Schroder Asian Total Return (ATR) fund managers have sounded the alarm over a potential bubble in Korean and Taiwanese technology stocks as well as the US artificial intelligence developers they supply, amid renewed signs that the immense capital spending on AI may be waning.

Half-year results showed the £638m investment trust benefited from the boom in Asian AI chip suppliers, reaping a total underlying return of 34.4% that beat the 25.6% gain in the MSCI AC Asia Pacific ex-Japan index.

However, managers Robin Parbrook and King Fuei Lee are increasingly wary after a sustained rally that has helped push the trust’s shares up 80% in the past three years, ahead of the benchmark’s 69%.

They said they had made three significant changes to the portfolio in the first half of the year: trimming Taiwan technology positions in a market that had shot up 65%; adding more defensive, higher-yielding stocks in Hong Kong; and consolidating their internet holdings in China into “key names” they believed were less vulnerable to AI disruption.

The managers said the outlook for AI capital expenditure, which had helped South Korea surge 121% in the six months to 30 June, was the main debate they were having with colleagues at Schroders. 

“Recent results from US hyperscalers suggest the AI boom has not yet slowed, but warning signs are emerging. Even higher capital expenditure is no longer being rewarded with rising share prices; indeed, Meta, Microsoft and Oracle are all down materially over the past year, with only Alphabet outperforming,” they said.

While concerns over hyperscaler borrowing and spending are not new – the duo expressed them in the trust’s annual results in March – what had changed they said was the capabilities of Chinese low-cost large language model providers such as Kimi K3. 

“This model was another wake-up moment with its capability being very close to leading AI models from OpenAI and Anthropic. Hot on its heels we had the latest version of Alibaba’s Qwen model which has similar or even better capabilities than Kimi K3.”

As Chinese models started to dominate outside the enterprise segment, where they said Anthropic did look strong, “we think valuations for all LLM providers will be questioned. For most uses you don’t need a cutting-edge AI model. Given this, we believe risks are now rising that the market questions the assumed valuations for companies like OpenAI. With revenue growth slowing, competition rising is it credible that loss-making OpenAI is worth 10 times what it was in early January?”

Following a $122bn funding round this year, OpenAI is valued at $852bn and was reportedly aiming for a $1trn flotation this autumn. Over the weekend its boss Sam Altman said the initial public offer would be delayed until next year. He cited safety concerns but the Schroders’ managers’ analysis suggests the company may be reluctant to face the exposure of public markets just yet. 

Rival Anthropic, which is backed by Baillie Gifford trusts Scottish Mortgage (SMT), US Growth (USA) and Schiehallion (MNTN), as well as Pantheon International (PIN) and RIT Capital Partners (RCP), is also eyeing a blockbuster IPO next month. Valued at $965bn after a $65bn fund raise in May, it was reportedly considering an IPO valuation above SpaceX’s record $1.7trn debut this summer, although again the concerns raised by the ATR managers could curb excessive enthusiasm.

“If the hyperscalers’ key customers – the LLM providers like OpenAI – struggle to generate cash flows, we are beginning to question how long the unprecedented AI data centre capital excpditure boom can continue, particularly given how much has been funded through circular and increasingly opaque financing structures,” Parbrook and Lee added. 

The managers said that they remain bullish on the outlook for AI tech stocks in Asia, but were likely to continue trimming positions if stocks rose further. They were focused on stocks with highest levels of intellectual property and genuine growth drivers and had no direct exposure to LLMs and data centres “where we see multiple providers and currently little product or service differentiation.”

The changes leave the trust for the first time overweight to China/Hong Kong, one of four clusters the managers identify in their region, with just over 25% invested compared to Taiwan at 30.7% and 16.5% in South Korea at the end of August.

IT is by far the biggest sector at 49.1% of the portfolio. This shows up in the top 10 stocks led by 17% in Taiwan Semiconductor Manufacturing Company, 9.6% in Samsung Electronics, followed by positions of over 4% each in Mediatek, ASE Technology, Tencent and SK Hynix.

Increasingly wary, the managers kept gearing, or borrowing, at around 5% and moved their hedging models from neutral to more cautious because of rising valuations in Korea and Taiwan. 

By contrast, stock markets in India and China fell 9% and 14% on concerns over rising oil prices and AI disruption to software and internet companies in the two countries. Indonesia was the worst market, however, recalling 40% in response to attacks on property rights by a populist government. 

ATR’s strong half-year results underlined why rival Pacific Assets (PAC) chose it as a merger partner in June. Its shares have risen just 16% in the past three years and, after a 25% exit, the merger should swell the Schroder trust’s assets to over £1bn.

The trust’s shares did less well than the underlying portfolio, returning 27.8% in the six months to 30 June as their discount, or gap, to net asset value (NAV) widened from 1.1% to 6%. This prompted the board, chaired by Sarah MacAulay, to make its first share buybacks in two years in an attempt to bring the discount back to 5%, which it has achieved.

Our view

Richard Williams, senior analyst at QuotedData, said: “This is an impressive set of numbers from Schroder Asian Total Return, with the 34.4% NAV return comfortably ahead of the 25.6% return from its benchmark. Much of that outperformance came from the managers’ overweight exposure to Taiwanese technology stocks, and it seems sensible that they have since been taking some profits after the extraordinary AI-driven rally in Korea and Taiwan and shifting towards cheaper, more defensive areas of the market. It is disappointing that such strong performance did not prevent the discount from widening from 1.1% to 6.0% over the period (5.3% today), although the board has been active with buybacks. The proposed combination with Pacific Assets should help, increasing the trust’s scale, improving its market relevance and lowering costs for shareholders. With the managers now adopting a more cautious stance, the second half may not match the fireworks of the first, but the strong stock selection demonstrated so far provides some reassurance as they navigate what could be a more volatile period.”