The sheer amount of capital diverted to the Magnificent Seven has created pockets of undervalued businesses, especially outside the US. We speak with Thornburg’s Miquel Oleaga about opportunities found in AI users and financials
It is no secret that active managers have been struggling with the outperformance of the Magnificent Seven in recent years, as capital diverted elsewhere is unlikely to have produced similar returns as these technology companies have managed to achieve.
And although the septet lost ground against the rest of the S&P 500 earlier this year, they are back on track to outperform their index peers by about 10 per cent at the time of writing, extending a five-year winning streak that puts them about 165 per cent above the rest.
But as legendary Dutch soccer player Johan Cruijff used to say: ‘Every disadvantage has its advantage’, and as more capital is flowing into the tech behemoths on the back of the AI boom, dislocations are starting to form that can be exploited by active managers.
“In the short term, [the performance of the Mag Seven] is a challenge, but I do think over the long term it does create many opportunities for us, because as those names become de facto vacuum cleaners of the world’s capital, it creates really large pricing dislocations around the world,” Miguel Oleaga, a Portfolio Manager for Thornburg Investment Management, says in an interview with [i3] Insights.
In the short term, [the performance of the Mag Seven] is a challenge, but I do think over the long term it does create many opportunities for us, because as those names become de facto vacuum cleaners of the world's capital, it creates really large pricing dislocations around the world
Thornburg is an independently-owned US asset manager and they like to think that this independence is reflected in their choice of headquarters. Located at an elevation of 2200 meters, on North Ridgetop Road in Santa Fe, New Mexico, they are one of the highest-located asset managers in the world.
It helps with keeping a distance from all the noise in the markets, they say.
Oleaga runs a highly concentrated global equity strategy that invests in no more than 40 stocks and, therefore, has to rely on independent thinking to construct his portfolio. Yes, he holds some of the Mag Seven stocks, but with only 40 names to play with, he can’t hold them all.
But neither does he want to.
His fundamental research has identified that there are increasingly better opportunities in countries outside of the US, especially in Europe. Having been neglected by investors during the rise of the AI boom, there are many sectors in this region harbouring great businesses at reduced prices.
“A strategy like ours, which is global, all-cap core with a high degree of flexibility, can go into some of those areas that are getting less capital and buy what we think are clearly much better than average businesses at great prices,” he says.
Betting on the User Segment of AI
Although the future promise of the Mag Seven might be overhyped, the AI boom is not, Oleaga says. In fact, he believes many of the benefits of AI are already starting to filter through to other companies, the end users, but these benefits have been underestimated by the market.
“An area of the market that we think is interesting is the users of AI. These businesses are going to be able to put AI to work and we don’t think that’s really reflected in the valuations of companies that are downstream of AI,” Oleaga says.
“A lot of firms have proprietary data sets, have proprietary workflows. I think AI is just going to enhance and make those more efficient, which in theory should lead to better returns for those companies.
“And you don’t really pay up a lot to get exposure to that today,” he says.
Oleaga is not much of a gamer – his thumbs don’t work fast enough for that, he says – but he does like to make a gaming analogy when it comes to AI: “We’re in the Atari stage of AI, and we’re going to get to whatever the latest console is that we have today,” he says.
When Atari launched the Atari 2600 in 1977, its ability to store games on swappable ROM cartridges was a marvel of new technology. But today the rudimentary graphics of its games look almost laughable when compared to the hyper-realism of games such as Cyberpunk 2077 or Gran Turismo 7.
AI is at a similar stage; it will get a lot more sophisticated and companies will see the results flow through to their bottom lines.
Oleaga gives the example of the energy sector. Oil and gas companies have for many decades collected data from seismic surveys for exploration, data on production rates for reservoir management and sensor data from pipelines and equipment for real-time monitoring of efficiency.
But often this data lives in separate siloes, leading to inefficiencies and sometimes outright failures. AI can be harnessed to tie these databases together and extract underlying patterns.
An area of the market that we think is interesting is the users of AI. These businesses are going to be able to put AI to work and we don't think that's really reflected in the valuations of companies that are downstream of AI
“When we look at the energy industry, this is an industry that has decades worth of data, whether it’s seismic data or other types, but often, those data sets are fragmented for a particular play. With AI, we’ll have the opportunity to put that data together and better understand the components of the play,” Oleaga says.
“That will reduce the kind of wasted capital in terms of drilling dry holes on one side, but then also allow more targeted development to the richest part of the play. You can bring products to market sooner, and maximise the value,” he says.
Even technology companies should be able to benefit from AI as users, rather than as developers. Take SAP, for example. The German enterprise resource planning software provider seems like an easy target for AI disruption, but Oleaga thinks the company will only become better at its job, because much of the data it processes is proprietary.
“SAP is helping thousands of companies manage their data, and most of that is proprietary data. SAP will be able to integrate AI and use the best-in-class AI tools to get better business insights and better efficiencies out of their models going forward,” he says.
“Now, the market will say there is some risk here that this business could be disintermediated because of AI, but more likely than not, its clients will need help in terms of putting those AI solutions into play, and so SAP is going be there to partner with them and try to really make the most of those proprietary data sets.”
Bullish on Financials
Although Oleaga has a large number of technology and technology-related companies in his portfolio, both in the US and outside of it, it isn’t just a tech play. For example, the portfolio is underweight Information Technology relative to the global equity benchmark.
It also has an overweight to financials. The narrative here doesn’t evolve around AI usage, but focuses on the unprecedented level of consolidation seen in many global markets since the global financial crisis (GFC).
In many cases, only a handful of efficient, well-capitalised banks are left standing, a situation that doesn’t seem to be fully recognised by the market.
“When you look at what’s happened with financials post GFC, clearly it was a bad performing sector, and a lot of capital left the industry,” Oleaga says.
The Irish banking market has gone from 12 or 13 players, 20 years ago, to something more like three to four players. Less players in this market means the returns have gone up for everyone, so their earnings power is much higher
“What essentially ended up happening there is you started to see a lot of consolidation and that has created these opportunities where you have businesses that were unremarkable 20 years ago, but are actually now operating in a pretty remarkable situation. Up until maybe the last one or two years, that hadn’t been really reflected in valuations,” he says.
Oleaga gives the example of Bank of Ireland, a company he has in the portfolio. The Irish banking system has seen a dramatic transformation since the troubled days of the GFC.
“The Irish banking market has gone from 12 or 13 players, 20 years ago, to something more like three to four players. Less players in this market means the returns have gone up for everyone, so their earnings power is much higher.”
Yet, the bank’s stock price has traded at very cheap levels multiple times over the past five years. “It didn’t reflect the improved nature of the banking industry or the quality of Bank of Ireland,” he says.
This article was sponsored by Thornburg Investment Management. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
_________
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.