Interactive Investor

Funds, trusts and shares to look beyond the ‘Magnificent Seven’

Faith Glasgow explains how a number of stock-picking global managers are looking for less high-profile stocks on cheaper valuations that are expected to play integral roles in long-term technology themes.

8th July 2024 09:00

by Faith Glasgow from interactive investor

Share on

An investor looking through a telescope

Investing in the seemingly unstoppable and constantly evolving technology arena may be enormously rewarding, if you get it right – but it’s a highly volatile path to tread.

To put that into some perspective, after a couple of years of runaway success, the FAANG stocks of Facebook, Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX) and Google-owner Alphabet (NASDAQ:GOOGL), found themselves sidelined by the emergent Magnificent Seven (NVIDIA Corp (NASDAQ:NVDA), Meta Platforms Inc Class A (NASDAQ:META), Tesla Inc (NASDAQ:TSLA), Amazon, Apple, Alphabet, Microsoft (NASDAQ:MSFT)).

As a consequence, while the S&P 500 index rose 24% in 2023, the Magnificent Seven as a group generated an average 76% return, with three stocks – Nvidia, Meta and Tesla – more than doubling in value over the calendar year. Nvidia was up by a breathtaking 239%.

But their individual fortunes have diverged quite significantly in 2024. While AI-focused Nvidia’s value has gained another 161% year-to-date (to 8 July), that of electric carmaker Tesla is up just 1.3%. 

In general, the obvious risk in seeking exposure to this area is that of paying a lot for hot stocks occupying huge positions within the wider index, which could take a nasty tumble in due course.

For example, Julian Bishop, co-manager of Brunner (LSE:BUT) investment trust points out that although Nvidia currently heavily dominates production of the graphics processing units (GPUs) used in AI, that arena may become more competitive over time as its customers seek to reduce their reliance on a single supplier.

Another uncertainty relates to the cyclicality of demand. “Currently, generative AI models are hugely expensive to develop, largely reflecting the cost of Nvidias GPUs, which cost tens of thousands of dollars each,” observes Bishop.

He adds: “However, many of these models generate very little revenue or profit so far. We are currently in a boom, but profitable use cases for AI will need to emerge for it to continue. Comparisons with the dotcom era are worth contemplating.”

The bottom line is that investors keen for a slice of the future-facing tech action could face a pretty rocky ride in the shorter term, if fashion or circumstance turns against their favoured mega stock.

A number of stock-picking global managers are therefore looking for less high-profile stocks, with cheaper valuations, that are expected to play integral roles in the long-term tech/digitalisation story, either instead of or alongside Magnificent Seven holdings.

Kepler Partners’ Pascal Dowling identifies Alliance Trust (LSE:ATST) as an interesting portfolio in this respect, given its specialist multi-manager structure and deliberate focus on both value and growth approaches.

ATST is underweight the Magnificent Seven on the grounds that they tend to be overvalued and not all seven are likely to have equal longevity; but Mark Atkinson, senior director at manager Willis Towers Watson, notes that the trust holds “a decent amount of tech more or less aligned with cyber security, AI trends and so on”.

He stresses, though, that ATST does not take positions on the basis of macro trends but concentrates on individual stock selection. “As with all sectors, we are never massively over or underweight tech, just selectively exposed to what our managers believe are the most attractive opportunities available.”

Examples include Ebara, held by sub-manager Black Creek, which manufactures precision machinery used in the production of semi-conductor chips.

Atkinson also highlights several stocks in the chunk of ATST’s portfolio managed by Lyrical: technology consultancy Arrow Electronics Inc (NYSE:ARW), TD Synnex Corp (NYSE:SNX), which helps build networks among tech companies, and cyber safety business Gen Digital Inc (NASDAQ:GEN).

“Given Lyrical’s deep value approach, I would assume all these stocks are sensibly valued,” he adds.

A third sub-manager, GQG, holds Synopsys Inc (NASDAQ:SNPS), which provides “electronic design automation solutions and services”. GQG also holds semi-conductor manufacturer ASML Holding NV (EURONEXT:ASML), an alternative stock popular among growth-focused professional stock-pickers, including the Brunner team.

As Bishop explains, ASML has 100% market share of the advanced lithography machines used in the manufacture of Nvidia’s GPUs, and as such is “a company controlling a choke pointin the supply chain for the most complex semiconductors”.

At Rathbone Global Opportunities fund, manager James Thomson holds Nvidia itself, but also the less mainstream French-listed electrical power product manufacturer Schneider Electric SE (EURONEXT:SU).

Thomson sees Schneider as “a key play on the electricity network upgrade that is required to service the AI power consumption explosion”. He adds: “Analysts expect global electricity consumption to grow 80-150% by 2040; upgrading the network in and out of the home is a key part of this.”

Another Rathbones holding is the US firm Amphenol (NYSE:APH), a picks and shovels’ play on electrification, digitisation, and AI,” producing the unglamorous connectors, jacks and cables critical to technological systems.

Thomson explains that these connectors are integral to automotive, mobile phone, military, broadband, and commercial aerospace systems. Importantly, Amphenol also manufactures more than 20 key components used in data centres, “the nerve centres of the AI revolution”. 

“This company is twice as large as Rolls-Royce and Barclays, but no one has heard of it,” he adds.

Guinness Global Investors has held Nvidia for more than 15 years, although managers Matthew Page and Ian Mortimer point out that it has only been in the headlines for the past 18 months. The duo manage WS Guinness Global Equity Income and Guinness Global Innovators

However, the Guinness team too takes a “picks and shovels” approach to the wider AI arena. It has been focusing on semi-conductors since 2018, allocating no less than six of the 30 stocks in its portfolio to that sector.

Hand going through portal shape and touching virtual hand. Metaverse concept Getty

“Historically, many semiconductor companies have had very cyclical earnings profiles, but we thought that cyclicality was likely to be dampened in the future and growth prospects were likely to increase,” explains Page.

Certainly, although semiconductor stocks did suffer a slowdown in 2023 after the boom time for online existence during and after the pandemic, the sector still outperformed the broader market, and the managers believe downcycles are becoming shallower.

Three of their six holdings are semiconductor equipment manufacturers, which the duo see as “an area set to benefit from both the wider application and the increasing complexity of chips, raising the requirements of the equipment used to make them”.

Applied Materials Inc (NASDAQ:AMAT) - the largest manufacturer in terms of sales – has “peer-leading levels of R&D and a range of solid competitive advantages”; Lam Research Corp (NASDAQ:LRCX) is another leader in its field with broad coverage; while specialist KLA Corp (NASDAQ:KLAC) focuses specifically on process control and the detection of defects.

Page and Mortimer consider all three holdings to be benefiting from “increasingly diverse end markets with long-growth runways” - not just in AI but also in areas such as cloud technology and mobile phones. Broader application, of course, helps to reduce overall sales volatility for these businesses.

However, it’s not only global funds and trusts that are picking up on the lower-profile businesses that support and enable Nvidia and its competitors; regional funds too have been capitalising on such stocks.

At JPMorgan European Growth & Income Ord (LSE:JEGI), fund manager Alex Fitzalan-Howard makes the point that Europe - still an under-appreciated market in valuation terms, compared with the US – has its own ‘Magnificent Seven’ stocks, albeit across a more diverse range of sectors than the US line-up.

The trust’s holdings include ASML and Schneider Electric for AI exposure, as well as drugmaker Novo Nordisk A/S ADR (NYSE:NVO) and luxury goods manufacturers LVMH (EURONEXT:MC) and Hermes International SA (EURONEXT:RMS).

Similarly, Ryan Lightfoot-Aminoff, an investment trust research analyst at Kepler Partners, picks out two Asia-focused trusts, Schroder AsiaPacific Ord (LSE:SDP) and Schroder Oriental Income Ord (LSE:SOI), as good examples of growth-focused investments with a strong tech focus and a particular eye to alternative routes into the AI territory.

The managers have selected Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM) as the top holding in both trusts, driven by the belief that the AI boom will continue to support demand for chips.

“TSMC is the worlds-largest chip foundry and has a near monopoly on global semiconductor manufacturing. It makes the chips for Nvidia, along with a number of other key players in the space,” explains Lightfoot-Aminoff.  

Brunner also holds the stock. “TSMC is very profitable in its own right, and recent comments from the CEO suggest it may be willing to leverage its strong position by charging Nvidia more, ensuring it enjoys a larger share of the AI profit pool,” notes Bishop.

Another Asian-oriented option picked out by Lightfoot-Aminoff is abrdn Asia Focus (LSE:AAS), whose second-largest holding is the Vietnamese IT service business FPT Corp.

He observes: “FPT recently announced plans to build a factory in Vietnam for Nvidia, focusing on AI research and development.”

Yet it is a small-cap, off-benchmark stock and therefore unlikely to be widely held, which Lightfoot-Aminoff regards as “a good alpha opportunity”.

Given the rich valuations and sheer size of the Magnificent Seven and Nvidia in particular, these lower-key service companies seem a useful back door into a part of the market that is overhyped but undoubtedly full of potential.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Get more news and expert articles direct to your inbox