While much of the market has been enthusiastic about the potential of AI driving large-caps stocks like Microsoft, Alphabet, and Nvidia to record highs, the investment manager has identified other potential disruptors.
Microsoft’s stock surged almost 60 per cent, rising from some US$272 mid-March 2023 to US$429 as at 22 March 2024, while the AI trend’s current darling, Nvidia, climbed over 200 per cent from US$264 to $914 over the same period.
Similarly, strong momentum has been observed among the rest of the Magnificent Seven, helping the Nasdaq 100 notch one of its best full-year performances in its history with a gain of around 54 per cent in 2023.
According to American Century Investment’s Christopher Chen, investors looking for opportunities in this space shouldn’t discount small caps.
Appearing on the Relative Return podcast, Chen explained that while the focus has been on tech giants and how they can capitalise on emerging technology, there are “clear” opportunities within small caps.
“In the small-cap space, we think there’s attractive opportunities in the more niche areas there,” he said.
“Without going into specific stocks, if we look at these areas, like thermal management within your data centres, and on the hardware side, chip design, and supply chain management within semiconductor and also related spaces like cyber security – these are all AI-related spaces with a bit more exposures or opportunities.”
He believes such stock-picking could offer great opportunities to “disrupt some of the legacy business models” and would importantly assist in building a diversified portfolio outside of the Magnificent Seven.
In recent years, small caps have been perceived as laggards in the investment universe by investors. Since 2021, Australian small caps have been disproportionately affected by an aggressive rate hike cycle aimed at taming inflation, hurting particularly those with significant debt and growth goals.
Over the calendar year 2022 and up to 30 August 2023, they suffered a 19 per cent decrease on a price basis.
However, Chen believes investors should look at small caps through the lens of certain picks becoming “the next big” thing.
“There’s been good examples in that semiconductor space as well, where you have small cap names that have sort of gone way beyond small caps. That’s a good way of looking at investing and certainly, we do want to look for these serial compounders in the portfolio,” he said.
“So, as we look at a theme like AI, I think certainly many of these do have the opportunity to become much bigger.”
Last month, Zenith Investment Partners also proposed a more diversified and long-term approach towards the thematic, and highlighted the prudence of spreading exposures across stocks rather than trying to pick specific winners.
Zenith consultant Calvin Richardson observed that the Magnificent Seven have become “eponymous with the AI hype”.
“However, their stretched valuations have gathered considerable attention following their rapid ascent over the last 12 months,” he said.
“Whilst we’re sympathetic to these concerns, as long-term capital allocators, it’s critical for us to partner with fund managers who thoroughly understand the immediate and longer-term risks and opportunities presented by innovative technologies, such as AI.”
Richardson added: “Our portfolios have retained a robust allocation to the AI thematic through our technology exposures, yet without relying on a concentrated bet on these tailwinds.”
