Liontrust Global Innovation Fund

The Liontrust Global Innovation Fund continues to invest in innovative global leaders, buying companies on the right side of AI at cyclically depressed prices ahead of a new innovation cycle.

The Liontrust Global Innovation Fund returned 1.1% in August, ahead of the IA Global sector average of 0.1% and the MSCI All-Country World Index return of 0.2% (both comparator benchmarks).

• A high bar for investor expectations led to some post-earnings share price declines
• Sentiment and earnings-related volatility present buying opportunities for the Global Innovation fund
• We continue to see strong signals that we are entering a new AI-driven innovation cycle

Market backdrop

July’s volatility spilled into August, with the VIX index, a key measure of market uncertainty, spiking early in the month following the unwind of the now infamous Yen carry trade. This event sent ripples through global markets, exacerbated by declining investor confidence and increased recessionary fears, particularly in the US where the economy appears to have finally run out of steam. Weakening economic data saw a broad de-risking of portfolios early in the month, leading to a sell-down in many companies that had been winners year-to-date, notably within the technology sector. However, market sentiment improved throughout the month, with VIX settling down to more normalised levels and high-quality companies with structural growth opportunities returning to the fore.

With inflation falling and economic data slowing, investors increasingly looked to Federal Reserve policy for relief against fears of a hard landing scenario. At the Jackson Hole Economic Symposium, Fed chair Jerome Powell indicated that “the time has come for policy to adjust”, signalling imminent interest rate cuts on the horizon.

Meanwhile peak earnings season forged ahead, with companies reporting against the backdrop of heightened investor scrutiny on AI, particularly regarding the timing of returns given ongoing sizeable investments. Alongside broader market uncertainty, this meant many companies faced a high bar for investor expectations coming in to reporting, leading to some significant – and often excessive – post-earnings share price declines in cases where companies were deemed to have disappointed on earnings or guidance, particularly relating to all things AI.

We continue to buy cyclically depressed companies

Sentiment and earnings-related volatility present buying opportunities for the Global Innovation fund, with the team maintaining our valuation discipline and continuing to take opportunities to buy high-quality innovative companies during periods of share price weakness. In August we capitalised on market fluctuations to build new positions in Amazon and Camtek. Both companies sold off excessively following their earnings update at the height of market volatility early in the month, presenting an attractive buying opportunity for innovative companies investing for growth in strong structural growth markets.

Innovative global leaders on the right side of AI disruption

We continue to see strong signals that we are entering a new AI-driven innovation cycle. From an investment perspective this poses both opportunity and risk: winners will be companies that can capture value in enabling or effectively harnessing AI, while losers will be those on the wrong side of AI-facilitated disruption. Company updates throughout August reinforced several key trends that we are seeing within the AI space:

1. Compute scale matters for AI: Compute scale is paramount: increasing compute enables better models, broadening AI applications and unlocking revenue opportunities across the economy. This trend has been in place since 2017, and is expected to continue for at least five more years, bolstering companies supplying AI-related hardware and equipment.

Top innovators driving this scale forward underscore this trend. Nvidia reported a 122% year-on-year increase in second-quarter revenues driven by AI-focused chip demand, which looks set to continue as CEO Jensen Huang noted that next generation of large language models will require 10-20 times more compute power. Meta, already generating strong AI-related revenues through enhanced recommender-AI driven advertising, revealed similar scaling plans for its upcoming Llama 4 model which will require ten times more compute than Llama 3. Ramping compute is driving demand for interconnect equipment, bolstering the likes of Amphenol who coming into August reported c$300 million year-on-year revenue growth almost entirely driven by AI, its high-speed solutions in strong demand. 2. Shift from chips to systems: As AI workloads become more complex, we are seeing a significant shift from individual chips towards larger integrated systems. This transition is altering value capture across the semiconductor value chain, introducing more process steps and requiring new supply chain innovations in materials engineering and advanced packaging.

Applied Materials has previously highlighted that the number of process steps for leading-edge chips has increased from 750 in 2010 to over 1900 today, and in August reported it expects revenue from its advanced packaging portfolio to grow by $1.7 billion this year as it leads the way in a rapidly expanding market. Lam Research emphasised the growing importance of materials engineering and advanced packaging for AI applications, highlighting $1+ billion growth opportunities in areas like gate-all-round, backside power delivery, and advanced packaging. Camtek reported strong demand for its inspection equipment for high-bandwidth memory, crucial for AI chips, helping Q2 revenues reported in August triple from the prior year. Onto Innovation saw increased demand for its metrology and inspection solutions, vital for the advanced packaging processes in AI chip production, which management announced it expects to grow over 70% this year.

3. Major upgrade cycle at the edge: after a tough couple of years for edge computing, we are now expecting a significant major upgrade cycle to occur at the edge – smartphones, PCs, and laptops. The scale of this is still underappreciated: for example, only 8% of iPhones today enable consumers to use AI on-device. Seven billion smartphones and four billion PCs will have to be ripped out and replaced by 2027 (as part of a $3trillion spend on AI infrastructure in total, including data centres). These compute devices need more memory to utilise new operating systems like iOS 18, which launches later this year, and Windows 12, which launches in 2025.

Well positioned innovators in the fund that we heard from in the quarter include Apple, which reported promising signs of smartphone recovery ahead of its hotly anticipated next-gen iPhone launch in September; and SK Hynix, which, with over 70% market share in high-bandwidth memory, remains well-positioned to meet the growing demand for advanced memory in both mobiles and PCs. Further, Arm, whose architecture underpins 99% of mobile application processors, reported strong licensing revenue growth (up 72% year-over-year) driven by demand for custom CPUs for AI applications. Arm's management reiterated its expectation of ARM-based PCs reaching 50% market share within five years, its highly energy-efficient architecture positioning them well to take significant share from incumbent Intel in this market.

4. Power is the key bottleneck: AI servers consume approximately 10 times more power than traditional CPU servers. We expect AI server penetration to grow from 10% to 30% between 2023 and 2027, and data centre power consumption to reach 10% of global energy consumption by 2030. This surge in power demand creates both challenges and opportunities across a range of sectors beyond technology, including industrials, utilities, and energy.

This demand is already starting to come through: Constellation Energy, the largest nuclear and carbon-free fleet operator in the US, reported growing power demand from data centres, leading it to raise full-year earnings guidance. Schneider Electric reported strong growth in its energy management division which helped drive record quarterly group revenues as management emphasised the growing importance of energy efficiency in AI computing infrastructure. Applied Materials similarly stressed the importance of power needs in its August earnings call, noting that for AI customers, "reducing power per operation is now more important than increasing operations per second." The company reported that leading AI companies are targeting a 10,000 times improvement in performance per watt over the next 15 years.

Opportunities across sectors

AI is a general-purpose technology with the potential to transform every sector – this is a once in a generation opportunity for investors of all industries. Early adopters are benefiting from enhanced productivity and product innovation, which will likely lead to share gains from slow movers as benefits compound over time. Helping facilitate this AI propagation, Palantir Technologies reported strong results in August, with revenues up 13% year-over-year driven by increasing demand for its AI-powered data analytics platforms across various industries. The company highlighted significant traction in both government and commercial sectors, demonstrating the broad applicability of AI solutions. Meanwhile in healthcare, Recursion Pharmaceuticals is leveraging AI to accelerate drug discovery. The company reported progress in its clinical pipeline and continued expansion of its proprietary biological and chemical datasets, which power its AI-driven drug discovery platform.

Beyond AI, other innovative companies in the fund are seeing strong results. On Holding, the up-and-coming Swiss running shoe company, reported record quarterly revenues which were up 52% year-over-year. The company's new innovative LightSpray technology, which allows for ultralight shoe tops to be sprayed in a one-step process, is driving both performance improvements and manufacturing efficiencies. Elsewhere, Eli Lilly reaffirmed the strong demand for its revolutionary GLP-1 diabetes and obesity treatments, with Mounjaro sales growing 280% year-over-year. The company is making significant investments in manufacturing capacity to meet surging demand, while continuing to pursue further scientific studies to unlock additional label expansion opportunities in the future.

As we move forward, we remain confident in the long-term growth potential of innovative companies across various sectors. Many of these businesses have emerged from the challenges of 2022 with leaner operations and improved profitability, positioning them well to capitalise on the new AI-driven innovation cycle, of which we are still in the early stages. Our focus remains on identifying and investing in these innovative disruptors, ensuring we capture the outsized growth potential such companies offer.

We will continue to engage with companies during upcoming research trips to the innovation hubs of Silicon Valley and New York. These interactions allow us to stay at the forefront of technological advancements and identify emerging leaders in the AI space and beyond. Additionally, the potential for interest rate cuts suggests further tailwinds for growth, supporting the companies best placed to lead the next wave of innovation.

Discrete years' performance (%) to previous quarter-end:

*Source: FE Analytics, as at 30.06.24, C accumulation share class, total return, net of fees and income reinvested. Fund inception date is 31.12.01; the current fund managers’ inception date is 01.07.19.

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