Growth Opportunities from Electrification

By Scott Crawshaw, Portfolio Manager | August 23, 2023

Portfolio manager Scott Crawshaw highlights several companies in our Emerging Markets portfolio that are poised to benefit from increasing electrical power demand.

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Meta Accelerates Its AI Game

By Igor Tishin, PhD, Analyst | August 11, 2023

Meta has been quieter about its artificial-intelligence-focused endeavors this year than some of its big-tech peers like Microsoft and NVIDIA, but it expects just as massive a transformation of its business from the much-hyped technology.

In its second-quarter earnings conference call, Meta founder and CEO Mark Zuckerberg detailed how AI permeates the company. For example, nearly all of Meta’s advertisers now use at least one AI-based product, allowing them, for instance, to personalize and customize ads. He also touted an increase of 7% in time spent on Facebook after launching AI-recommended content from accounts that users don’t follow.

Now the company plans an aggressive push of its own version of generative AI, the kinds of large language models that have gotten so much attention lately. In July, the company released an open-source—i.e., free for even commercial use—generative AI platform called Llama 2, which Meta hopes will emerge as a competitor to OpenAI’s GPT-4. Meta is betting its platform will unleash users’ creative potential and result in a flood of content. If that occurs, Meta’s powerful algorithms for matching content with users—4 billion of them across all of its platforms—will become indispensable as a content-discovery tool with a rich set of monetization options from advertising to ecommerce to subscriptions.

The big-picture view suggests that Meta is building a hub for user-generated content (UGC) discovery and distribution that aims to go head-to-head with the likes of YouTube and TikTok. In the world of unlimited content, the power shifts from creators to distributors and curators. In this scenario, the ultimate constraint on demand for content is the totality of leisure man-hours; Meta’s goal is to optimize how to fill those hours with the most compelling content.

Generative AI could also help transform Meta’s main money-maker, its advertising business. The digital-ad market comprises roughly 70% of the overall advertising market, and is dominated by two firms, Meta and Alphabet. Finding a way to expand its market share has been a stumbling block for Meta. However, with these new AI tools, Meta may have found a way around that constraint. It may not be able to take much more share of the advertising market, but it could start taking share of the advertising-creation market. On the call, Zuckerberg specifically mentioned the strides made by its Advantage+ generative AI tools that allows advertisers to supply just an image, from which the AI will then develop an entire ad campaign. For small companies that can’t afford to hire an advertising agency, this could be a powerful alternative and a lucrative market for Meta. Its Advantage+ ad program has the potential to take share from creatives and even advertising agencies by customizing, altering, or outright creating content for advertising, rather than just targeting or measuring it.

Source: Statista

Meta’s embrace of AI is one of several efforts the company’s made over the past year to reverse the slump that followed its 2021 shift into the metaverse. Zuckerberg showed common sense on reining in spending, the company executed on its new identifier for advertisers (IDFA) independent ad-targeting model, and it ramped up new initiatives like Reels, Advantage+, and most recently Threads. Meta has also delivered robust recoveries in free cash flow and revenue, with free cash flows for 2023 now forecast at approximately US$30 billion, a big increase from the US$10 billion forecast at the end of 2022. Even critical media coverage about privacy concerns and Facebook’s effects on democracy have waned and regulatory pressures have eased (except in the EU).

All this doesn’t mean Meta’s out of the woods, though. While impressive, the turnaround only just got the company back to where it was a year ago, when it was facing hard questions on rising costs, large infrastructure investments, and its incredibly audacious spending on the metaverse. Reality Labs—the division of the company building the metaverse that has already burned through US$30 billion since 2020—is losing a further US$15 billion per year, and Meta expects those losses to increase meaningfully in fiscal year 2024. Meta has yet to provide an explanation about how this is going to pay off. Even with its recent good fortune and AI potential, Zuckerberg will have to provide some real clarity soon to avoid another investor rebuke.

Image source: Romain TALON – stock.adobe.com.

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Generative AI Through a Fundamental-Research Lens

By Jingyi Li, Co-Lead Portfolio Manager | July 26, 2023

The following is an excerpt from our second-quarter report for the Global Equity strategy. Click here to read the full report.

Anyone who has interacted with popular AI models—asked them about the mysteries of life and the cosmos or created convincing Van Gogh replicas using AI-enabled image generators—can sense that we may be in the midst of a technological revolution. That prospect has consumed equity markets lately, with seven US tech-related stocks responsible for most of the market appreciation in the second quarter.

As an investor in high-quality, growing businesses, we have always tried to position this portfolio to benefit from secular trends, the kind that transcend economic cycles and are driven by fundamental changes in key areas such as tech. Still, it is incredibly difficult for anyone to predict how such trends will unfold; the vicissitudes of cryptocurrency are a sobering reminder of this. Furthermore, as seen with the rise of the internet and, later, mobile connectivity, technology is merely a platform; it’s the applications of the technology that eventually determine many of the winners and losers. In the case of generative AI, some of the future applications may not yet be conceivable, although many companies, even outside the tech field, are now pondering the possibilities.

ChatGPT, the chatbot that helped spark the market’s AI enthusiasm, is an important innovation because it can digest large amounts of text (hence the term large language model), communicate in natural (human) language, and generate sophisticated responses. Based on the Transformer architecture, a technique first introduced by Google in 2017, ChatGPT demonstrates the advances that have been made in AI that open the door to a wider set of business uses. But while natural language models recently produced epiphanies among lay chief executives and investors regarding AI, some tech companies were already investing in such capabilities and are being rewarded for that foresight. NVIDIA has been the biggest beneficiary this year in terms of its stock run and projected revenue gains; however, our other holdings, such as Adobe, Microsoft, Salesforce, ServiceNow, Synopsys, and TSMC, also appear among the possible beneficiaries. More companies—including, perhaps, some not yet in existence—will certainly join the ranks over time.

While it is still early, it’s evident that these companies see generative AI as transformative to their businesses and something upon which they can build new revenue models. Additionally, they are turning to AI to boost internal productivity, enhance existing customer offerings, and improve the quality and efficiency of customer interactions.

Most notably, Microsoft was able to gain an immediate leadership position in generative AI by making a US$10 billion investment in OpenAI, the company behind ChatGPT, earlier this year. Microsoft’s Bing search engine has since introduced ChatGPT into its web index data—a collection so large that it is rivaled by the dataset of only one other business in the world, Alphabet’s Google. Data are the feedstock of AI models, and an AI-enhanced search engine trained on so much data may attract more users to Bing, allowing Microsoft to sell more ads on the service. Microsoft is also adding generative AI to other products, including the Azure cloud service, enabling business customers who use Azure to easily integrate OpenAI models to glean more insights from their data and automate functions such as certain IT tasks. These added capabilities should motivate more businesses to migrate their data to the cloud and make Azure more competitive with Amazon.com’s AWS and Google Cloud.

The beneficiaries of demand for generative AI aren’t limited to traditional IT-sector companies. Data centers used to train AI models require up to ten times more power than typical data centers, thus requiring more-powerful equipment and backup power. Given the amount of heat they generate, new liquid-cooling solutions will be needed as well. This creates an opportunity for Schneider Electric, which has been developing innovative data-center equipment solutions for many years.

In the meantime, NVIDIA has emerged as the unrivaled global leader in providing the technologies at the center of the AI arms race. Due to an explosion of demand related to generative AI and LLMs from across its customer base, NVIDIA projects that data-center revenue for its fiscal second quarter ending in July will surge to US$11 billion. Not only is that more than double last quarter’s total, but the forecast also shattered the average analyst estimate that called for about US$7 billion.

Our investments in NVIDIA and Schneider are reflective of how we are thinking through the many unknowns and approaching portfolio structure in this environment. Through our fundamental framework, we can appreciate the broad excitement for AI, but we also remain conscious of valuations and thoughtful about diversification, recognizing that it’s unlikely anyone can predict today the biggest long-term winners.

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Why Own International Companies?

By Tim Kubarych, CFA, Co-Deputy Director of Research | June 07, 2023

When US stocks have outperformed for as long as they have—creating the world’s first trillion-dollar companies in the process—it’s easy to forget that plenty of highly profitable businesses exist a long way from Silicon Valley or Seattle.

While US companies account for just over 60% of the market capitalization of the MSCI All Country World Index, their weight is a tad misleading given that a few technology giants—Alphabet, Amazon, Apple, and Microsoft—weigh heavily on the scale. Together, those four are valued at nearly US$8 trillion, more than the next 15 largest US stocks combined.

Even if the US features most of the world’s biggest companies, it’s hardly the exclusive repository of the best ones. Using cash flow return on investment, rather than market value, as our measurement reveals that the majority of the most profitable and capital efficient businesses in just about every sector are located outside the US. The only exceptions are two areas where US companies are clearly dominant—Information Technology and Health Care.

Source: FactSet, MSCI Inc.; Harding Loevner, HOLT database.

Of course, profitability alone doesn’t define the best companies. As quality-growth investors, we examine a broader set of characteristics to determine business and management quality as well as long-term growth prospects. And still, the data show that regional diversity wins out: About three-quarters of large-cap stocks in the top two quintiles of our quality and growth rankings are non-US firms, increasingly anchored by emerging markets such as China.

Investors are naturally biased toward their home territory, which is easy to do when it is giving an electric performance. For the US, that’s been the case for more than a decade as the economy recovered from the Great Recession and smartphones, digital advertising, mobile shopping, and workplace productivity tools—areas dominated by a handful of American giants—became ingrained in daily life.

This has left international markets with more attractive share prices relative to the profitability and cash flow of their underlying businesses. We can’t predict when international markets will rise again, but we do think fundamentals and valuations ultimately drive stock performance. The valuation spread between US and international stocks today happens to mirror the gap that existed in 2001, which ushered in a period of international outperformance.

Eschewing stocks in the rest of the world not only misses out on the diversification benefits but also ignores an attractive set of companies whose valuations may be poised to rebound.

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Out of Our Minds

Growth Opportunities from Electrification

Meta Accelerates Its AI Game

Source: Statista

Generative AI Through a Fundamental-Research Lens

Why Own International Companies?

Source: FactSet, MSCI Inc.; Harding Loevner, HOLT database.

Disclosures

Out of Our Minds

Meta Accelerates Its AI Game

Source: Statista

Generative AI Through a Fundamental-Research Lens

Why Own International Companies?

Source: FactSet, MSCI Inc.; Harding Loevner, HOLT database.

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Disclosures