As government bond yields have been rising, investors have re-embraced the comfort blanket of AI stocks. However, there is an increasing sense that a lot is resting on the success of AI adoption – and that may not be a slam-dunk. There are a number of global fund managers actively seeking out alternative sources of growth in a market that is only looking in one direction.
AI has become the dominant theme across financial markets. In the US, the top 10 stocks in the S&P 500 now make up 39% of the index, and all are linked to the AI adoption curve. In the MSCI Emerging Markets index, semiconductor giant TSMC is now 16% of the index, the technology sector 44%, and technology-dependent South Korea and Taiwan 50% between them. The technology giants have been issuing corporate debt to fund their AI build-outs. That has taken their share of corporate debt markets from 2% in 2022, to almost 10% in 2026.
In other words, every way an investor turns, there is AI. Even if they believe that AI is likely to bring about the revolution it promises, there is an argument that a ‘neutral’ allocation to markets puts a lot on a single bet. Every technology revolution comes with volatility. Joe Bauernfreund, manager of the AVI Global Trust, says: “What happens if the AI thing doesn’t work out as we think it might, or as the market thinks it might?” His view is that the relentless focus on one theme has left many other parts of the market neglected, and holding plenty of value.
Put like this, it is a not just a case of finding diversification, but also about tapping into a breadth of opportunities. Bauernfreund says that they routinely measure the weighted average discount to the market for stocks in their portfolio and this is now at historically high levels, suggesting there is plenty of value out there for those willing to look beyond AI. Alan Bartlett, manager on the Global Opportunities Trust, agrees: “There are plenty of other things we can invest in that can deliver the 10% annual return we look for, and that aren’t exposed to the same draw down risks.”
Bauernfreund likes companies that can put their destiny in their own hands. This means looking at countries such as South Korea or Japan, where corporate governance reforms are pushing companies to become more shareholder friendly. In South Korea, for example, the focus has been on the stellar performance of Samsung and SK Hynix, but the wider stock market is benefiting from the government’s ‘Value Up’ initiative, which is improving governance standards. “We see good quality businesses, growing businesses, low valuations, an environment that’s becoming more conducive to active engagement, and real tailwinds from a governance agenda that helps drive those tailwinds further,” says Bauernfreund.
He sees a similar confluence of factors in Japan, where the domestic economy is improving, and corporate governance reforms are driving stock market growth. “One of our largest holdings in Japan is a company called Mitsubishi Logistics. Logistics is, in some respects, “old economy”, but it’s driven by massive, increasingly sophisticated distribution units. It’s real assets. They own a separate real estate portfolio that underpins a lot of the value.”
The Global Opportunities Trust also finds value in Japan. Bartlett points to companies such as Katakura, a Japanese property business trading at a significant discount to the value of its underlying assets: “It owns a shopping mall that is worth twice the value of its market capitalisation.” He also likes the domestically-focused small cap sector, where valuations are low and there can be little or no correlation with the MSCI World. Bauernfreund agrees: “The further down the cap spectrum you go in Japan, the crazier the valuations are.”
Major themes
Other major themes have been overlooked in the vogue for all things AI. Bartlett says: “Defence for example, is likely to have state-mandated, mid-teens earnings growth over the next 10+ years.” He says there is an AI angle to this area – the lack of innovation in the defence industry has been a problem, so governments are trying to force defence companies to become more innovative, supporting small, technology-heavy competitors. However, AI is not the story. Geopolitics and governance spending are the real drivers behind the sector.
Healthcare is another area. It is well-supported by demographics and emerging market growth, yet – until recently – widely neglected by investors. Barlett says: “The structural drivers of growth in healthcare are unarguable. If you can get the right exposure, when the froth comes out of more fashionable sectors, investors might rediscover it.” The trust doesn’t hold big pharma, where there are a lot of challenges, but instead companies such as Laboratorios Farmaceutico in Spain, Terveystalo in Finland and RaySearch Laboratories in Sweden.
Private equity has also been dominated by AI – from SpaceX to Anthropic – but here too, there are alternatives. The Caledonia trust has around two-thirds in private equity – with directly invested and fund of funds options. However, this has a different flavour to conventional private equity strategies. Caledonia’s largest holding is Blue Diamond, which runs a series of highly profitable garden centres in the UK. The public portfolio is also differentiated. CEO Mat Masters styles these as “high-quality compounders, which we can own for a long period of time”. That includes Philip Morris, Microsoft, Watsco and Hill & Smith.
He adds: “We’re trying to invest in companies that are going to give us 10% annualised return over the medium to long return. It’s equity investing, so it’s up and down, but over the medium to normal return, that’s what we’re aiming for. We want to take as little risk as possible to achieve that.”
Barlett says that investing away from AI requires a different lens on risk: “If you define risk as being the potential for capital loss, it takes you in a different direction to missing out on interesting AI stocks that everyone else is buying. It’s a lot easier to get a pricing anomaly where other people aren’t looking – and I think the market’s forgotten that.”
The AI trade is significant, and affects many different industries, but there is a world beyond it. It makes sense to build in alternative exposure just in case AI doesn’t work out as planned.
