Blog

AI has been around since the mid-20th century, with Alan Turing, often regarded as the father of AI, introducing the Turing Test in his paper “Computing Machinery and Intelligence”. This is a method for determining if a machine can exhibit human-like intelligence, involving a human judge asking the same questions to a machine and another human; if the judge cannot distinguish which responses were provided by the machine or the human, the machine is said to have passed the test.

Turing’s work paved the way for artificial intelligence, first giving life to traditional AI which processes input databased on pre-defined patterns to make decisions. This technology is now ubiquitous in everyday life, seamlessly integrated into various applications like Spotify recommendations and online chess opponents. Today, Turing’s ambitions are even closer to being realised with the advent of generative AI which can create novel content based on its data inputs, making it vastly more sophisticated than traditional AI with potentially limitless use cases.

It was in fact the launch of Chat-GPT in November 2022 that show cased the unprecedented capabilities of Gen-AI on a global scale. Since then, we have seen the emergence of a large number of AI start-ups, accompanied by huge investments from both investors and large tech companies. This boom is reflected in the staggering growth of private sector spending on Gen AI-centric systems, which is expected to rise from $14 billion annually in 2020 to $137 billion annually by 2024¹.  

Just as the advent of the factory may have been unimaginable to the 16th century peasant, or the advent of Chat-GPT may have been unimaginable to Turing’s peers, it is thought that Gen AI will lead to similar transformative inventions leaving no industry or corner of the globe untouched, hence Nvidia’s CEO Jensen Huang apt description of us witnessing “the dawn of anew industrial revolution”. A compelling example of Gen-AI’s potential to revolutionise an industry is in healthcare, where it promises ground breaking advances in medical treatment, diagnosis, distribution, vaccine development, and more. For example, early studies indicate that Gen-AI has the capability to detect early signs of breast cancer that may not be visible to the human eye. Given that approximately 13% of breast cancers go undetected by mammography², a technology capable of reducing these omissions could potentially save millions of lives worldwide.

While there is no universal consensus on how much Gen-AI will contribute to productivity growth, numerous studies and forecasts highlight substantial contributions. For example, Goldman Sachs predicts Gen-AI will boost productivity growth by 1.5 percentage points over a 10-year period from 2023, and BCG estimates that productivity gains in the public sector will be valued at $1.75 trillion per year by 2033.

Estimates of Gen-AI’s contribution to economic growth also vary widely but all represent significant figures. Goldman Sachs estimated that Gen-AI will drive a 7% increase in global GDP between 2023-32. Meanwhile, JP Morgan estimated a wider range of a 7-10% increase over the same period. However, nearly all forecasts align on the industry’s Compound Annual Growth Rate (CAGR) which is being estimated at between 35-45% over 10 years, an impressive figure that underscores the opportunities for long-term investor returns.

Given this trajectory it is unsurprising the technology has been a major driver of investment this year. However, there are and will continue to be losers as well as winners in the AI story. The key is not only recognising today’s obvious winners, companies like Nvidia, which now have the downside of increasingly expensive valuations, but also identifying undiscovered, innovative companies with competitive edges that play lesser known, yet vital roles in the Gen-AI industry. Focusing on the semiconductor industry reveals that emerging markets are crucial for diversified exposure to the Gen-AI industry.

Countries like Taiwan and South Korea have established dominant positions in semiconductor manufacturing through a medley of factors, including decades of state-directed incentives and tax advantages, a favourable talent pool, a strong work ethic culture, and robust infrastructure. Today, Taiwan, ‘the Silicon Valley of the chip industry’, produces 60% of the world’s semiconductor chips and 90% of the most advanced ones³.

Accordingly, Taiwan, the Fund’s largest exposure (20.4% as of 28 June 2024), delivered a total return of 17.7% over Q2 2024. While the media often portrays US companies like Nvidia and OpenAI as epicentre of the Gen-AI industry, at MCP we recognise that these companies rely on the semiconductor manufacturers in EM which play a crucial, but perhaps less visible, role in the industry.

The complex semiconductor supply chains in emerging markets have led to a large universe of under-researched companies. Given their limited coverage by sell-side analysts, MCP researches investment opportunities within a diverse array of overlooked segments of the supply chain, including providers of niche components and equipment such as CPU sockets, CCLs, and connectivity solutions, as well as leaders in the IC design and semiconductor testing fields. MCP aims at identifying the market leaders in these sectors – companies often recognised as preferred vendors to industry giants for outsourced chip components and services. These companies typically operate in oligopolistic markets characterised by high barriers to entry due to their deep specialisation and have strong balance sheets, robust fundamentals and deep moats. A prime example of this type of company is Taiwan-based Lotes which we recently added to our portfolio (see company spotlight in MCP Manager’s Commentary Q2 2024).

Additionally, several other emerging markets are positioning themselves as the next leaders in the semiconductor and Gen-AI industries, perhaps most notably India. In February, the Indian government approved a $15 billion investment to build three new semiconductor plants, including its first semiconductor fab facility: a move to kick-off its journey to becoming a semiconductor manufacturing hub⁴. Additionally, the authorities have attracted tech companies to set up operations in India through incentives. For example, Microsoft has pledged $3.7bn to Telangana, and Amazon is planning on investing $12.7 bn in cloud infrastructure by 2030⁵. We see this as a reflection that innovation and leadership in Gen-AI and related industries not only stretches beyond the US, but also stretches far across EM.

Once Gen-AI has been developed at the hardware level, it can be applied to various software applications in almost any industry. We are proud that almost all of our portfolio companies are embracing the technology and implementing it in their processes and software to improve operations, efficiency and productivity. Moreover, the software companies that are offering Gen AI products that help businesses to implement Gen-AI within their systems provide another type of AI exposure. Persistent Systems for example has earned the title of Generative AI Market Leader in the HFS Horizons: Generative Enterprise™ Services 2023 Report, which evaluated 35 service providers’ generative enterprise services.

Overall, we believe the generative AI industry has a bright future. While there will be obstacles along the way (e.g. environmental and safety concerns), the industry is set for significant growth. However, simply jumping on the Gen-AI bandwagon will not result in a surefire success story. Reflecting on the years of the internet boom, we see that the long-term trajectory of the industry will likely result in different winners and losers compared to those of today. At MCP, we identify under-researched companies in emerging markets which we believe are today’s innovators, and tomorrow’s winners of the Gen-AI story.

To find out more about portfolio manager Carlos Hardenberg’s and the MCP team’s insights into the Gen-AI industry, listen to Gen-AI, Beyond the Hype. This episode is part of our podcast channel, Insiders and Outliers -MCP on Emerging Markets, available on Spotify, Apple Podcasts and Soundcloud.  

‍

¹ Bloomberg Research

² American Cancer Society

³ Council on Foreign Relations

⁴ Press Information Bureau

⁵ The Financial Times

‍

After a six-week period, India finally received its much-awaited election results on 4 June. Incumbent Narendra Modi and his party, the BJP, won 240 seats, failing to maintain the absolute majority they have enjoyed since 2014. However, the BJP’s wider alliance, the NDA, secured 292 seats, surpassing the 272-seat majority mark. As a result, Modi will remain the prime minister of the world’s largest democracy, leading a coalition government in which the BJP relies on smaller parties within the NDA.

Source: Citi Research, ECI

Over the past decade, the BJP’s pro-business agenda has proven to be highly popular among investors, making this week’s result a shock and disappointment for many who are worried about pro-business policy continuity. The party has implemented a wide spectrum of reforms aimed at prioritising economic growth, maintaining low inflation, ensuring fiscal prudence, boosting exports, attracting FDI and improving foreign relations. Here we list some of the party’s most significant reforms:

Make in India, 2014.

Promoting Manufacturing and Infrastructure

This multi-faceted initiative aimed to make India a manufacturing hub, particularly in electronics, whilst upskilling its labour force and attracting domestic and foreign investment into 25 key sectors, such as automotive and textiles. It included simplifying regulations and reducing red tape to improve the ease of doing business. Additionally, it placed a crucial emphasis on improving infrastructure through increased investments, as well as opening previously restricted infrastructure sectors to FDI, such as railways and construction.

Throughout its tenure, the BJP has intensified its efforts to develop electronics manufacturing along with semiconductor manufacturing, introducing further schemes such as the Production Linked Incentive scheme (2020) and the Semiconductor Mission (2022). These initiatives have attracted international businesses such as Apple, which aims to manufacture 1/4 iPhones in India by 2025, along with Taiwanese Powerchip Semiconductor Manufacturing Corp, Japanese Renasas, and Thai Stars Microelectronics, all of which are supporting the construction of India’s first three semiconductor fabrication facilities this year.

These initiatives reflect the agenda of the BJP in government over the past decade in which they have significantly increased capital expenditure across various sectors, not limited to manufacturing alone. This government has helped to drive investment, stimulate job creation, bolster consumer demand, and place India as a robust and stable alternative for countries looking to diversify their supply chains.

Source: Reuters, Indian Budget documents/speeches

Goods and Services Tax, 2017.

Reforming Tax

Another key reform is the Goods and Services Tax (GST) which consolidated the numerous cumbersome indirect taxes at both Central and State levels into one simplified and unified national tax framework. This overhaul not only streamlined tax processes but also accelerated the transport of goods and enhanced logistics efficiency by eliminating state barriers and reducing compliance burdens, measures particularly important in a country as large as India.

Furthermore, the GST has increased tax collections by broadening the tax base, integrating more businesses into the formal sector, and increasing tax compliance and administration efficiency. Since its inception, GST collections have consistently followed an upward trajectory, increasing from an initial Rs 92,283 crore in July 2017 to its highest yet of Rs2.1 lakh crore in April 2024¹. This has ensured fiscal prudence alongside the government’s increased capital expenditure on reforms such as Make in India. The government’s fiscal prudence is evidenced by the FY2023-24 fiscal deficit of 5.6% betting the forecast of 5.8%, according to recent data released by the CGA. Moreover, it is projected to further reduce to 5.1% this financial year².

Source: PIB, WorldBank, Make in India

Technology Incubation and Development of Entrepreneurs (TIDE 2.0), 2019.

Encouraging Innovation

The Ministry of Electronics and Information Technology under the government launched TIDE 2.0, an upgrade of the original TIDE project launched in 2008. This initiative supports startups involved in emerging technologies like IoT, AI, and blockchain through technical and financial assistance. TIDE 2.0 reflects the government’s commitment to positioning India as a global hub for science and technology and fostering a favourable business ecosystem for innovative startups.

Source: World Intellectual Property Organisation

How will the election result impact the Indian market moving forward?

Modi will inevitably face greater challenges in passing certain business reforms this term. Unlike his previous two terms, he now must juggle the demands of allies with differing policy priorities to maintain a stable coalition, which may stymie the progress of certain business reforms. Vulnerable pipeline reforms include his land and capital reforms, the Uniform Civil Code, and the One Nation One Election initiative. On top of this, India may witness an increase in populist measures, such as unemployment reforms and higher rural spending.

However, a coalition government does not spell the end for pro-business reforms. Many of Modi’s core allies have a strong pro-business track record in their respective provinces. For example, Chandrababu Naidu of the TDP, who served as Chief Minister of Andhra Pradesh (1995-2004, 2014-2019), prioritised making the state an FDI and technology hub during his tenures. Progress is expected to continue in key areas such as manufacturing, regulatory improvements, labour law implementation, job creation, and workforce upskilling. Furthermore, the business reforms of the past decade will continue to drive India’s impressive economic growth, with an 8.2% GDP growth in FY2023-24, making it the fastest-growing major economy. The Reserve Bank of India recently raised the FY2024-25 real GDP growth forecast from 7.0% to 7.2%, highlighting the country’s ongoing growth prospects. Further still, the result does not undermine macro tailwinds such as India’s demographics, including a growing talent pool and consumer market, as well as its favourable position as the world looks to diversify supple chains.

Source: IMF, April 2024 Outlook

The Nifty 50 saw a sharp 6% drop on the day of the result³, the steepest decline in two years. Stocks in sectors such as PSUs and realty, which have benefited from the general market optimism and were trading at high valuations despite average fundamentals, were most affected by the volatility, which was largely a correction from the previous day’s rally and a short-term sell-off on unfulfilled expectations. By 7 June, the Nifty 50 had already recovered all of its election day losses and we expect the Nifty 50 and Sensex 50 to continue their strong performance so far this year, up 7% and 8% respectively⁴ (as of 7 June 2024). 

This week’s election result has not affected our bullish view on India. Our conviction in India’s long-term growth story has further strengthened over the past year, leading MCP to add three new high-conviction Indian ideas to the portfolio. A two-month trip by an MCP analyst to meet with companies and experts on the ground reinforced our bullish view. We believe India’s journey to become one of the world’s great economic powerhouses will not be undone by a single election result.

¹ Press Information Bureau

² Press Information Bureau

³ Capital IQ

⁴ Capital IQ