Beyond the AI headlines: A Q+A with Katie Potts

How have you seen the opportunities in AI evolve over the past 12 months? 

• There has been a dramatic explosion in data centre capital expenditure, fuelling demand and creating supply chain bottlenecks in areas such as memory. More significantly there have been several holdings in HIT’s portfolio of smaller companies, which supply components to data centres.
• Share-price moves have been dramatic: in the second quarter alone, our 20 largest holdings with AI exposure rose by an average of 99%, before correcting by around 25% in Q3. It was evident that exuberance in the second quarter was excessive, so we aggressively reduced positions, which was very helpful in funding the Trust’s tender offer in July.
• Advancements in AI models and software development capabilities have further disrupted the software sector. However, many software companies are harnessing AI to enhance or build new products and improve internal efficiencies. This reinforces the importance of being selective and identifying the companies we believe can benefit from AI over the long term. In Q1, the software sector sold off aggressively for fear of being replaced by homegrown AI solutions. This fear seems exaggerated and we are selectively investing at much more attractive valuations.

How are smaller companies adopting and benefitting from AI? 

• Apart from benefitting from the capex boom, smaller businesses can often adopt new tools more quickly due to having shorter decision-making chains and entrepreneurial management teams.
• Many are adopting AI to improve internal efficiencies including much faster software development, process automation and customer support; in addition to enhancing product.
• We are still very early in the application phase of AI and as this evolves, it should create exciting opportunities to invest.
• The barriers to entry for smaller companies are smaller than they used to be because capital expenditure requirements have evaporated now that they can rent processing power, storage and applications from the data centres.

Are valuations more compelling for smaller technology companies than larger ones? 

• Over the past few years, investor attention and capital have been concentrated on a relatively small number of large technology companies. The very big ones, such as Microsoft, Alphabet and Amazon have secure recurring revenues and strong profit margins to justify their valuations. Meanwhile, the semiconductor companies have been rerated to high levels, and some larger software companies are on excessive valuations when not perceived to be exposed to AI substitution.
• This year the market has begun to recognise how unprecedented AI infrastructure investment is benefitting smaller companies across the supply chain, broadening performance and driving smaller technology companies to outperform their larger counterparts.
• The flight to index trackers means that valuations are invariably higher in companies with market capitalisations large enough to attract index flows. Meanwhile, small cap funds have seen outflows, particularly in North America and the UK offering more attractive valuations.

What is the percentage in private holdings in the Trust? And what type of opportunities are you finding in the private market?

•  The Trust does not invest in private companies.

Can you highlight some non-AI technology areas that you're invested in? 

• AI is only one of many opportunities. We invest across structurally growing markets, including digital transformation, automation, cybersecurity, and defence tech.
• We also continue to find opportunities in software, particularly in businesses embedded in critical workflows with proprietary data.
• The portfolio is actively managed and offers diversified exposure across the tech arena.
• Position sizes and portfolio weightings are determined through a bottom-up approach; we monitor subsector exposure, but it does not drive capital allocation.
• Around 25% of the portfolio has direct exposure to AI, but many of these companies have diversified revenues and are not solely reliant on the data-centre build-out.

What is the geographic balance in the Trust? Do you find more sources of growth in particular markets? 

• The Trust provides international exposure to technology growth, and generally stocks, wherever they are domiciled or listed, supply the same global marketplace.  
• The UK weighting has fallen from over 60% of NAV at the end of 2017 to around 20% today, reflecting the opportunity set reducing. Many UK-listed companies have been subject to M&A and taken private, but there has not been the flow of IPOs to offset this decline.
• Asia has increased to around 20% as companies in the region have moved up the technology value chain, and have been the greatest beneficiaries of the AI-related capital expenditure boom
• North America is the Trust’s largest regional exposure, around 32%, reflecting the depth of opportunity across this market. Like the UK, manufacturing has migrated to Asia, but we have benefitted from several North American-listed stocks with Asian subsidiaries. Meanwhile the US-focussed software and media companies have been dull like the UK but are offering better value now.

How do you source your ideas? 

• We hold a significant number of meetings with company management teams globally. These businesses are often suppliers, customers or competitors of one another, helping us build a mosaic of information and contacts across the industry.
• Conferences in overseas markets, industry events, broker research and screening for companies with attractive growth prospects and valuations are the prime route to new positions. IPOs have been more relevant historically, but with cash withdrawals takeovers are more prevalent.
• Our approach and sector specialism allows us to cross-reference what we hear across technology supply chains and geographies, helping us test management claims and identify emerging themes.

Can you give two or three examples that bring your portfolio to life? 

• Silicon Motion: a fabless semiconductor company designing controllers for solid-state storage. We first invested in 2006, when it was below US$500 million in market value and traded on low earnings multiple. Its end markets have evolved, and it now benefits from datacentre and AI infrastructure demand, illustrating the value of identifying a strong business early and holding it patiently.
• BizLink: a specialist manufacturer of cables and connectors. We first met management in 2015 but waited until 2024, when valuation and its exposure to high-performance computing aligned. It shows that our process can involve following a company for years before investing.
• Trustpilot: an online review platform, is one of the few relatively new holdings in the UK. When it listed in London in March 2021, we met management and liked the business model, a subscription platform with network effects and high gross margins but declined to participate on valuation grounds. Less than a year later the shares had fallen c.50% and we initiated a holding. The business has since expanded geographically, become profitable and cash generative.
• Together, the examples show the breadth of the portfolio and a common process: specialist research, valuation discipline and a willingness to invest for the long term.