5 year review of the Sanlam Global Artificial Intelligence Fund

Chris Ford

Senior Fund Manager

Review of the last five years

We are in the early phase of the adoption of AI and we believe that companies with the ability to deploy AI successfully can use it to achieve a competitive advantage. The Fund is designed to take advantage of this opportunity.

Five years ago the market was observing seemingly unrelated disruptions across a range of sectors in the economy. ‘Disruptors’ back then would have included the likes of Netflix, Expedia and Priceline. Whilst these disruptions may have looked isolated, there was actually a common nexus of technologies behind them which facilitated the disruption that was happening.

Wall Street misunderstood the disruptions and continued to view them as unrelated events. However, if you took the time to understand the technologies, and the context in which that technology was materialising, you could begin to see how the disruption might play out – so you needn’t be surprised at all that the disruption was happening.

Over the past five years we’ve seen a lot of disruption, whether it was in healthcare, business services or financial services. Now we are beginning to see disruption in agricultural equipment and food production more broadly and other parts of the economy as well. If you can understand disruption, you can build a better framework and develop a better understanding of the change that is now emblematic of the economy.

Back in 2016 and 2017 we started to hear from top-tier companies – like UnitedHealth Group (UNH) – that AI was transforming their business. At one meeting in 2017, the then CEO of UNH opened his presentation to us with the following words:

We are going to start talking about how UNH will use AI to transform its business.

This was a real ‘lightbulb’ moment. UNH is a big business and it’s not based in Silicon Valley but Minnesota. It’s not culturally a tech company but it is a company that worked out well over a decade ago that data science would be the thing that determined its commercial success over the long term. We didn’t appreciate the importance of this at the time, but UNH took the opportunity to split the business into two parts – one called UnitedHealthcare and one called Optum. They essentially crated a data solo, with the role of being a great curator of all the amazing data that is collected by UNH. The only organisation with more healthcare data in the entire world is the NHS and it’s no surprise to us that there is huge cross-pollination of data between the NHS and UNH. Both organisations understand that data is the future; the only way to control spiralling healthcare costs is to try and deliver health solutions at the ‘herd’ level, rather than addressing individual cases, by which time it is often too late to ensure a good outcome for the patient.
 

What are the key characteristics of the Fund?

Unsurprisingly it’s a growth fund. However, there are several things that it definitely isn’t; for example, it is not a North American fund – around 50% of the capital is invested in North America, the rest is invested elsewhere. That might sound like a lot but bear in the mind that the MSCI World has had a c.70% weight in North America recently. We don’t manage against a benchmark but we do have a tilt against North America in a global context.

We’re not a tech fund, although some data vendors try to treat us at such. Only half of the capital of the Fund is invested in tech and related areas. We’re actually a decent way below 50% at the moment, with the rest of the Fund invested across a range of sectors.

We’re also not a systematic fund. We use AI in our investment process and we have clear view on why and how AI is important for the asset management industry over the coming decades, but we have yet to see evidence that AI is good at building portfolios. If it were that simple we would all be sat on a beach somewhere! We use AI in a very particular way in our portfolios, to help automate the ‘insight’ part of the investment process. But, at its heart, the Fund is a long-only, growth-oriented global equity fund with around 35 holdings and a strong tailwind blowing at its back.

When we launched the fund we had to do quite a lot of evangelising around the theme. When we came up with the concept in 2016, people didn’t necessarily believe in AI or its power to transform or disrupt industries. Now, in 2022, we do much less evangelising – it’s become very apparent that AI will have lots of different impacts right across the world.
 

What has performance been like?

Over the five years to 6 Sep 2022, we’ve produced a GBP return of over 123%, in other words annualising at about 18%. We’re really pleased with this outcome, even allowing for the more challenging market conditions of the last 12 months. We don’t run the Fund against a benchmark but to give you some perspective the MSCI ACWI has annualised at 9.9% over the past five years in GBP. The MSCI ACWI Growth index has risen 11.9% annualised. In other words, we have outperformed those indices.
 

Past performance is not a guide to future performance. Source: FE Fundinfo, TR to 6 September 2022.


On a risk/reward basis, some people aren’t sure where to categorise us. Some (sensibly) put us in a global growth category, but some will say: ‘We don’t care what you say Chris, you are a tech fund’. Other people say we are not really tech but we aren’t a global equity fund either, so they put us in the ‘Specialist’ category. The latter is kind of a sump where you end up if no-one knows how to categorise you.

To be clear, we don’t care what people think we are; we want you to look at the data and leave you to draw your own conclusions. We think we’re a global fund, but what we think on that front doesn’t really matter.

Looking at the positive contributors to return over the past five years, the standouts have included the likes of Tesla, but there have been a range of names whose contribution to return has been 300bps or higher. In other words, we’ve had a very high hit rate, bearing in mind at launch that we only had 31 holdings. What’s really important to us is breadth and diversification; in the list of winners you’ll see names from the US, Japan, China and even Latin America. In the UK, Ocado has been a good performer. Crucially the Fund is diversified across sectors as well as geographies.

We have made mistakes of course, but our worst performer (Expedia) cost just under 1.5% over the five-year period.

In the UK, Ocado has had a tough 12 months but is still one of the standouts over the longer term. We have a fairly strict portfolio construction methodology and this determines the maximum position size that we will have; in general terms, companies which are purer and broader expressions of AI can be larger positions, on a liquidity-adjusted basis. Those that are narrowly or less purely exposed will be smaller positions. This means that when we have stocks that have performed well, we will reach the maximum position size and take profits; a natural ‘profit harvesting’ methodology is built into the investment process and this has served us well over the last five years.

It’s interesting to remember back to our three-year anniversary when Tesla was our worst-performing stock; of course everyone knows what has happened since then and we think that it’s important to have conviction and to continue to run positions where you believe the business model is going to deliver the economic outcome that you expect.

What is your stock-level approach?

Just because we run an AI fund, it doesn’t mean we skimp on fundamental analysis; you still have to understand the corporate strategy and metaphorically ‘kick the tyres’. For example, what is the cash generation capacity of the business? We still need to meet the management on a regular basis and judge whether they can deliver vs the stated strategy. As investors, we have to record all that; work out an appropriate valuation metric; record that; and make sure there is no creep in the investment thesis. All of this is then distilled into what we call ‘investment pillars’, i.e. the 3-6 things that have to be true in order for us to maintain our position in the Fund. If one of those pillars weakens, we’ll re-evaluate, and if we can’t stand behind the investment thesis we’ll sell.

There are times when we get things wrong; Netflix (NFLX) is a good example. At the peak this was about 6% of the Fund; we cut it to just over 2% at the beginning of this year. In their Q4 call they said subscriber growth was slowing and content costs were still going up. We weren’t worried about slowing subscriber growth; this was inevitable, it is the law of large numbers – with such high market share levels in e.g. the US, it could not grow indefinitely. All the headlines were about subscriber growth. What we cared about were the costs; because our view was that Netflix would pivot from being all about the top line to being all about cash flow; i.e. it will dominate its sector for 20+ years and the EBIT margins would improve very significantly. However, our thesis got blown out of the water. The market didn’t care about costs, it was only focused on subscriber growth. But we care about costs and we had to exit.

The following quarter they did the same thing again, i.e. missed on subscriber growth, but profitability was even worse. Everyone is now beginning to realise that NFLX’ s competitors are prepared to poor cash into a black hole in order to generate content to compete with Netflix. In five years’ time, NFLX will probably still be a dominant player and it will be generating a lot of cash by then, but there will be a difficult period to negotiate in the interim. This is difficult to analyse as we just don’t know how long the likes of e.g. NBC will be prepared to pour cash into a black hole. We’ll revisit the stock when we think there is some scope for the investment pillars to repair themselves.
 

Learn more about Sanlam Global Artificial Intelligence Fund
 

 Stock examples are for illustrative purposes only and not a recommendation to buy or sell. 

Fund Risks
The Fund may invest in  shares of companies listed on stock exchanges in the United Kingdom, and outside the United Kingdom, exchange rate fluctuations may cause the value of investments to go down as well as up. Investing in companies based in emerging markets may involve additional risks due to greater political, economic, regulatory risks, among other factors. The Fund may invest in derivatives for the purposes of efficient portfolio management and hedging.