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23 Nov 2023

Investing in AI, what history can teach investors

By Research Partner Consilium

Investing in the share market can often feel like a rollercoaster ride, especially when new transformative technologies emerge, and artificial intelligence (AI) which recently exploded into the mainstream domain, is no exception. In the year to date, share market returns for companies with significant investments in AI have been stellar. Nvidia which specialises in AI hardware and software is up over 200%. Microsoft, who has invested heavily in ChatGPT is up over 30% and Meta (Facebook) is up over 150%.

While AI feels like nothing we’ve seen before, over the years the share market has witnessed the rise of various technological innovations from the advent of electricity to the internet revolution. These innovations have reshaped industries, created new opportunities, and, in turn, impacted share market performance. They also provide instructive data to investors to see the dangers and opportunities of investing into this type of technology.

In this article, we delve into historical share market reactions to transformative technologies, examine the current landscape with AI and reinforce the importance of disciplined investment principles.

The Historical Perspective

To understand how the share market responds to transformative technology, it's essential to take a historical perspective. Throughout history, new technologies have disrupted existing industries, leading to both winners and losers in the share market. Let's look a few examples:
1. The Industrial Revolution: The late 18th and early 19th centuries saw the advent of the Industrial Revolution. Companies that embraced new manufacturing processes and machinery flourished, while those clinging to outdated methods faced obsolescence.
2. The Internet Boom: In the late 20th century, the emergence of the internet kickstarted a wave of innovation, giving rise to companies like Amazon and Microsoft. These technology giants became share market darlings, with their shares experiencing meteoric rises. Yet even these companies experienced some excruciating price drops. Amazon lost 80% of its share value in 2000 and another 30% in 2002, and it was considered one of the winners.
3. The Dot-com Bubble: Unfortunately, not all companies in the internet sector fared well long term. Many startups that couldn’t translate their ideas or their potential into profits went out of business altogether.

The Current Landscape with AI

Artificial Intelligence, with its potential to transform nearly every industry, is the latest technological frontier. But how is the share market responding to AI-focused businesses?

Based on history, what we should expect is increased volatility. It’s clear that AI will contribute to greater business efficiencies in the future but it’s very difficult to price. What sort of profits will these businesses make?

Which businesses will be the winners, and which will fail to achieve their potential? Uncertainty means prices will move as investors absorb new information and adjust their expectations.

Like the dot-com craze, most AI companies will likely fail to outperform the market. Academic research has shed light on this topic and the results are instructive.

One widely cited study by Hendrik Bessembinder, titled 'Do Stocks Outperform Treasury Bills?' (2018), found that the majority of individual shares (about 58%) underperformed one-month Treasury bills over their lifetime. This means the odds of picking an individual share that outperforms a risk-free investment like US Government short term Treasury bills is less than 50%.

The key to investing into AI then, like many other technological revolutions, is diversification. By owning thousands of companies in your portfolio, you will have exposure to individual firms such as Nvidia and Meta that are making big moves into AI. If they succeed, some of the investment funds in your portfolio will continue to appreciate they have done so far this year. However, if any of these individual companies underperform, and it’s certain some will, you have spread your investment out broadly enough that it shouldn’t affect you achieving your long term goals.

The share market's response to transformative technologies like AI can be both exhilarating and nerve-wracking.

Historical patterns show that while these technologies can lead to greater market volatility, they also create opportunities for disciplined investors. In the long run, investors who adhere to disciplined investment principles, maintain a diversified portfolio, and exercise patience are more likely to achieve their financial goals.

As we continue to witness the AI revolution and its impact on the share market, it's crucial to stay focused on your investment strategy and remain committed to your long term objectives. By doing so, you can ride the waves of transformative technology with confidence and resilience.

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