rates hurting growth stocks and cloud-computing stocks coming off the boil after a few years of strong gains (CLDD rose 40% in calendar-year 2023). No doubt, more capital has rotated out of cloud-computing stocks, which looked overvalued at the end of 2023, into AI stocks.
CLDD is down 11.5% year-to-date to end-May 2024. Its unit price is below peak prices in 2021, suggesting an emerging opportunity for long-term investors.
CLDD can be volatile. Since inception, the ETF has had large positive and negative annual returns. Buying CLDD after a large negative return appeals, given expected long-term growth as more data transitions to the cloud – a trend that will surely be sped up by the AI boom and the data deluge it creates.
Chart 2: BetaShares Cloud Computing ETF
- Global X Cybersecurity ETF (ASX: BUGG)
A relative newcomer to ASX, BUGG tracks an index comprising 24 global cybersecurity stocks. To be included in BUGG, a company must make at least half of its revenue from cybersecurity products or services.
BUGG owns a who’s who of global cybersecurity leaders, in a trend with years of growth ahead. Global X notes forecasts showing the cybersecurity market will be worth US$350 billion by 2029, from US$203 billion in 2024. If that forecast is correct, the cybersecurity market will grow by about 70% in the next six years.
It does not take a tech expert to understand how the AI boom will boost demand for cybersecurity products and services to protect online data. The thought of even more malicious AI trawling the internet to steal personal data is terrifying.
BUGG is 7.3% over the past three months (the ETF launched in September 2023). Like CLDD, BUGG is probably suffering from more capital rotating out of previously strong tech trends into AI stocks.
A comparable ETF, the BetaShares Global Security ETF (ASX: HACK) is down 9.3% over three months to end-May 2024, after strong gains in 2023.
BUGG suits experienced investors. With only 24 stocks, it is highly concentrated by ETF standards, though offers more diversification than trying to pick a few cybersecurity stocks leveraged to the AI boom.
BUGG’s annual management fee of 0.47% compares to 0.67% for HACK. The cloud-computing ETF, CLDD, also charges 0.67% annually.
Each thematic ETF suits experienced investors with at least a 5-7-year investment horizon. Through a small allocation, these ETFs could be used as portfolio satellites to potentially achieve ‘alpha’ – a return greater than the market return and complement broad-based index funds in the portfolio core through an exposure to global AI stocks.
Chart 2: Global X Cybersecurity ETF
Source: Google Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 20 June 2024
