Technological dominance is the new geopolitical battleground. Companies and countries alike must embrace artificial intelligence if they don’t want to be left behind. Baillie Gifford and Blackrock warn that those who don’t act quickly will face significant risks and geopolitical tensions.
Geopolitics and investing
This article is part six of a seven-part series by Investment Officer on the impact of geopolitical developments on investments. This topic will also be discussed at the Investment Officer Fund Event on September 30 in Bussum, the Netherlands.
In 1908, Augustus Baillie and Carlyle Gifford joined forces in Edinburgh to establish the Scottish asset management firm Baillie Gifford. They believed they were living in a revolutionary era where car tires would soon replace horseshoes. Their vision quickly came to fruition. In just a few years, horse-drawn carriages were replaced by automobiles, as illustrated by two photos of Fifth Avenue in New York: one showing only horse-drawn carriages (1900), and the other showing almost exclusively cars (1913).
‘‘Getting the technology right is only half the battle. It is the anthropological aspect that is really important. In that sense, what we do is an art as much as a science.’
Tim Garratt, Baillie Gifford
Nearly 120 years later, stockpicker Baillie Gifford is anticipating a new «horseshoes moment»: the rise of artificial intelligence (AI). It’s a paradigm shift comparable to the beginning of the 20th century, says Tim Garratt, a partner at the Scottish firm, which calls AI «the alchemy of algorithms». «People sometimes ask us if it’s difficult to be a long-term investor and predict what’s coming. We don’t think so,» Garratt explains. «Many trends were established years ago.»
This is the case, for example, with Nvidia, in which Baillie Gifford has been investing since 2016. The chipmaker is a favorite in global stock markets. Last week, it released its second-quarter results: revenue doubled compared to the same period last year, reaching over $30 billion, and profit increased by an impressive 168 percent.
Exponential sales growth at Nvidia
Nvidia is reaping the benefits of the vast ecosystem it has built since 1993, which allows it to meet the global, almost frenzied demand for chips used in gaming and artificial intelligence. Baillie Gifford claims to have identified developments like these early on, partly by collaborating with third parties, such as Delft University of Technology. These partnerships help the firm understand society’s response to technological advancements. «Getting the technology right is only half the battle. It’s the anthropological aspect that truly matters. In that sense, what we do is as much an art as it is a science,» Garratt says confidently.
Blackrock, the world’s largest asset manager, shares a similar outlook. The firm identifies «artificial intelligence, combined with digital disruption, as one of the five megatrends that will lead to a new era of greater macroeconomic and market volatility». To protect yourself from this development and take advantage of it, Blackrock suggests, «you need to identify the catalysts that could drive these trends and understand how they interact. The next step is to uncover potential winners before these megatrends are fully priced into the markets.»
«AI is absolutely a megaforce, and the way we define a megaforce is an innovation-powered transformation with the potential to impact the economy and markets in the medium to long term.»
Simona Paravani-Mellinghoff, Blackrock
Blackrock emphasises in its analysis, Artificial Intelligence – Beyond the Buzz, that AI is not a new concept. Its origins date back five decades, with the emergence of large language models (LLMs), machine learning, and automation. Now, hardware computing and deep learning have been added to the mix. The catalyst for what is being called an “intelligence revolution” was the launch of ChatGPT in 2022 by the company OpenAI, which, according to Blackrock, will drive “exponential growth and advancement” within the next five years.
Simona Paravani-Mellinghoff, the CIO for multi-asset strategies and solutions at Blackrock’s Mass team, explained in an interview with Investment Officer: “AI is absolutely a megaforce, and the way we define a megaforce is an innovation-powered transformation with the potential to impact the economy and markets in the medium to long term. However, when we think of such a transformation, it’s important to recognize—especially in the case of AI—that there is a build-up phase. This is what the market has largely been focusing on so far. So, the focus right now is primarily on the mega-technology and the infrastructure needed to enable AI components. After that comes the broadening, the so-called diffusion phase, which will be a much longer process.”
AI: a threat to business survival
Given that we still are at the early stages of the «intelligence revolution», Blackrock is focusing on a tactical investment horizon of 6 to 12 months. The reason for this cautious approach is the belief that the entire technology industry is reorienting itself around AI, creating a kind of arms race led by a handful of mega-cap companies. As a result, many companies are adjusting their strategies. According to Blackrock, companies and sectors that fail to integrate AI into their product or service portfolios risk falling behind their competitors, especially as AI capabilities continue to evolve. This is why, according to Blackrock, selecting individual stocks is so crucial at this stage.
This warning is echoed by a recent survey reported by the FT: as many as 56 percent of companies listed in the Fortune 500 fear that AI could be life-threatening for them. In 2022, this number was only 9 percent. Of the 108 companies that were further questioned in the survey about generative AI, only 33 view it as an opportunity.
An infinite number of interns
According to Tim Garratt of Baillie Gifford, «there are currently two types of companies when it comes to AI. I think most companies can handle the easy part, which is effectively using AI capabilities to improve efficiency. This often involves the idea of AI as ‘an infinite number of interns.’ That’s the foundation. Companies can fairly easily access these widely available capabilities.»
«But what will distinguish the big winners from the losers in this field are the companies with the adaptability to figure out how AI can enable them to make significant changes to their business models. This adaptability allows them to remain at the table rather than ending up on the menu of others as a result of these changes.»
As a stock picker, Baillie Gifford focuses therefore primarily on the adaptability of publicly listed companies. «That’s a quality we look for in a company. It’s an interesting concept because it doesn’t appear on an income statement, balance sheet, or in a quarterly report. It highlights the need for cognitive diversity at the board level in the face of these major technological changes.»
Companies can already benefit from AI at a fairly basic level. For example, AI can help tackle a challenge that many companies and countries have faced for several years: stagnation in labor productivity (and/or a lack of sufficiently qualified personnel).
Adoption accelerates
For example, the study Experimental Evidence on the Productivity Effects of Generative AI on the platform Science shows that for a specific set of writing tasks, using AI can increase individual productivity. When AI was used for such tasks, completion time was reduced by 40 percent, while the quality of the output improved by about 18 percent. Additionally, robotics and automation, including AI, can boost labor productivity.
The extent to which AI adds value also depends on the speed and degree of its adoption. The latter is happening faster than expected, according to research by the U.S. Census Bureau, an agency of the U.S. Department of Commerce. This research shows that the companies are increasingly using AI, with adoption rates rising from 3.7 percent in September last year to 5.4 percent early this year, and projected to reach nearly 7 percent by the end of this year.
Researchers from the Massachusetts Institute of Technology (MIT) state in the report From Automation to Augmentation that AI offers significant opportunities, particularly in manufacturing, which currently faces an aging workforce and labor shortages. Models can be trained using relevant data, domain expertise, and research. «In other words, when we think about the opportunities in AI, it is very important for us to emphasize that this is a transformation—meaning it is not a sprint but a marathon—and this influences all of our investment decisions,» says Paravani-Mellinghoff at Blackrock’s Mass team.
Also see: From Automation to Augmentation, MIT.
US attracts most new AI investments
Source: CB Insights, Gavekal Dragonomics.
Leading the «intelligence revolution» are American tech companies and Chinese government-backed firms. This year alone, Microsoft, Google, and a handful of other companies have allocated over $100 billion for capital investments in AI.
«Over a five-year period, I think the figures will be even higher. We’re talking about $1 trillion in capital expenditures (Capex) from the major technology companies. To put that in perspective, that’s more than the combined investments of the next 90 companies in the S&P index. So, it’s an enormous amount. In a sense, it’s a forced choice, because it’s probably still too early to determine whether it will generate enough additional revenue for a good return. But if they don’t invest, they become vulnerable. Some of these investments will likely prove to be redundant,» says Garratt of Baillie Gifford.
Garratt draws another parallel to the railway revolution of the early 18th century, when vast amounts of money were spent on laying down tracks. «But ten years later, locomotives had evolved, requiring much of that track to be relaid. This is partly unavoidable. And as with any arms race, it’s likely driven as much by defensive thinking as by offensive strategy. None of them want to be left behind, so it’s likely that overcapacity will develop. For this reason, we need to consider the business models that will be built on top of this. Truly interesting returns in the future may be found in areas like finance, consumer goods, or robotics.»
“There will be many unsustainable business models built on this, and that’s where stock picking becomes really important.”
Tim Garratt, Baillie Gifford
Garratt notes that there is a lot of «AI-washing» happening, similar to what was seen during the dot-com era at the beginning of this century. «Many unsustainable business models will be built on this, and that’s where stock picking becomes really important. We need to figure out that it’s not just about a compelling top-down narrative; it’s about where the actual margins will emerge. Where will the significant returns in these industries occur?»
«We are already seeing a lot of capital destruction, even in relatively traditional industries like cosmetics. For example, you have a company like Elf Cosmetics, which has redesigned its entire supply chain based on AI. This isn’t just at the front end, where they use influencers to get rapid feedback on their products, but also through a very tight link and predictive supply chain analysis that allows them to get products to stores within two weeks. “In contrast, I heard that incumbent cosmetic companies like L’Oréal are holding regular crisis meetings because they can’t respond to this. So, in that sense, there will be a lot of creative destruction, as AI supports completely new business models that established companies and many traditional industries will struggle to respond.»
Vertical model for the digital world
The big question currently occupying both investors and scientists is how the digital world is evolving before our eyes. This involves not only identifying where the investment opportunities lie but also where power and sovereignty will become concentrated.
Haroon Sheikh is focused on that latter question. He is a special professor of Strategic Governance of Global Technologies and a senior researcher at the Scientific Council for Government Policy (WRR) in the Netherlands. In 2022, Sheikh published the study European Digital Sovereignty: A Layered Approach, which has recently been released as a book titled Atlas of the Digital World.
“Whoever controls digital technology controls global trade, and whoever controls global trade possesses all the world’s wealth—and, with it, the world itself.”
Haroon Sheikh, WRR.
Sheikh argues that «the once casual sentiment has been replaced by more doubts about the effects of digitalization and fears about its dangers». He notes that various authors refer to this as «techno-feudalism», while India labels China’s Silk Road (Belt & Road Initiative) as «digital colonization», comparing tech giants to the British East India Company and the Dutch East India Company.
The question Sheikh poses is: Where does the digital domain begin and where does it end? Critical scholars like Shoshana Zuboff argue that the big tech companies are engaging in «digital land grabs». Data is seen as the new oil, Sheikh writes. «Whoever controls digital technology controls global trade, and whoever controls global trade possesses all the world’s wealth—and, with it, the world itself.»
To somewhat contain this development through laws and regulations and to strengthen digital sovereignty, Sheikh has created the atlas of the digital world. After all, digitalization is placing us in a new kind of space.
«And that’s why it’s wise to create an atlas of that space,» Sheikh explains. «We are moving from a horizontal to a vertical model. By creating a ‹stack›, you can visualize the different layers of the digital world and anticipate challenges more strategically. This also makes it clear that this vertical world fundamentally impacts our global order.»
Against this backdrop, the European Union aims to strengthen its strategic autonomy, including by securing the digital sovereignty of the union.
Atlas of the Digital World provides guidance
Source: Haroon Sheikh, Atlas of the Digital World.
Not only scientists and policymakers are concerned about these developments; investors and asset allocation strategists are also aware of the significant uncertainty accompanying this AI revolution. To address this, Blackrock has introduced an AI-Technology Stack, essentially a roadmap for its investment policy.
The first layer (orange in the diagram) consists of cloud infrastructure and chips, which are the foundational building blocks. The second layer (yellow) includes models, data, and data infrastructure. The final layer (white) comprises the applications that leverage these innovations. Blackrock believes that the world is currently situated somewhere between the first and second layers.
Blackrock’s AI Technology Stack
AI fuels geopolitical rivalry
Blackrock expects the impact of AI to extend across multiple domains. One key area where it will intensify geopolitical rivalry is the semiconductor supply chain. On the hardware side, the focus is primarily on global chip manufacturers due to the enormous computing power required to develop and train AI models. Blackrock also anticipates that more capital will flow into chip production, especially as countries like the U.S. incentivize domestic manufacturing with subsidies.
The next step—leveraging data—is underestimated, according to Blackrock. The demand for digital infrastructure, such as hardware, data, and locations for server farms, is expected to outstrip supply. Companies with extensive proprietary datasets will likely be able to utilize this data more quickly and easily to create fundamental, innovative models compared to those without such data. Additionally, developers of applications that aim to use AI to analyze data and unlock the value of these “data mines” could also present potential investment opportunities.
«We are witnessing significant technological innovations that are enhancing connectivity, security, and physical automation, and are merging these with AI.»
However, Blackrock warns that, like any technology, AI has its adoption limits. One example is cybersecurity risks, which governments are countering with stricter regulations and the use of counterintelligence services. Still, Blackrock believes that the AI revolution can no longer be stopped or even slowed down. «We are witnessing significant technological innovations that are enhancing connectivity, security, and physical automation, and are merging these with AI. We believe the entire AI ecosystem will benefit in the long term.»
Blackrock concludes: «The leaders in this race will likely be the companies that attract the best talent, have deep pockets, and can invest in scaling up computing power to leverage data.»
Cees van Lotringen is a writer, journalist, and entrepreneur. He is the former editor-in-chief of Investment Officer. This article originally appeared in Dutch on InvestmentOfficer.nl
Further reading in this series:
- Energy transition ushers in biggest bull market ever (12 August)
- ‘Dancing on the volcano - as long as it lasts’ (22 July)
- China’s sudden electric car boom stirs strategic concerns (1 July)
- An autonomous EU would create a new framework for investors (7 June)
- Europe’s rude awakening: Geopolitics is back (21 May)