Adam Xiao, Portfolio Manager of KAR’s Thematic Quality Strategy sat down with The Wall Street Transcript to talk KAR’s investment philosophy, his research process, and the role of AI in the investment world.
Investment Philosophy
Discussing KAR’s investment philosophy, Adam says “There are two parts to it — the quality investment philosophy, which is shared across Kayne Anderson Rudnick’s investment strategies, and then the thematic overlay. Starting with quality, as a firm we view quality to mean differentiated businesses with enduring competitive protections, favorable long-term prospects, and robust economic characteristics. When I speak about themes, it’s a framework for recognizing that there are structural changes to our economy that frequently happen at an accelerated pace. These changes can be because of technology, demographics, or global issues. And what these changes do is either create entirely new industries or reshape the market share of existing industries through the introduction of better-fit products or services.”
The Research Process
The research and investment process can be broken down simply to seeking out the highest-quality businesses that we can identify through our fundamental bottom-up research process. What we’re looking for are companies with effective competitive barriers, prudent management teams, steady and consistent earnings growth and strong free cash flow and above average returns on capital. Our research process includes reading company documents, meeting with management teams, attending conferences, and speaking with industry participants.
When it comes to portfolio construction, an important element is high quality. Because we are managing high conviction, concentrated portfolios with low turnover and long holding periods, once we identify a great business, we want to hold on to that building and not dilute the ownership.
The Future of AI in Investments
Adam touches on a topic that is on the minds of many investors and that is generative AI. Adam says “Artificial intelligence is a very important technology. Today, most of the spending is on semiconductors, the hardware, and the data center groundwork to deliver more performance and higher-volume generative AI capabilities.”
Adam’s view is that businesses have only scratched the surface of what can be achieved with generative AI paired with real-time data access. “Usually for a business, capex expense is a percentage of sales, and not vice versa, where sales are a percentage of capex. So, from my perspective, for the AI business model to be sustainable, end-product revenues would have to grow to become multiples of the amount of dollars spent on GPU capital expenditures today.
That is why I believe there’s another leg of growth that could eventually come from the total generative AI industry that could dwarf the growth seen this year, just in its nascent stage.
Therefore, we see opportunities today in the important enabling technologies that have more recurring type revenues and strong opportunities to be a lasting part of the AI stack. These, in my view, are attractive approaches to invest in the future usage of generative AI and include vendors at the edge of computing and the data management layer.”
Download The Wall Street Transcript report to read the rest of Adam’s thoughts on AI and learn about specific holdings in KAR’s Thematic Quality strategy.
Watch Adam discuss the Thematic Quality strategy in a Q&A here.
The securities mentioned in this article were chosen based upon objective, non-performance-based criteria and are current holdings of the strategy except for Expedia. The companies were chosen to exemplify diversification. We typically select companies that operate in large, vast industries, but have overwhelming market share for their particular niches. It should not be assumed that securities recommended in the future will be profitable. Holdings are subject to change. Individual investors’ holdings may differ slightly. KAR uses the Morningstar taxonomy to define its portfolio themes. Individual securities are categorized within this taxonomy by KAR. In Morningstar’s Taxonomy, there are 31 total Theme Groupings organized in 4 Broad Themes: Technology, Physical World, Social and Broad Thematic. Portfolio Themes are emergent categorizations to communicate which secular themes the portfolio is participating in through its holdings. These classifications are outputs and are not inputs for constructing the portfolio. KAR determines which of Morningstar’s Theme Groupings a holding falls into, and such determinations as well as Morningstar’s Theme Groupings themselves are subject to change by KAR or Morningstar, respectively. The S&P 500® Index is a free-float market capitalization-weighted index of 500 of the largest U.S. companies. The index is calculated on a total return basis with dividends reinvested. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges, and is not available for direct investment. Data is assumed to be reliable.
