Can AI keep driving returns?

Portfolio Manager explains what he sees as the ongoing drivers behind AI and outlines why his firm launched their first AI ETF

Can AI keep driving returns?

AI has been an investor obsession for almost two years now. Since Chat GPT launched in 2022, wowing users with its well crafted answers and rapid responses, AI has been a huge tailwind for equity performance. The so-called ‘magnificent seven’ of Tesla, Amazon, Apple, Nvidia, Alphabet, Meta, and Microsoft drove the majority of US equity returns in 2023 largely on the back of their exposure to the AI trend.

Even as the field split somewhat in 2024, those large-cap companies who continue to be viewed as AI leaders are still performing, while drop-offs in stock performance have been attributed to an inability to keep pace with AI. With AI dominating the news and driving investor sentiment, questions arise about how much room to run this growth trend still has.

Peter Hofstra believes that AI exposure can still deliver for advisors and investors. Hofstra is the senior vice president, co-head of equities – research, and portfolio manager at CI Global Asset Management and the lead manager on the new CI Global Artificial Intelligence ETF. Hofstra spoke with WP about why his firm has launched this strategy now and why he thinks AI can still deliver despite the trend’s remarkable run to date.

“When you look at the percentage of IT spend from all firms going into AI, it’s still tiny. The spend that’s going to AI has been projected to be around two per cent of total IT spend for 2024,” Hofstra says. “As much as [AI] has grabbed headlines in part because of things like Chat GPT, it’s actually still such a small part of the overall tech spend. So we see AI as having long legs.”

Hofstra’s view on AI impacts is multi-sectoral. Looking at service businesses like call centres, for example, he sees AI driving efficiency and expediting service delivery. Healthcare, too, is a sector where AI applications appear to be limitless, from collecting and analyzing data, to helping patients and doctors manage primary care.

At the moment, the new CI ETF aims to capture AI tailwinds largely through exposures to publicly traded tech and communications companies. These sectors are currently the big spenders on AI infrastructure, the ones building out the compute power, communication linkages, and storage requirements that are needed for the widespread adoption and implementation of AI. Those include the ‘big four’ AI-exposed megacap tech companies: Nvidia, Amazon, Meta, and Microsoft who are the largest spenders on AI right now.

Hofstra uses that spending to contrast this AI trend with the dot com bubble of the 1990s. Where that era was an investor driven bubble that paid little attention to underlying company fundamentals, those ‘big four’ names at least are spending billions to build and expand their AI infrastructure.

The ETF is not just a mega-cap exposure play, however. Hofstra offers two names as examples of lesser-known AI-exposed stocks: Gitlab, which uses AI to help developers write code, and Supermicro, which develops servers and computers that are key underpinnings in AI infrastructure. Other subsectors like data center REITs appear to offer some additional exposure to AI and while the new ETF currently doesn’t hold any REITs, Hofstra says the managers are looking at both REITs and utilities companies which may be positively exposed to the power demand that AI will place on existing and new infrastructure. Because the ETF is actively managed, Hofstra and his team are looking for these additional opportunities and should be ready to move on them as they arise.

As constructive as he is on the AI trend, Hofstra does not deny that there could be short-term volatility or corrections as the pace of investor interest potentially dislocates from the pace of earnings growth. Nevertheless, he believes that AI spending will be far higher in five years than it is today, making this a longer-term play. He argues that the active management in the ETF should allow the managers to deal with short-term ebbs and flows in valuation, including the ability to write call or put options on their holdings.

Hofstra says that his management team is targeting “better than market returns,” which means exceeding the S&P 500’s average return of between nine and ten per cent. If they aren’t achieving outperformance, Hofstra says they’ll be ‘disappointed,’ but that the long-term growth outlook makes him confident.

“My own experience of investing over the last 20 plus years tells me that the market underestimates long-term growth,” Hofstra says. “If you look at Microsoft over the past 15 years, for example, it has generated dramatic returns. This is the most well-known company in the world, yet it massively outperforms the market. Why does that happen? It’s because people have a hard time giving credit for longer-term growth, growth beyond the next year or two. If we’re right on that, that’s how this product would create better than market returns, is if the tail on this growth is higher than what people are willing to give credit for, with that tail being three, five, even ten years out.”