The spotlight on artificial intelligence has already fuelled astonishing valuations for companies like Nvidia, but long-term tech investors expect an abundance of investment opportunities in the sector in coming years as innovations appear on the horizon.

The biggest paradigm shifts in technology history – the internet and cloud computing – both had common characteristics, in that there was initially a cycle of investment in infrastructure before the applications were delivered to consumers, according to John Donnelly, managing director at Jennison Associates.

“We don’t think AI is going to be any different,” he told the Fiduciary Investors Symposium at Stanford University. “There’s going to be an infrastructure cycle that is going to create great investment opportunities, and there’s going to be an application cycle that also does that.”

Donnelly says chipmaker Nvidia and ChatGPT founder OpenAI have been instrumental in the current infrastructure phase. But while graphics processing units such as the ones developed by Nvidia have increased speeds 50 times in the past couple years, data centre speeds haven’t been able to keep up, creating a real bottleneck, and creating potential investment opportunities.

“The risk is that the rest of the supply chain can’t keep up, and so we have to really watch companies evolve, because the technology transformation is happening so rapidly,” Donnelly said.

“Nvidia is way ahead on the computing side, but networking and storage need a lot of work, so there’s going to be some great companies that will solve problems in those areas.”

Market challenge

Nvidia has seen its share price surge since 2022 to its current valuation of around $3 trillion, making it the third-most valuable company in the world.

The challenge for public market investors, though, is that there are not a lot of opportunities, says Angus Botterell, senior managing director at Canada’s $77 billion Investment Management Corporation of Ontario.

“There’s Nvidia, and then there are some smaller companies that have exposure, but they’re not pure plays on AI,” he said.

“And I’m not sure we actually know how AI is going to play out. We don’t know who the winner is going to be.”

IMCO has chosen to play the sector through a hybrid investment strategy where it holds data centre investments in its infrastructure group, and also owns a stake in company called CoreWeave, which does actual computing.

“You’re going to start with investing in the infrastructure, and ultimately there will be consumer facing applications,” Botterell said.

“Given that consumers are two-thirds of all the economy, that’s where the real money will be made.”

It’s a sentiment shared by Prabhu Palani, an investment industry veteran who is currently chief investment officer at the City of San Jose, part of the Silicon Valley.

He said that while the hype is real, because many of these early AI companies are doing transformational work investors don’t want to be caught up in the hype in terms of valuation.

Palani pointed out that startup funding has fallen off a cliff since equity markets saw the tech-wreck phase in 2022, with AI now dominating funding.

“But I have to say we have been slow in deployment,” he said.

“You want to be careful. You want to be cautious and and the way to access these companies is through funds. We rarely make direct investments.”

Consumer Transformation

The rapid pace of development in artificial intelligence and the shift towards consumer applications means it is difficult to pick winners from the Magnificent Seven technology stocks that currently dominate equity markets.

“The incumbents don’t usually win in any major paradigm shift,” Jennison’s Donnelly said.

“And so the new companies probably haven’t even been founded yet. The infrastructure companies probably have, but the consumer companies probably haven’t.

“Secondly, consumer is the biggest AI market it’s going to be, and we haven’t even started yet.”

On the question of whether the development of AI will result in loss of employment in parts of the economy, Palani said many positives will also come out of it and it’s better to not put barriers on the development of technology. Instead, the focus should be on developing safeguards around it.

“With any technology, once it’s unleashed, there’s no way to put it back in the bottle. And so the consequences will be the consequences, hard to predict those although that does worry me,” he said.

IMCO’s Botterell said one of the issues with the evolving sector is the potential for market concentration, given that data is the foundation of AI, and the more data you have, the better your AI is, resulting in kind of virtuous circle.

“We’re trying to be cognizant that, if you pick a winner now, it might end up being the ‘one app to rule them all’ sort of thing in the future,” he said.

“The other big questions we’re asking ourselves is regulatory pushback, regulatory issues as well as data privacy. Those are sort of the big things on our radar screen as we’re thinking about it going forward.”

The changing nature of volatility in financial markets and a more client-centric approach that allows allocations to be tailored is helping more institutions adopt a total portfolio approach (TPA) to investment management.

In a discussion at the Fiduciary Investors Symposium at Stanford University,  a number of large asset owners outlined their efforts and the challenges they are tackling to achieve a comprehensive total portfolio view amid an evolving investment landscape.

“What we have figured out is that volatility is changing and you have to be more dynamic,” said Pedro Guazo, the CEO for investment management at the US$95 billion United Nations Joint Staff Pension Fund (UNJSPF). “You have to adapt your portfolio, still respecting a disciplined approach, but also understanding your total risk in the total portfolio.”

Guazo says the fund is aiming to have a convergence of both systems, by starting with the total portfolio approach information, then using it for tactical deviations to the strategic asset allocation (SAA).

He says the comprehensive approach has excited his investment team, because they will have more flexibility for deviations or take more risks, while the risk management people are also big defendants because the approach is a good model to start bottom-up and include responsible investment factors that they consider important for portfolio creation.

AIMCo’s director of investment strategy research Jean David Tremblay-Frenette says the US$170 billion Canadian pension fund’s client centric approach required the move towards TPA because it allows tailoring of allocations for clients on the basis of liquidity, maturity profiles, and other specific considerations

“The TPA approach is the way to go, to be able to have that unified view of all those risks and different factors on a client by client basis,” he said.

Unified Approach

The total portfolio approach involves taking a unified view of all the risks and returns of the entireportfolio. The approach focuses on the fund’s absolute return goals, in contrast to the strategic asset allocation, which seeks to outperform benchmarks.

TPA does not use a specific model, but instead comprises a range of approaches that can be tailored to each asset owner’s long term investment thesis.

A recent global study by the Thinking Ahead Institute found TPA can add between 50 and 150 basis points of return above the SAA. Its exponents emphasise that the two portfolio allocation approaches are targeted at different problems.

The study found the trend towards TPA is continuing, with 20 of the 26 funds survey stating they were either at their maximum TPA or moving more towards TPA. The approach has also been successfully deployed for years by both Australia’s sovereign wealth fund, the $272 billion Future Fund, as well as Kiwi sovereign fund New Zealand Super.

James Wingo, the head of the quantitative analytics at the US$46.7 billion pension fund, South Carolina Retirement System Investment Commission, says its important to ensure a unified view through TPA is by focusing on regular interactions between the risk and investment teams.

“One of the big things as we move beyond the basics, is really creating that culture and fostering a common language between investment and risk teams in order to have good conversations around risk and around TPA and understanding what risks in different parts of the portfolio are impacting others.”

Governance, technology challenge

 The biggest challenge that fund manager’s struggle with in implementing a total portfolio approach is adapting the institutions culture and governance, as well as the use of technology.

AIMCo’s Tremblay-Frenette said as an asset manager, he is targeting consistency, swiftness and accuracy to ensure capital allocation across both public and private assets, but that has been difficult from a cultural standpoint, because of different operational teams or even investment teams.

“This becomes a real challenge, because everyone has their own little version of what the total portfolio, or even the portfolio component they’re responsible for is looking like,” he said.  

“We’d want to really veer away from that state of the world towards a place where we feel we can truly come up with insights on the total portfolio, because the whole package is really what matters here.”

 Allen Zimmerman, the head for Americas at technology provider SimCorp., says part of the governance problem is the data problem, taking the example of an institution running a private book completely separate from where it runs a public book, meaning it struggles to confirm in real time that all investment guidelines are being adhered to.

“Absolutely correlations are important from that total portfolio perspective, because oftentimes people think that they’re making an investment and it’s a diversifier. Sometimes they don’t recognize that it’s actually an amplifier. Sometimes you take a specific bet and you don’t realize that it’s primarily a FX risk,” he said.

“The only way to do this is to start bringing things together, whether this be because I’m looking at correlations or, how risks are always changing.”

Public authorities need to develop regulatory frameworks that create incentives and provide policy support in order to attract long-term private capital for infrastructure needed for the ongoing energy transition, the Fiduciary investors Symposium at Stanford University has heard.

The discussion considered how a wealthy economy like the US state of California has struggled to address the under-resourcing of infrastructure during an increasingly urgent climate crisis, and what could be done to attract adequate funding.

“You can’t just throw money at the problem. There needs to be some thoughtful analysis in assessing whether or not these policies are really working,” said Malia Cohen, the Controller for California, who is the state’s chief fiscal officer and responsible for its financial resources.

Cohen said a major hindrance has been the democratic process, because you have to solicit feedback from everyone. While these are very important policy discussions, what slows the process down is the solicitation, the feedback, the thought process, and sometimes even inflexible rules for how things get built or torn down, she said.

The policies continue to be strict and old, and are not dynamic, which affects public entities’ ability to make changes.

“When that changes, I think you will start to see a fundamental change on how projects get built, how money and investment, particularly investment in infrastructure, is also moving. It’s very political on who, what companies, what countries we’re partnering it with,” Cohen said.

Private Success

IFM Investors’ chief strategy officer, Luba Nikulina, said her organisation is an example of how pools of private capital can successfully work with governments on policymaking to try and shake the inflexible, rigid, old structures.

IFM was formed decades ago when 27 Australian superannuation funds came together to participate in the privatisation of airports in the country. The group now manages more than $200 billion and holds infrastructure assets in more than 20 countries.

Nikulina said IFM is actively engaged in dealing with another big challenge of energy transition in Australia, one of the most carbon-intensive countries in the world.

“For private capital, especially the superannuation industry, to engage with the government, with policymakers, and essentially help the country to figure out how to transition to a low carbon future, but also do it in a socially responsible way ensuring that no one is left behind in this transition, is incredibly important,” she said.

IFM is doing this by helping develop the energy transition blueprint for the country, which defines priorities where, if and how the government steps in; then private investors, including IFM’s owner funds, will be prepared to provide capital, while maintaining fiduciary responsibility for the retirement savings of working people.

One interesting example has been the development of a sustainable aviation fuel industry in Australia, to reduce the carbon footprint by using fuel produced from agricultural waste.

IFM, which is also a major infrastructure investor in the UK, is also looking to transport its Australia experience and energy blueprint to the UK, the London-based Nikulina said, adding she had met new British Prime Minister Keir Starmer during his first week in office.

The fund is also building the second-largest solar plant in the US, in Chicago.

Public Policy, Education are Crucial

Cohen said it is important that public entities provide policy and regulatory support by developing a regulatory framework, by creating incentives that will encourage the private sector to come in to the conversation.

“What does that actually look like? That could be subsidies. It could be grants, it can be tax credits. And these are all things that the government has done in the state of California to a certain degree,” she said.

“What we have not done is applied it to lofty goals such as reducing our carbon footprint.”

The other important parts of the conversation are equity and eduction.

Inequity is important because there have been people who have been injured by many policies that business and government have inflicted upon them in the past, Cohen says.

Similarly, when initiatives are put in front of voters, on, it is crucial those voters are educated on why it is on the ballot and why or how it is important to them personally and the society at large, she said.

Nikulina said, as an investor, the critical ingredient will vary, depending on the industry.

“I wish there were a silver bullet where I could say, here is the solution, please use it,” she said.

“Unfortunately, it requires engagement pretty much sector by sector, company by company. And this is what we are doing in Australia, in the UK.”

The big trends of demographics, digitisation and de-globalisation are throwing up plenty of opportunities for investors in spite of a risky international environment, according to the president of Franklin Templeton Investments.

Jenny Johnson, who has led the US$1.37 trillion global investment firm as CEO since 2020, told the Fiduciary Investors Symposium at Stanford that it is not possible to predict geopolitical risks, so figuring out the big trends that bring opportunities is important.

“The key is to recognize you’re not going to be able to call in advance the risks that are out there. They’re going to pop up unexpectedly and make sure that you’re prepared with a diversified portfolio,” Johnson said. “But where you are making those investments and bets, make sure that you’re doing it in places where there is a natural trend.”

Johnson was in a conversation with Dr. Condoleezza Rice, 66th US Secretary of State, and Tad and Dianne Taube director of the Hoover Institution at the Top1000finds.com Fiduciary Investors Symposium.

Johnson highlighted the massive opportunity from the younger population in the global south, where a billion people are entering the middle class. Other big opportunities that investors can take advantage of will come up with the ongoing technological innovation, despite the accompanying pitfalls.

Rising de-globalisation and the split between US and China after COVID is also prompting companies to diversify their supply chain.

“You look at the FDI investment in places like Vietnam, the Philippines, Indonesia – places that probably were historically somewhat overlooked, other than kind of for commodities, and you see real investment opportunities,” Johnson said.

Geopolitical Risks

Despite ongoing tensions between the US and China, the world’s second largest economy continues to hold attraction for investors across the globe, thanks to its huge domestic consumer opportunity for growth.

The challenge is going to lie in finding those investment opportunities, Johnson says. For example, making tech investments may be difficult because there will be this bifurcation with the US.

“But there are other places in China, and it’s still a huge market that has opportunity. I just look at it and say, as a global company, you can’t ignore the second largest economy in the world. And I do tend to think that the politicians will ultimately try to be practical.”

The discussion also covered another major global geopolitical risk – the Russia- Ukraine conflict.

Secretary Rice believes Ukraine would ultimately have to consider the importance of territorial integrity to resolve the long-drawn conflict. She cited the erstwhile West Germany as well as South Korea, which prospered economically despite the lack of territorial security, as examples of one of the pathways the current dispute could take.

“Understanding how important territory is or is not to a prosperous, united and secure Ukraine, I think the Ukrainians will have to determine that,” Rice said. She noted, though, that both South Korea and West Germany had received an American security guarantee.

Optimism on AI

Franklin Templeton has expanded rapidly in recent years, helped by a string of acquisitions including Legg Mason, Lexington Partners, and Putnam Investments. Johnson says the asset manager has been really careful about keeping the integrity of its investment teams and tries to integrate other things that are external.

“The first step is, you make sure the investment teams feel comfortable, that they remain independent. And the second piece is you provide them opportunities to see the benefit of being part of a bigger firm. AI is obviously one, but other things we do, these CIO forums and conversations that folks have from different perspectives, that has been really valuable.”

As one of the largest investment managers globally, it is also focusing on innovation to ensure that it keeps up with clients demands.

Earlier this year, Franklin Templeton announced a partnership with Microsoft to build an advanced financial AI platform that will help its distribution team. It is working on another partnership with a different tech firm for its investment teams.

Johnson says these AI models have to be trained on data, which will make it harder for smaller asset management companies to compete, because data is really expensive, and they will be limited in the data they have internally,

“We are leading in areas like blockchain and digital assets; you couldn’t do that if you didn’t have scale. And I do think it’s going to be harder and harder for smaller managers as AI becomes more important to actually be able to compete,” she said.

The transformational effect of artificial intelligence has already been felt across a number of industries. Its impact is now also being felt in financial markets and particularly in the function of investing within asset management.

David Wright, co-head of Quest, quantitative business strategy, at the Switzerland-based Pictet Asset Management, told the Fiduciary investors Symposium at Stanford University that current techniques being used included large language models, natural language processing, and machine learning to make predictions.

Wright quoted a recent global survey by Mercer that showed nine out of 10 investment managers were either already using AI or planned to use AI in the future as an indication of the potential uses for both quantitative and fundamental managers.

“On one side, you’ve got tools that can help be more effective, be more efficient, and focus where the investor want to spend their time,” he said.

“At the other end, you’ve got the quant space, where you’re starting to see front-to-back machine learning-based models to forecast returns.

“It comes together a little bit in the middle as well, with kind of quasi-tools. These are often natural language processing, where you want to assess sentiment, or you want to summarise documents.”

He gave the example of a Pictet team developing an in-house, large language model to summarise all the 10-K financial documents – comprehensive financial reports required by the US Securities and Exchange Commission to be filed annually by public companies – that they otherwise would have to go through by hand, bringing it down to a summary that takes only 10 to 15 minutes to read.

Quant Race

Wright says machine learning has been looked at in some capacity for 10 to 15 years on the quantitative side of the industry, with the equivalent of an arms race in the quest for data, technology, and computing speed.

With significant progress being made, there have been a lot of headlines and even academic papers over the past couple of years suggesting stock picking can be done by large language models. Wright says this is not credible yet, but machine learning is starting to really have an impact on stock picking elsewhere in the investment world.

“The reason this is possible is that the opportunity has really accelerated for quantitative investing over the last 10 years,” he said.

“There’s so much more data, there’s much faster computing speed, computer storage is much cheaper. The barriers to doing machine learning today are much lower than they ever were historically.”

Some recent applications of AI lend themselves to the more traditional stock picking fundamental managers as well.

That includes being able to make more accurate return forecasts, particularly over shorter horizons, because it can incorporate a much larger number of features or signals or data sources.

“What machine learning can allow you to do in the quant space is overcome one of the key challenges that we have, and that is the trade-off in modelling between complexity, accuracy and errors,” Wright said.

Fully Transparent

One of the key challenges with machine learning relates to transparency, with asset managers generally wary of not being able to fully understand where the returns are coming from, or where the investment positions come from

Wright says his team used some academic work focused on currency markets undertaken in the US, and wrote a paper that took that work and transported it over to the equity market.

“Where we stand today with our live models is that every single position in our portfolio, we can take it back to which features drove that, what is the interaction effect between those features, and then we can explain to our clients and attribute the performance to the features.” he said.

“It gives them a lot of comfort that we can truly understand what we’re doing. We can move from a black box to a fully transparent crystal box.”

With that growing comfort level, institutions are looking for machine learning models to help them generate pure alpha, stripped of common factor returns. They want active returns that are independent from the market regime, customisable approaches that can be implemented in different types of strategy, and transparency and interpretability.

“The alpha is getting harder and harder to come by in the market,” Wright said.

“Trading off analyst sentiment in the market now is much less effective than it ever was historically. But if you understand how an analyst forecast interacts with how close it is to the company reporting its results, there is alpha to be made from that.”

A higher interest rate environment, increasing divergence among major central banks, and geopolitical uncertainty are some of the major risks that top asset owners are bracing for in coming years.

In a discussion at the Fiduciary Investors Symposium at Stanford University, long-term investors including APG Asset Management, MFS Investment Management, CPP Investments, considered the top macroeconomic themes that will play out over the next few years and what their implications will be for investors.

“Our expectation is that we’re moving into a higher-interest rate, higher-inflationary environment. Yes, rates are likely to come down from where they are currently, but we’re unlikely to go back to where we were in the period following the global financial crisis,” said Jonathan Hubbard, managing director in MFS’ investment solutions group.

Hubbard said he believes the driving elements behind the current persistence in inflation are less well understood, given that it follows more than a decade of zero interest rate environments after the GFC. Despite central banks kicking off a monetary easing cycle, that could mean periods of rolling inflation.

Inflation is also top of mind at Canadian pension fund CPP, head of portfolio design and construction Derek Walker said, with the potential that we have entered a world where inflation is either higher or more volatile.

“The reason that is relevant for us, as it will be for asset allocators in general, is that diversification benefits that we see between fixed income and equities are very strongly driven by that,” he told the audience of pension and sovereign funds.

“In those environments where it’s primarily growth that’s driving that correlation, we see a more negative correlation. But when it’s primarily inflation and real rates increasing, then that tends to be a positive relationship. So it has big implications from a diversification standpoint.”

Policy Divergence

APG global head of fixed income Ann Marie Griffith said one of the key issues that central bank policies have largely been co-ordinated since the global financial crisis, with rates coming down to very low levels.

However, now we’re seeing dispersion. The Federal Reserve delivered a supersized 50 basis point rate cut on Wednesday, the Bank of Canada has already eased three times, the Bank of England once and, two cuts have come from the European Central Bank.

“But what we’re really seeing is these central banks reacting to facts on the ground in their particular countries or regions, instead of acting in concert. So that’s creating a bit more volatility within markets and then across markets,” Griffith said.

She pointed out that some other countries such as Japan and Brazil, are actually thinking about raising rates as they deal with issues such as weakness in their own currency, and wage and inflation pressures.

“These are very sort of unusual activities, considering where we’re coming from since the financial crisis, but definitely creating a lot more volatility and a lot more interesting opportunities in portfolios.”

Another issue that is finding resonance is re-globalisation where global trade relationships, global supply chain structure and logistics are all changing.

What started in 2017 with the Trump administration tariffs were underscored during Covid, where companies couldn’t access their supply chains in different countries; then was impacted by the Russian invasion of Ukraine; and is currently being felt through the war in the Middle East, which is impacting shipping channels.

“Put that all together, and as a COO of an organisation, does it make sense to have outsourced all of this business and manufacturing?” Hubbard said.

“So we’re starting to see some of that come back to the US. But we’re also starting to see some of those trade relationships change and I think the beneficiaries will be countries in Asia, some countries in South America.”

Strategic Allocation, Tactical Play

Asset owners are looking to deal with the volatility in different ways. As a long term investor, CPP’s first line of defence is around building a resilient and robust strategic allocation, Walker said. That also involves stressing portfolio allocation to a number of different scenarios.

 “So making sure that we are not allocating capital in assuming a very benign inflation and rate environment. We kind of put more weight on a higher rate, higher inflation environment.”

APG’s Griffith noted that there is still a very compressed spread environment, with potential for the Federal Reserve to be a little bit slower than the market has anticipated.

“We’re probably still a little bit biased to have risk on in the portfolios, but much more closer to home, and also trading up into more liquid, larger names and trying to create a little bit of extra liquidity in the portfolios to take advantage of some of the volatility that we may see in the coming months.”

Hubbard said while short-term market trends took precedence, he was advising clients to continue to focus on the long term.

“Don’t give up on diversification. I think that there’s too big of an opportunity set outside the US. Maintain that as part of your strategic assets allocation, even if it doesn’t work out this year or next. I think over the longer term, there are definitely great opportunities.”