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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.  

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¹ Bloomberg Research

² American Cancer Society

³ Council on Foreign Relations

⁴ Press Information Bureau

⁵ The Financial Times

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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 

The history of semiconductors dates back to the 19th century, marked by Karl Ferdinand Braun’s discovery of rectification in 1874. Practical applications then emerged in the early 20th century, such as the cat’s whisker detector, a rudimentary semiconductor device used in early radio receivers. This device consisted of a thin wire, or ‘whisker’, that made contact with a semiconductor crystal, such as silicon, to detect and convert electrical signals into audio signals.

Since its inception, the industry has been characterised by cyclicality as well as its relentless pursuit of innovation, defined by Moore’s Law, which states that the number of transistors on computer chips double every two years with little change in price. Of course, the industry has come a long way since those first primitive semiconductors and their applications, and continuous advances have given way to semiconductors so sophisticated that they have become indispensable to the functioning of modern society. The industry’s rapid evolution is reflected in its staggering growth, with annual sales quadrupling in just two decades – soaring from $139 billion in 2001 to $573.5 billion in 2022¹. This rapid growth is well illustrated by the development of ASML’s market capitalisation below.

Cyclicality and Semiconductors

Most recently, the semiconductor industry has faced global supply chain disruptions, triggered by the Covid-19 pandemic. While some sectors, notably automotive, faced reduced orders, most, such as consumer electronics, saw unprecedented growth due to the shift to remote working. US sanctions on companies with ties to China, combined with factors such as the 5G rollout, the Russia-Ukraine war and severe weather events, added to sector volatility. Semiconductor manufacturers responded to heightened demand during the pandemic by increasing inventories, supported by government subsidies. However, the end of the consumer electronics replacement cycle resulted in an industry slowdown in the latter half of 2022 and excess chip inventories.

A year later, inventory levels stabilised, particularly in the global IT components sector, marking a turning point in the cycle. TSMC’s revenue, a key indicator of industry health given they manufacture around 90% of the world’s advanced chips, rose by 14.4% in Q4 2023 from the previous quarter². Some concerns persist regarding oversupply, especially for foundational chips, as Chinese chipmakers continue to increase production. Nonetheless, the industry is expected to maintain its upward trajectory, with sales revenue estimated to reach between US$588-613 billion in 2024, surpassing 2022’s record of US$574 billion, and 2027 forecasts come in around US$736.40 billion³.

Geopolitics and Semiconductors

The global shortage of semiconductors provided a wake-up call for many governments, particularly in the US and Europe as it served to highlight the vulnerability of over-reliance on the global supply chain. In response, governments began efforts to de-risk their supply chains through onshoring and nearshoring production. This trend has proved beneficial to some players in the supply chain as the total addressable market for existing suppliers increases in line with an increase in capacity and production. For example, Park Systems, which supplies wafer inspection equipment, is benefitting from the increasing demand of smaller nodes and the corresponding expansion of manufacturing lanes.

The US government’s 2022 CHIPS Act is a prime example of efforts to onshore. It allocated $52.7 billion⁴ in federal subsidies to support domestic chip R&D, manufacturing and workforce development. Just recently, President Biden announced up to $8.5 billion direct funding to US chipmaker Intel under the CHIPS Act to fund new chip plants in the US.

The US government-imposed restrictions on the export of advanced chips and chip manufacturing equipment to China in October 2022, and tightened the restrictions in November 2023. The move was intended to pre-empt the prospect of Chinese global dominance in the industry, as the Chinese government also sought self-sufficiency. However, the move has yielded mixed results. While it has hindered China’s progress in advanced chip manufacturing and AI development, leading to a focus on foundational chip manufacturing instead, it has likely accelerated China’s path to self-sufficiency by making this an even higher priority for Beijing and forcing Chinese companies to be more innovative in order to develop their own advanced chips. For example, in October 2023 Beijing announced a $40bn state-backed fund to boost the semiconductor sector, and at the same time, scientists at China’s Tsinghua University announced the development of the world’s first fully system-integrated memristor chip in October 2023, with significant applications in AI and autonomous driving⁵.

Semiconductors and Artificial Intelligence

In 2024, the consumer electronics sector is poised for solid growth with a forecasted 3.5% and 4% increase in PC and smartphone sales respectively according to Gartner. This upswing is fuelled in part by a new notebook renewal cycle, as well as a wave of smartphone replacements driven by on-device AI, which allows smartphones to process data within the device rather than on a remote cloud server; this reduces security issues and enables AI services without internet connection. This development, we believe, will benefit a number of our portfolio companies that cater to this industry. One example is Elite Material, a key supplier of high-density copper clad laminates, a crucial component used in advanced chip production. Another example is LEENO which is set to see higher revenue growth in 2024 given their significant R&D exposure to on device AI.

NVIDIA’s recent Q4 2023 report of a 265%⁶ increase in quarterly revenues from one year ago serves as a prime example of the substantial growth AI can drive, with CEO Jensen Huang asserting that AI has reached a ‘tipping point’. The seemingly limitless potential of the AI revolution will sustain growth in the semiconductor industry for years to come, benefiting well established companies like NVIDIA and Arm, as well as lesser-known businesses in our portfolio that cater to such industry giants.

eMemory Technology

Within the semiconductor industry, eMemory, a world-leading IP provider to over 2,400 foundries, IDMs and fabless companies, is a prime example of the type of company we like to invest in, with deep moats, sound balance sheets and a strong outlook based on sustainable growth and expansion. In a recent quarterly earnings call, chairman Charles Hsu summarised their strong growth potential: ‘‘Our total addressable market will increase as the world expands foundry capacity and move toward more advanced technology. Our technology coverage in each foundry will increase as more technology processes develop and more fabs are established.’’ To this end, the company has several advanced 3/4/5nm semiconductor projects underway and has successfully licensed its 3nm OTP and PUF technology to a US foundry customer with whom it will work to develop the most cutting-edge processes. In addition, the royalty income for each foundry is increasing, as is the demand for licensing, resulting in increased licensing income, all of which increases eMemory’s profitability.

The promising outlook for eMemory, which will very likely profit from both increasing semiconductor capacity and complexity, is reflected in the positive outlook for many of our other portfolio companies. For example, LEENO, (see Company Spotlight in our Q1 2024 Manager’s Commentary) should be benefiting from the increasing complexity of chips, which require more advanced pins and sockets for testing in the R&D phase.

Outlook

The expanding total addressable market of semiconductor end markets, facilitated by this expansion in semiconductor capacity and complexity, suggests we may come to see a potential reduction in the industry’s cyclicality. The industry may become increasingly shielded from the vulnerabilities associated with single market trends with dampened demand in one sector likely having a less pervasive effect on the overall semiconductor industry and its supply chain. Furthermore, many of the new end markets, such as automotive, industrial automation, 5G infrastructure, AI and cloud computing, have larger chip demands per unit compared to those associated with consumer electronics. The outlook for the semiconductor industry is positive, not just for 2024, but for the next decade. Despite historical peaks and troughs, the industry’s overarching trend is one of exponential growth, with forecasts pointing to a milestone of $1 trillion in market revenues by 2030.

At MCP, we avoid trying to time each cycle perfectly and instead focus on identifying highly innovative companies that are positioned to benefit from the industry’s long-term trends, such as eMemory. This strategy does not begin and end with the semiconductor industry, but extends to all the industries in which we invest. In this way, we aim to create long-term, sustainable value for our investors.

To find out more about portfolio manager Carlos Hardenberg’s and the MCP team’s insights into the semiconductor industry, listen to Decoding the Semiconductor Industry. This episode is part of our new podcast channel, Insiders and Outliers – MCP on Emerging Markets. Monthly episodes are available on Spotify, Apple Podcasts and Soundcloud.

¹ SIA

² TSMC

³ Statista

⁴ The White House

⁵ CSIS

⁶ NVIDIA

On 26 February 2024, South Korea’s Financial Services Commission (FSC) together with the Korean Exchange (KRX) announced the country’s Corporate Value Up Programme. Similar to, and most likely inspired by, Japan’s decade-long initiative, the aim is to raise valuations and boost shareholder returns. This is a move to address the so-called ‘Korea discount’ where listed companies tend to have lower valuations compared than their global peers. In fact, over two thirds of listed companies on the Kospi have a price-to-book (P/B) ratio of less than 1¹.

Source: Bloomberg

A significant contributor to the Korea discount is weak corporate governance standards, particularly within the notorious chaebols – wealthy and influential family-owned conglomerates like Samsung, Hyundai Motor and LG. Chaebols have traditionally prioritised maintaining control over maximising shareholder value and including minority shareholders in active participation. One notable example is the deliberate suppression of company value to minimise the blow to the next generation when it comes to paying the hefty 50-60% inheritance tax. However, it’s important to recognise that while chaebols play a crucial role, there are other factors contributing to the discount, including traditionally low dividend payouts and inefficient asset utilisation among Korean companies.

The Corporate Value Up Programme is a set of voluntary guidelines encouraging companies to devise mid- to long- term plans and targets to increase shareholder value, with board members playing a key role in the implementation. Companies are encouraged to disclose these plans annually on the KRX website. Korean financial regulators have emphasised that there are significant financial incentives for companies to participate in the programme, claiming that the incentives will exceed those offered by Japan in its equivalent initiative. In addition, best practice companies (those with a proven track record of profitability or those that are expected to boost valuation) will be included in the upcoming Korea Value-up Index, the other major pillar of Korea’s efforts.

The Korea Value-Up Index, to be introduced in June, mirrors Japan’s JPX Prime 150 Index by including companies that are making efforts to improve their valuation. The purpose of the index is to create a market environment that promotes investments in such companies, makes them more accessible to retail investors and enhances market transparency. Pension funds and institutional investors will use the index as a benchmark, and ETFs tracking the index are expected to be launched by December. Evaluations of key financial indicators, including P/B ratio, price-to-earnings ratio and return on equity will be part of the index’s criteria. These indicators, along with dividend payouts, will be regularly published on the KRX website.

Concerns have been raised about the lack of detail in Korea’s Value Up Initiative, particularly regarding the unspecified tax incentives the FSC places great emphasis on. Another source of disappointment is the voluntary nature of the programme; without enforcement companies may not take decisive action to improve valuations, rendering the initiative meaningless. As a result, the Kospi Index fell by 0.8% on the day of the announcement².

The FSC has responded to such criticism by stating that is it more realistic to provide powerful incentives than to enforce cooperation, and that final guidelines will be announced in June. The FSC has also stressed the importance taking a long-term view. Chairman Kin Joo-hyun stated that “enhancing the corporate value of a company is not something that can be achieved in a short period of time with only one or two measures.”

A look at Japan may help to better understand Korea and its initiative. Japan has faced similar challenges of low valuations and shareholder returns since its market crash in 1987. As a result, the country embarked on a corporate governance mission over a decade ago. Efforts ramped up last year when the Tokyo Stock Exchange (TSE) announced in March that listed companies with a P/B ratio of less than one must submit a plan to improve capital efficiency. In October, the TSE announced its ‘name and shame’ measure whereby from January 2024 it will publish a list of companies with poor shareholder returns that have disclosed these plans, thus indirectly calling out companies that haven’t. These efforts are finally bearing fruit as the Nikkei 225 hit a 34-year high on 22^nd Feb closing above 39,000 points³. Many investors are putting Japan back on the agenda in 2024 after a 34-year hiatus.

So, what lessons can Korea learn from Japan? While Korea’s initiative may result in little change in the short-term, due to its unspecified and voluntary nature, it should not be deemed insignificant. Given that Japan’s reforms took over a decade to take effect, Korea’s equivalent reforms should not be expected to happen overnight but should be considered an important starting point for long-term improvements.

¹ Bloomberg

² Bloomberg

³ Bloomberg