A leading UK small-cap fund manager has urged investors to look past the titans of the AI trade and consider allocating capital to companies adopting the technology in order to drive returns.

Laurence Hulse, founder of investment trust Onward Opportunities, questioned whether the AI cycle has entered a stage where it is more lucrative to buy “cheaper operating companies” than overvalued hyperscalers and tech infrastructure stocks.

Drawing the comparison between the Victorian railroad boom and seaside stocks, where investors poured into capital-intensive infrastructure builders while downstream service beneficiaries were generating profit, Hulse pointed out AI adopters are capable of capturing significant profit without the required debt and thin margins.

In an interview with , Hulse said: “There are some parallels brewing with AI as a digital knowledge railroad. The price to invest in…that infrastructure is getting very, very expensive.

“Whereas the place now for investors to be is the secondary benefit of this new phenomena. What are the businesses that are going to start benefiting from this?”

While Hulse said that he is not “slating the AI traders”, calling it one of the most “successful” investment themes in history, his words follow the Nasdaq Composite index shedding 8.1 per cent over the last month.

“The AI trade is getting its first serious challenges and prices reflect that,” he said.

Onward Opportunities has also begun positioning for this shift. The trust’s largest holding is a 20.4 per cent stake in RentGuarantor, which uses AI to automate its back-office operations and tenant verification. It has seen its share price rocket 225.2 per cent since January.

But the majority of the portfolio still distances itself from the AI trade, with Hulse continuing to keep his focus on fundamentals and valuations.  

Stockpicker market

Hulse also argued the wave of takeover bids hitting UK small-caps reinforces the need to be an active stockpicker rather than rely on passive tracker funds.

He said: “Passive works when everything moves together in a predictable market. Today’s dispersed market belongs to truly active managers who actually pick stocks.”

Buyers have been circling depressed UK valuations since the start of the year and Onward has already seen three portfolio holdings targeted for takeovers, while others have rebuffed approaches.

Hulse argues these deals have also exposed the limits of passive tracker funds in a “flat” market, while Onward’s net asset value has jumped roughly 75 per cent since its March 2023 launch.

He blamed some of the lack of growth on the impact of the end of zero-rate monetary policy, as funds have spent 20 years getting conditioned to “cheap money” following the financial crisis.

“More expensive money and higher interest rates mean an increased price of time. That favours… a catalyst-focused approach like ours,” he added.

The dispersion is also benefiting Onward with holding Likewise, a UK flooring business, seeing sales grow 36 per cent year on year following the collapse of its debt ridden competitor, Headlam. Likewise went on to acquire key assets from Headlam, including its distribution centre.

“Most businesses can weather a downturn for a year. In the fourth year of it, you’re really going to find out. It’s a real sorting out of the winners and losers and the wheat from the chaff.”

Slicing liquidity

Hulse also took aim at broader institutional and government efforts to revitalise UK capital markets, casting doubt on London Stock Exchange’s decision to launch a Private Intermittent Securities and Capital Exchange System (PISCEs).

Pisces was introduced by the government last year as a means for private companies to conduct secondary share sales, enabling employees and existing investors to cash in their stakes. 

“I’m not convinced the solution for low liquidity and shrinking markets is another small, low liquidity market,” he said, “It… doesn’t deal with the fundamental issue of how we get more capital into better companies.”

The fund manager instead urged ministers to address structural disadvantages plaguing listed companies, including tax discrepancies which favour private equity, questioning why ministers “meddled” with Capital Gains Tax, leading private assets and assets under management performance fees to be taxed separately.

Hulse also warned industry figures to do more to end the image problem plaguing the stock exchange, arguing it is mischaracterised as a “casino” rather than a way to boost the economy.

“The industry needs to do a better job of marketing itself and lobbying for itself, the way private equity has done, frankly,  fantastically for 20 or 30 years. If you create great companies and keep hold of them in the UK, the capital will come and find them.”