Morgan Stanley Investment Management’s Dennis Lynch is adopting a cautious approach to investing in artificial intelligence (AI), questioning whether there’s a clear long-term investment case for any particular company in this space. Lynch, whose strategies have delivered top 1% returns in their category in Hong Kong and Singapore, has managed to outperform without significant exposure to AI market darlings like Nvidia, Meta, and Microsoft.
Skepticism About AI ‘Winners’
Lynch expressed skepticism about the existence of a clear AI ‘winner’, citing the absence of very profitable products that can support the necessary capital expenditure on the latest chips. While Nvidia’s products are highly profitable, Lynch questions the sustainability of chip demand, wondering whether it’s a one-time infrastructure build or a continuous process.
Investment Strategy
Lynch’s strategies haven’t invested in companies based on the progress of large language models (LLMs) or infrastructure companies supporting them, as he’s unsure about a clear, unique company with sustainable competitive advantage. He noted that consumer interest in using LLMs has started to fade over the past twelve months, with some widely used LLMs struggling with rising hallucination rates.
Opportunities in Less Widely Owned Stocks
Unlike many top-performing funds that have been betting on mega-cap technology stocks, Lynch sees opportunities in less widely owned stocks. He believes younger companies with big end-game potential still offer strong upside, despite experiencing a tough year in 2022. Lynch’s growth strategies have since bounced back to deliver top-ranked returns in 2023, 2024, and year-to-date.
Critique of Factor Investing
Lynch is critical of factor investing strategies, which he believes generalize companies rather than considering their unique characteristics. He thinks factor-driven trading strategies exacerbate market volatility, as they treat everything with a broad brush in a reactive manner.
Quality Growth Investing Has Become Formulaic
Lynch also believes that quality growth investing has become overly formulaic, with investors overly focused on certain financial fundamentals like high return on invested capital (ROIC) and growing earnings per share. He argues that this approach has become so crowded that most potential outperformance has been arbitraged away, and investors risk missing fundamental changes in companies.
Embracing Volatility
Lynch suggests that investors are overly focused on low volatility at all costs, creating opportunities for those willing to accept some volatility. He believes that drawdowns can be a source of resilience and that volatility can be a positive thing for long-term investors.
