Innovative sectors such as artificial intelligence (AI) can generate investment returns over the long-term, but too much optimism may presently be priced in, according to Mike Coop, European chief investment officer at Morningstar Wealth.
Meanwhile, others see opportunities in different parts of the market where the hype has been less pronounced.
Coop says that with any investment there are a wide range of possible outcomes, from the most pessimistic, to the most optimistic, with those being low probability events.
"But the key is to invest when the sentiment is pessimistic, because at that valuation, it is not that it changes the range of probabilities, but it means you don’t need the most optimistic of the range of scenarios to happen in order to make a return on your investment," Coop adds.
He says many investors remember the period between 1999 and 2003, as being a period of “euphoria”, and compares that to present market conditions.
Coop adds: “That period of euphoria, just because sentiment was strong, that doesn’t mean there weren’t good companies then alongside the bad ones. But if you waited and bought in 2004 instead of 1999, when valuations were lower, then the probabilities were more in your favour.”
He believes present market conditions are more akin to those of the 1999-2003 period than the buying opportunity period of 2004.
The chief investment officer is also sceptical of the significance of higher interest rates on the investment case for these assets.
He feels that rates move up and down over the course of economic cycles, “and fund managers who are using that as an excuse for losing money, well I think it’s nonsense. Interest rates move up and down over the course of economic cycles, so aren't very important if you are a longer-term investor. I think f you got those fund managersin a dark room they would admit that they simply overpaid for some assets.
The sharp falls in the valuations in 2022 did prompt Coop to invest in some tech shares based on valuation, but he feels the advent of a new wave of a hype cycle, focused around artificial intelligence, means the valuation case that may have been emerging in 2022 has evaporated and we are back in a period where the risk to reward calculation is not attractive.
In terms of understanding where sentiment is at any one time, he uses fund flows data.
Coop says the second part of the calculation investors have to make is around which innovative companies will emerge as the winners.
His view is that: “when a new theme emerges, the key things to ask are: “What value can be created by this innovation, and of the value that is created, how much of that value can be kept by the company that creates it."
One of the mistakes, he says investors make, is to assume that just because a company has an advantage today, it will always have an advantage, or that because something is a trend today, it always will be.
"If you think of the range of possibilities, a company such as Nvidia, it is a leader now, but how can anyone know it always will be. Now I’m not predicting anything around it; it's about looking at the valuations and probabilities.
"An analogy I like to think of for this is coffee. I have lived in the UK since the 1990s, and when I moved here no one drank coffee, and now everyone does, so things change.
"But again, if you focus on valuations, that can help to get pricing on your side, and then divide the investment universe into small chunks and try to have exposure to all of them. I think that’s a much more efficient way to build wealth over the long-term, and that is the reason for investing in the first place.”
Peter Ewins, who runs the £710mn Global Smaller Companies investment trust, is another investor wary of being exposed to what he calls the “hype cycle”, where company valuations accelerate based on excessive optimism around a theme.
Hype cycle
For example - as Ewins explains - around 2000 there was a surge of interest in anything internet-related with many new companies listed or converted from existing quoted stocks, promising rich returns from investment into various online initiatives.
In many cases these companies' share prices become over-inflated based purely on speculation around the potential that they were felt to have, only to subsequently collapse when the reality of underwhelming progress became apparent..
A similar trend is happening with artificial intelligence. [
Ewins says: "In more recent times, we have seen a lot of excitement around the potential for artificial intelligence ( AI ) related businesses, with leading chip supplier Nvidia seeing its share price surge this year, along with other perceived beneficiaries in the technology sector.
"The difference here is that Nvidia already has a strong existing market position with a track record of revenue and profits, though the extent of the recent share price rise does on the face of it appear to be discounting a lot of good news.”
Mikhail Zverev, who runs the recently launched Amati Strategic Innovation fund says it is important when seeking to invest in this part of the market, “to be long-term, but not to try to be a "futurist".
"When we speak with a company that we are looking to invest in, we prefer them to be profitable now but if they are not, then we want to see a clear road map to how they can be profitable and when."
"The way to think about diversification is to invest in some of the companies that supply the new technology firms, that way, it doesn’t matter which precise technology firm wins.”
Noel O'Halloran, chief investment officer at KBI Global Investors, says many stocks in innovative areas are receiving a boost as investors look again at technology and more generally growth type assets as a result of the excitement around ChatGPT.
But he feels that a key difference for those seeking to invest in innovative parts of the market is that there are more areas where such innovation is taking place, making it easier to construct diversified portfolios.
O'Halloran says: “At one time people might just have looked at electric vehicles, but now there are opportunities to invest in sustainable mining to obtain the commodities needed to make the electric cars, and there are innovations in areas such as agriculture that weren’t really there in the past. Those changes mean investing in these areas is a different experience now than when we started 20 years ago.”
David Thorpe is investment editor at FTAdviser
