What Terry Smith thinks about investing in artificial intelligence

Fundsmith Equity manager Terry Smith is sceptical that investors will be able to pick winners from breakthroughs in artificial intelligence (AI). 

Writing in his January 2024 annual letter to investors, the star manager said that early winners from technology breakthroughs often do not go on to be the longer-term market leaders, citing the example of Yahoo in search engines and BlackBerry in smartphones. 

He adds that it is still not certain that there will be winners from AI, such as in the provision of large language models or their use, where the OpenAI/Microsoft tool ChatGPT is currently the market leader.  

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Therefore he posits that early AI perceived winners – Microsoft and Nvidia – may not be the longer-term winners.  

Smith says: “Moreover, maybe there won’t be a winner, either in the provision of large language models or their use. There are numerous large language models in development and deployment by the major tech companies: such as Alphabet’s Gemini, Meta’s Llama 2 (stands for Large Language Model) and Microsoft’s ChatGPT, as well as stock market excitement about the deployment of such models by Adobe, Intuit and Fortinet among just the companies that we follow.  

“There is no shortage of contenders. The adoption of AI may lead to a situation where everyone has it, so no one has any advantage.” 

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Smith therefore says that he will “suspend judgement” on who, if anyone, will emerge as a winner in AI. 

On the topic of AI, Smith also noted that it is not a new investment theme, as IBM launched an AI model called Watson which beat two human champions in the US quiz show Jeopardy! in 2011, and Google (now Alphabet) acquired the AI developer DeepMind in 2014. 

Last year was an underwhelming one for Fundsmith Equity investors. T-Class units returned 12.4% on a total return basis, which is below the 16.8% gain of the MSCI World index. This is the third year in a row that the fund has underperformed its benchmark. 

However, since inception in November 2010, Fundsmith Equity has risen 549.7% compared with 316.7% for its benchmark, making it the best-performing global fund in that period.  

Fundsmith Equity is a member of ii’s Super 60 listed of rated funds.  

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Smith said: “Outperforming the market or even making a positive return is not something you should expect from our fund in every year or reporting period, and outperforming the market was more than usually challenging in 2023.  

“The performance of the Nasdaq Composite Index, which was up 43% in US dollars in 2023, was dominated by a few companies, the so-called Magnificent Seven — Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla — which accounted for 68% of that index’s gains. Nvidia, the designer of chips for use in AI applications, alone accounted for 11% of the 43% gain. We do not own all the Magnificent Seven and would probably not be willing to take the risk of doing so, even if all of them fitted our investment criteria.” 

Last year, the largest contributors to Fundsmith’s performance were Meta, Microsoft and Novo Nordisk and the largest detractors were Estee Lauder, McCormick and Diageo.  

Portfolio turnover in 2023 was 11.1%. Smith sold stakes in Adobe, Amazon and Estée Lauder and purchased stakes in Procter & Gamble, Marriott and Fortinet. 

Smith says: “As last year this may seem a lot of names for what is not a lot of turnover, as in some cases the size of the holding sold or bought was small. We have held 10 of our companies for more than 10 years, five of which since inception in 2010.”