Why these four UK shares are a hidden AI play

Royal London Sustainable Leaders’ manager Mike Fox sits down with ii’s Sam Benstead to discuss how he manages his fund.

This includes where he has been adding to cheap shares, the hidden artificial intelligence opportunities in the UK, and what he has learned about investing over the 20 years he has been at the helm of this fund.

Fox also speaks about why shunning fossil fuels and tobacco has been an excellent long-term investment decision, despite the high dividend yields on offer.

Royal London Sustainable Leaders is a member of ii’s ACE 40 list of recommended sustainable funds.

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Sam Benstead, fixed income lead, interactive investor: Hello and welcome to the latest Insider Interview. Our guest today is Mike Fox, manager of the Royal London Sustainable Leaders Trust. Mike, thank you very much for coming into the studio.

Mike Fox, manager of the Royal London Sustainable Leaders Trust: You're welcome.

Sam Benstead: You can invest in fossil fuels, but you choose not to. How has that affected the performance of your portfolio?

Mike Fox: Time horizons are really important for this. If you look over the last 20 years, it's been a huge benefit to the fund not investing in fossil fuels. In 2022, clearly the war in Ukraine, it wasn't helpful not investing in fossil fuels that year.

Interestingly, the oil price remains subdued for all the tensions geopolitically and an economy that's better than expected, oil remains subdued. More recently, it's been more neutral. But again, your time horizon when you think of that issue is quite important.

Sam Benstead: And over these 20 years without oil, where have you generated your returns from that have led to so much outperformance? Can you name a couple of sectors and companies that have really done well for the portfolio?

Mike Fox: The single most important sector to get right as an investor is technology. That's the one sector that really can innovate in a material way. You can see this in the headlines today. NVIDIA Corp (NASDAQ:NVDA) is $3 trillion company, Apple Inc (NASDAQ:AAPL) is a $3 trillion company. These companies were fragments of that 10 to 15 years ago.

So, you have to get technology right. It's a sector that people often misassociate terms with like "bubbles" and "speculative" and so on and so forth, mainly because every decade or two it does have something of that nature.

But if you can invest in sensible technology companies, so Sage (LSE:SGE) would be a good example in the UK, if you can invest more globally as well. Microsoft (NASDAQ:MSFT) is a great example. These are the companies that are most likely to deliver strong innovation and therefore strong returns.

Sam Benstead: Technology is an exciting theme. So where are the technology leaders in the UK, and are there ways of profiting from artificial intelligence by owning UK shares?

Mike Fox: There are some really great opportunities to invest in artificial intelligence in the UK. The big winners will be the companies that have data sets that AI allows them to use in a more valuable way in reference to their own clients.

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So, we've already talked about RELX (LSE:REL). We've already talked about London Stock Exchange (LSE:LSEG). You can add Experian (LSE:EXPN) and Sage into that, and you've got four large UK companies that are world leaders that will benefit from AI. It's actually quite a clever way of thinking about investing in AI.

Nvidia is the big topic of the day. Whether they'll be the winner or loser in five or 10 years' time comes down to technology cycles, which may or may not go in their favour.

But the four companies I've just mentioned will exist with or without AI, but AI will benefit them if it is proven to do what some people think it can do.

Sam Benstead: And is that in the price of these companies? Do you think there's potential for AI to help them and grow their businesses, or are they still perhaps undervalued relative to the opportunity there?

Mike Fox: Our sense is they’re still undervalued. To give you some examples, cloud computing first came along in 2013 when Amazon.com Inc (NASDAQ:AMZN) split out their cloud computing business, so you could see how profitable it was.

At that time, Amazon had already performed well and many people had the mentality that it was too late. But you were very, very early on into a 10-year bull market in this area.

It won't be linear, there will be ups and downs, but our sense is that we are very early on in understanding how AI will benefit broader society and the corporate world, and the mentality of having missed it is not a good idea at the moment.

Sam Benstead: You've owned some long-term winners, but are there other areas that are undervalued at the moment that you're putting money into?

Mike Fox: Yes. So GSK (LSE:GSK) or GlaxoSmithKline, as it used to be, is one example of that. That's a company that has struggled to develop an innovative pipeline of drugs. But we think the current CEO, who's been in place now for six or so years, is starting to turn that around.

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Pharmaceutical businesses are like that. They do take 10 years to turn around. AstraZeneca (LSE:AZN) was the same before its recent run of success, so that's a good example. It trades on a 10 times price-to-earnings (p/e) multiple, which is, for those who follow markets, cheap and it would be classed as value. But we think if the business can do what it says it can do in time, it will be classed as a growth stock that you can buy cheaply today.

Sam Benstead: You have about 20% invested overseas. Why do you do that, and where are you finding opportunities?

Mike Fox: Yes, we absolutely do use that. We think it's a very powerful way of adding on to core UK exposure.

Some names that you can't get exposed to in the UK. Visa Inc Class A (NYSE:V) would be a good example of what we own. Texas Instruments (NASDAQ:TXN) would be an example of a semiconductor we can own. Microsoft is, even Novo Nordisk A/S ADR (NYSE:NVO), which gives us exposure to obesity drugs, is in there.

So, the core of the fund will always be the UK. But the ability to select, to invest selectively overseas, is a very useful and additive part of the process.

Sam Benstead: Given you have this global perspective, and also there are funds from Royal London that deploy the same portfolio strategy but only invest internationally, do you consider the UK market undervalued at the moment?

Mike Fox: I consider the UK market misunderstood at the moment. The valuation point depends on where you look. The market looks cheap as a whole because it has a large number of banks and mining companies and oil and gas companies that trade at low valuations.

So, it's like an index composition issue. If you look at AstraZeneca, if you look at RELX, if you look at London Stock Exchange, there isn't obviously a mis-valuation versus global peers. US investors are happy to buy those names, so they don't allow that arbitrage to exist.

So, I think the question about the UK, really, is not whether it's cheap or expensive, it's more where are the attractive parts of it you can invest in that can give you similar type returns as global funds, and they absolutely do exist.

Sam Benstead: You've been managing this strategy for 20 years now, so what are the big investment lessons that you've learned along the way?

Mike Fox: My view on investing is that individual investors take too little risk and professional investors take too much risk. And by that I mean individual investors are often put off by the volatility of equities and don't get the benefit of what is a compelling way to invest in the long run. But then professional investors, they're a little bit like people who got in the snow in 4x4 vehicles.

They're more likely to have accidents than people with traditional cars because they have a perception of safety and expertise and knowledge, which isn't always the case.

So, I do think if you're an individual investor and you've got a long-term horizon, most tend to take too little risk. But for me as a fund manager over my career, I've probably become more risk averse the longer I've done it.

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Sam Benstead: And what's been your best investment decision over that 20-year period?

Mike Fox: Cloud computing in 2013.

Sam Benstead: How did you access that via the fund?

Mike Fox: So, that would be a good example of when we would use the overseas exposure. So, owning Amazon, now owning Google (Alphabet Inc Class A (NASDAQ:GOOGL)), and owning Microsoft, would be examples of that. Lots of UK companies benefit from cloud computing because it makes them more productive and more efficient.

Another example would be in 2000. It was emerging markets and the whole infrastructure boom that went around in China. There was a lot of very productive engineering businesses in the UK market that performed extremely well for a period of time. So, I would say emerging markets in the 2000s and cloud computing in 2013 would be the two big ones.

Sam Benstead: There's lots to watch in terms of the macro economy at the moment; inflation, interest rates. Do you pay attention to those elements when it comes to investing?

Mike Fox: For us, we found that taking pronounced economic views over the years has been detrimental to investment performance.

A great example of this is the famous headline from Bloomberg in October 2022, when they said that there was a 100% probability of a recession, statistically that tested in the US in 2023. That was completely wrong, but it tainted so many people's views of how to invest, and many investors missed out on a really great 2023.

So, I think for us, one lesson of investing is, be aware of macro. There's no point not understanding it, but if it becomes the dominant way you're thinking about investing, that can be risky.

Sam Benstead: You spend a lot of time talking to companies. What are you learning from them at the moment?

Mike Fox: The most interesting thing the companies that we meet say to us is how fast US investors are buying up UK equity. Take Compass Group (LSE:CPG), for example. Their US shareholder register has increased significantly in recent years.

US investors are happy with the disclosure of corporate governance, the rule of law in the UK, and see it as a really attractive place to invest.

One CEO said to us that the only investors who seem to be unhappy with UK equity investing are UK investors. When they meet their investors globally, they do not get that same feedback.

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Sam Benstead: Why do you think that is? Why haven't we seen a strong market bounce-back in the UK? There has been a recovery, but there hasn't been a very strong one yet.

Mike Fox: The market issue is again the composition point that if you've been invested in oil and gas companies, if you've been invested in mining companies, if you invest in tobacco companies, you're right, you've missed out on these things, but that is a choice.

There are plenty of other areas in the UK market that have delivered global equity-type returns. So, you have to be precise in where you're going to invest.

I think, ultimately, why overseas investors are more optimistic than us [is because] if you're a UK-based individual, you've seen multiple prime ministers, multiple governments, you've lived through Brexit and I think you can get a little bit downbeat about your own circumstances.

Whereas when you look at the broader context, people who haven't experienced that may look at the UK and see it in a different light.

Sam Benstead: And finally, the question we ask all our guests, do you personally invest in your fund?

Mike Fox: Absolutely I do, and I wouldn't recommend someone buy my fund if I wasn't prepared to own it myself.

Sam Benstead: Mike, thanks very much for coming in.

Mike Fox: Thank you.

Sam Benstead: And that's all we've got time for. You can watch more Insider Interviews on our YouTube channel, where you can like, comment, and subscribe. See you next time.