Artificial intelligence is just one exciting area of innovation
Guy Feld, Manager of Marlborough Global Innovation, explains that while the fund has exposure to companies at the cutting edge of artificial intelligence, the investment team are also identifying attractive long-term opportunities in a whole range of other areas of innovation.
Investor sentiment is white hot on artificial intelligence (AI) at the moment, and our fund is invested in a number of companies across different industries and geographies benefiting from the AI theme. For example, we hold a small company that leads the world in the AI-based detection of drivers’ illegal mobile phone usage and non-compliance with seatbelt laws.
However, we see innovation as a much broader theme permeating many industries. It is certainly not restricted to AI or the broader IT industry. In reality, AI really is not that new. It could be seen as a natural extension of the exponential growth of software used to analyse large volumes of data, and companies extracting value from that, and from the development of machine learning. Arguably, it is an evolved form of software automation, analysis and predictive insight, which is not ‘new’ news. AI has not just exploded on to the scene out of thin air – rather ChatGPT is a milestone that has drawn a powerful spotlight on to this evolving technology.
Water conservation and molecular diagnostics
We take a far broader view of innovation. It can come in a wide variety of forms, whether it is a new business model, new products and services or new processes. We are invested in companies bringing fresh thinking and applications to areas such as water conservation and treatment, and molecular diagnostics, where scientists look at the unique genetic codes found in our cells to identify warning signs of diseases.
We also have a play on the substantial capital going into upgrading electricity networks so they are ready as we move from burning fossil fuels to much greater use of electricity from renewable sources such as wind and solar power. This energy transition is driving major decentralisation of not only the generation of power, but of its storage too, as compared with the historical set-up based around a limited number of huge power stations.
Established innovators and emerging winners
Our strategy is to invest in companies that are creating ground-breaking new technology, using technology in fresh and original ways or exposing the fund to other high-growth areas. We invest in companies of all sizes, both established innovators, which are often global giants still pushing the boundaries in exciting ways, and emerging winners, which are small, growing businesses that most people will not have heard of, but which are coming up with ideas that could change our lives.
While the large caps we hold in the fund are outstanding businesses with exciting prospects, we generally have a preference for smaller companies, which we believe offer superior long-term growth potential. So, the majority of the portfolio is invested in businesses with a market capitalisation of less than $10bn. In our view, these small and mid-sized companies can out-innovate the behemoths, offer superior customer service and address customer needs more quickly and flexibly.
The fund has a high allocation to UK-listed companies, which account for around 35% of the portfolio. However, overall, our portfolio companies generate only approximately 13% of their revenues in the UK (based on information sourced from annual reports/Bloomberg). The lion’s share of their revenues come from North America (close to 40%), EMEA (21%) and Asia Pacific (19%). This reflects the global nature of the fund.
Valuations creating long-term opportunity
Historically, smaller companies have achieved stronger growth than their larger counterparts and we see no reason why this should not continue over the long term. While small cap stocks can be significantly more volatile than large caps, this can create attractive valuation opportunities among companies with exceptional long-term prospects – and that is exactly what we are seeing today. The chart below shows that in recent years valuations of US small caps have reached a discount to US large caps not seen for more than two decades.
Three companies with strong growth prospects
We take a long-term approach and, while a number of our holdings have seen their share price pull back this year because of economic uncertainty, we believe that looking ahead their growth potential remains as strong ever.
The semiconductor wafer maker, which is headquartered in Cardiff, has seen its share price decline in the wake of weaker demand caused by inventory build-up in the supply chain. However, we believe the company’s long-term growth prospects remain strong and, as existing investors, we participated in a placing in May at 20p, a share price which we believe fundamentally undervalues IQE’s future earnings potential. Senior figures in the company also made very substantial investments.
Wafers are a key component in semiconductors used in an array of growth areas, ranging from 5G communications, data centres and aerospace to wearable health devices, autonomous vehicles and industrial automation. CEO Americo Lemos, who was appointed last year, has put the company on a fresh strategic growth path, targeting new markets and customers, and is increasing the efficiency of operations.
IQE has considerable spare capacity and when production is ramped up we believe a large proportion of the increased revenues are likely to translate directly into profits. IQE is strongly positioned geopolitically, with many of its manufacturing sites in the UK and US, providing a welcome alternative for customers anxious to avoid uncertainty in Taiwan. In addition, the UK and US governments are likely to be keen to support this cutting edge industry. We believe the strength of IQE’s intellectual property is currently under-recognised and that the company is in a sector that, while notoriously cyclical, has always recovered from previous troughs. Indeed, there are signs things are stabilising and the industry is set for a recovery over the next year.
This leading international cybersecurity services provider, which is based in the UK, has seen its share price drop this year after it warned about the impact of spending cuts by clients including US ‘megatech’ giants, against the backdrop of slowing economic growth. However, we believe the long-term investment case remains robust.
CEO Mike Maddison, who joined a year ago, has a strong track record and has made a number of senior appointments, including a Chief Technology Officer brought in from cybersecurity leader Microsoft. This senior team will help Maddison implement a dynamic new growth strategy, focusing on more specialised and higher-margin activities, together with a streamlining of costs.
While cybersecurity budgets have come under pressure this year, there is no question about the long-term need to safeguard data and other assets from hackers. Around the world, we are seeing increasing legal requirements for organisations to take stringent precautions. Looking ahead, a trading update in June pointed to signs of stabilisation in the market. We believe that with the new CEO and senior team in place, investors will, in due course, reap the rewards from NCC’s enhanced strategy and a recovery in the cybersecurity sector.
Kin & Carta
This UK company is a leading global player in digital transformation, which is the business of helping companies and governments use the latest digital technology to create new and better ways to serve the needs of their customers or citizens. Kin & Carta’s share price has fallen this year because of a hit to revenues as large businesses, including those in financial services, became more cautious about spending. As a smaller company, Kin & Carta has a relatively concentrated customer base and the deferral of revenues has made a significant impact on financial performance in the short term.
However, well-regarded CEO Kelly Manthey, who was appointed last year, is highly experienced and understands the strong culture of Kin & Carta extremely well. The company has made good progress in acquiring and using lower-cost overseas personnel and is highly mindful of cost control, providing greater flexibility in a more challenging environment. It also has artificial intelligence and data divisions, providing exposure to strong growth themes. Kin & Carta should be well placed for a recovering market, especially in the US, where it has a strong roster of blue-chip clients built up through superior service delivery. In the months and years ahead, we believe companies will continue to see a strategic need to position themselves for the digital future and, in our view, Kin & Carta is strongly positioned for long-term growth.
We hold a conviction portfolio of just over 35 companies and we believe these businesses have outstanding long-term prospects. Looking ahead, we will continue to take a broad-based approach to global innovation. While artificial intelligence is creating very interesting opportunities, we remain keenly aware that human ingenuity is driving exciting innovation across a wide range of business sectors.
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Issued by Marlborough Investment Management Limited, authorised and regulated by the Financial Conduct Authority (reference number 115231). Registered office: PO BOX 1852 Lichfield, Staffordshire, England, WS13 8XU. Registered in England No. 01947598. Investment Fund Services Limited (IFSL) is the Authorised Corporate Director of the Fund. IFSL is registered in England No. 06110770 and is authorised and regulated by the Financial Conduct Authority. Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Copies of the Prospectus and Key Investor Information Documents are available from www.ifslfunds.com or can be requested as a paper copy by calling 0808 178 9321 or writing to IFSL at the registered office above.