Forget the railroad, buy the seaside: Fund manager urges investors to look to AI’s secondary boom

A prominent UK small-cap fund manager has advised investors to shift their focus from the leading AI firms to companies that are integrating the technology into their operations. Laurence Hulse, the founder of Onward Opportunities, suggests that the AI cycle may be reaching a point where investing in "cheaper operating companies" could be more profitable than purchasing overvalued hyperscalers and tech infrastructure stocks.

He compares the current situation to the Victorian railroad boom, where investors poured money into capital-intensive infrastructure builders, while downstream beneficiaries generated profits. Hulse highlighted that AI adopters can generate substantial profits without incurring debt and maintaining thin margins. In an interview with City AM, Hulse noted the growing parallels between AI and a digital knowledge railroad, with the investment required for such infrastructure becoming increasingly expensive.

He emphasized the need for investors to target the secondary benefits of AI adoption, rather than the technology itself. Hulse acknowledged the AI trade as one of the most successful investment themes in history, but warned that the Nasdaq Composite index had shed 8.1 percent in the last month, indicating the start of serious challenges for AI traders.

Onward Opportunities has started positioning itself for this shift, with a 20.4 percent stake in RentGuarantor, a company that uses AI to automate its back-office operations and tenant verification. The share price of RentGuarantor has surged 225.2 percent since January. Despite this, the majority of Onward's portfolio remains away from the AI trade, as Hulse continues to prioritize fundamentals and valuations.

Hulse also argued that the flurry of takeover bids targeting UK small-caps underscores the necessity of active stockpicking rather than passive tracker funds. He noted that passive funds work well in predictable markets, but today's dispersed market belongs to truly active managers who actively select stocks. UK valuations have become depressed since the beginning of the year, and Onward Opportunities has already seen three portfolio holdings targeted for takeovers, with others rejecting such offers.

Hulse argues that these deals have also exposed the limitations of passive tracker funds in a flat market, while Onward's net asset value has increased by approximately 75 percent since its launch in March 2023. The dispersion is benefiting Onward Opportunities, as evidenced by its holding of Likewise, a UK flooring business that saw its sales grow by 36 percent year-on-year following the collapse of its debt-ridden competitor, Headlam.

Likewise subsequently acquired key assets from Headlam, including its distribution center. Hulse criticized broader institutional and government efforts to revitalize UK capital markets, questioning the introduction of the Private Intermittent Securities and Capital Exchange System (PISCEs) by the government. He doubted that this new low-liquidity market would address the fundamental issue of getting more capital into better companies.

Instead, he urged ministers to tackle structural disadvantages that hamper listed companies, such as tax disparities that favor private equity. Hulse also questioned why ministers meddled with Capital Gains Tax, leading to separate taxation of private assets and assets under management performance fees. He urged industry figures to improve the image of the stock exchange, arguing that it is often characterized as a "casino" rather than a way to boost the economy.

Hulse emphasized that the industry needs to market itself and lobby for itself better, similar to how private equity has done for two to three decades.