Rushing into AI deemed a ‘universally bad idea’

Tech-focused funds have had just one month of negative flows since mid-2016

FOMO

Wealth managers have argued that the fear of missing out (Fomo) has been driving investors to funds in many technology related sectors, most notably artificial intelligence (AI).

Money has been flowing into tech-focused funds, with only one month of negative net asset flows since mid-2016, according to Morningstar data.

FOMO

Source: Morningstar

At the beginning, it was about the opportunity and valuations of the larger technology companies which were attractive given their growth, explains Adrian Lowcock, head of personal investing at Willis Owen.

“However, through 2018 we have seen some valuations go to extreme levels which become harder to justify even given the growth potential of these businesses.  This is part of the Fomo issue,” he adds.

“Investors become willing to buy at any price and the consequence is the stocks become increasingly sensitive to changes in expectations – so miss a target growth rate by even a little and the share price will take a hit.”

Likewise, Ben Yearsley, director at Shore Financial Planning, compares the rush into AI with how the Faang stocks have been driven up to high valuations.

“I’d say that AI is currently similar,” he says. “I’m not sure that today’s AI is true AI. Lots of areas seem to be badged as AI when it seems to me to be ‘smartish tech’ rather than true AI. Inflows have been good as it’s been a hot area with lots of chatter and huge long-term potential.”

Kenneth Lamont, analyst at Morningstar, says investing based entirely on Fomo is “universally a bad idea and likely to lead to poor outcomes”.

“We would recommend a measured approach which involves fully understanding the risk and return drivers of the strategy before investing, ” he adds. “The thematic investment proposition is based on selecting future trends before they are fully recognised by other market participants and captured in the current market price.

“A strong narrative shouldn’t mean that investors set aside the time-tested tools they use to evaluate other investments.”

Growth driver

However, Ryan Hughes, head of active portfolios at AJ Bell, says while there is an element of Fomo at play here, essentially that is a characteristic of “momentum investing” and technology has had momentum in recent years.

“Over the last few years, investors have loved anything with a growth story and the biggest theme of all has been technology disruption. This has attracted other investors who have jumped on the momentum bandwagon taking the view that the large technology companies such as Apple, Amazon and Alphabet will rule the world for many years to come.

“With little ‘value’ to be had in other parts of the market, technology has been seen as an easy tangible way to play the global growth theme, which has seen global GDP increase steadily, and of course in the case of the US where much of the major technology companies are found, growth has been absolutely flying since Trump’s tax cuts.”

Hughes explains that technology is a high growth area with lots of great stories about how new technologies are going to change the world and the excitement that this brings comes with its attractions.

“However, more recently, investors who are later to the party have had a sharp reminder than these stocks can fall sharply”, he adds.

Cherry picking

Lamont says while a small number of funds explicitly invest only in AI, others invest in AI as part of a wider tech mandate, for example the Amundi Stoxx Global Artificial Intelligence ETF versus the Lyxor Robotics and AI ETF. “While both funds explicitly target AI the latter has a wider mandate which includes firms involved in robotics.”

FOMO

Source: Morningstar

The table above shows funds that have seen significant flows over the past year, however managers argue that while AI is growing, it isn’t wise to invest solely in this area just yet.

Hughes says: “While some dedicated AI funds have emerged, I prefer to play this theme through a more traditional technology fund where the manager has the ability to cherry pick a few high quality AI companies to complement an existing portfolio of established technology names.”

Winners and losers

Yearsley agrees, saying it is still too early to invest in an AI fund and he would stick to broader tech funds that will have some AI exposure. “Don’t forget that companies like Alphabet will be investing millions into AI as will most of the other tech giants.

“The reason I say it’s too early to invest in a singular fund is that AI is at an early almost blue-sky stage where there will be big winners but also big losers.”

Likewise, Hughes argues that AI is still “a relatively young and emerging theme” and therefore while there are some established companies, many are in the early stages of their life which makes the theme relatively risky.

“In some way, it reminds me more of the original technology boom in 1999/2000 where lots of young companies captured the imagination,” he adds. “Of course, some of these are today’s household names and I’ve no doubt that some of today’s AI companies will become tomorrow’s household names too, but the trouble at the moment is that it’s too early to say which ones will be the winners.”

Expensive and vulnerable

Darius McDermott, managing director at Chelsea Financial Services, says AI stocks tend to be quite expensive and are therefore vulnerable to a market correction, such as the one we have just seen.

“The other big risk with investing in tech is that better tech may emerge and disrupt you in the future,” he adds. “These businesses may not even exist yet or may be private companies.

“This is something tech investors often forget. What happened to Bebo, Friends Reunited and MySpace, for example? The fact that investors have poured into the space is another yellow flag as it suggests investors may be over excited. Will these investors stick around when the going gets tough?”

Additionally, Lamont says another factor is timing. “You might select the right theme – and even the right strategy – but your fund may not be around to benefit.

“We need only glance at the rogue wave of launches and subsequent closures of internet-themed funds in the late ’90s and early ’00s to validate this concern.”

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