The Viewpoint: Is volatility your friend?

A notable change in recent years has been the marked increase in share price volatility. Individual share price moves of 10% following company results, which a decade ago would have been considered significant, are now often more than twice that. In general, share prices appear to move further, faster, and with greater frequency.

The recent AI panic illustrates this clearly. Concerns about the sustainability of AI-related spending, and the returns it will ultimately generate, led many AI market favourites to halve in just six weeks. Yet many of these same companies had enjoyed meteoric gains beforehand and remain strongly positive year to date.

This greater volatility reflects a significant shift in market structure. Estimates suggest that around 60% of the market is now held by passive investors, 25% by retail investors buying and selling shares directly, and only 15% by professional active investors.

That represents a material change over time. When I started, retail investors had little influence, and passive investing was only beginning to emerge. The market was then largely driven by professional investors who generally had a longer-term mindset and greater sensitivity to fundamentals such as valuation, returns and business quality.

Arguably, 85% of today’s market is less anchored in this discipline. Passive funds must buy the largest index constituents regardless of valuation and prospects, while retail investors often operate with shorter time horizons and more speculative investment theses. Retail participation can also involve leverage – borrowing to invest – which amplifies returns in both directions.

The impact of narrative over fundamentals

This rise in volatility, driven by a structural decline in price-sensitive and fundamentals-driven investing, has important consequences. In markets, price often drives narrative: investors become more optimistic about companies whose share prices are rising, and more pessimistic about those whose prices are falling.

If price is less anchored in fundamentals, investors are more likely to overstate the strengths of winners and understate the strengths of losers. Put simply, companies may become more overvalued and undervalued in the future. Leverage is likely to accentuate this further, particularly in rising markets: gains can become more rapid, while declines can resemble a cliff edge. That is exactly what we have seen so far this year.

If price is less anchored in fundamentals, investors are more likely to overstate the strengths of winners and understate the strengths of losers.

In theory, this should be good news for active management. Mispricing of company prospects is the lifeblood of active investors. However, in my view, capturing those opportunities will require high-quality research and greater patience. Active managers may increasingly need to hold a view that differs from the prevailing share price for prolonged periods before fundamentals reassert themselves.

In summary, I think that higher volatility is not simply a cyclical feature of today’s market; it reflects a deeper structural change in who sets prices and how those prices are formed. For active investors, this creates both risk and opportunity. Short-term price moves may become more extreme and less fundamentally grounded, but that should also increase the rewards for disciplined research, valuation focus and the patience to look through market noise.

AI users

Since AI became a more pronounced force in markets, companies have largely been sorted into two buckets: AI winners and AI losers. Those placed in the ‘winners’ bucket have seen almost limitless share price appreciation, as concerns about valuation and the long-term economics of AI have been overwhelmed by exceptional demand for their products and services. Equally, those placed in the ‘losers’ bucket have struggled to shift investor perception, even when they have delivered results ahead of expectations.

Over time, we will discover whether these classifications were right. In the meantime, however, a third category of companies is beginning to emerge, one that could succeed regardless of which AI narrative ultimately proves correct: AI users.

AI users need to be defined more precisely than the broad assertion that AI should benefit every company in some way. Three criteria are likely to matter:

• Their end markets are not fundamentally changed by AI. This may seem counterintuitive. However, what we have learnt over the last 12 months is that industries whose prospects are materially improved or impaired by AI are not easy places to invest. Those enhanced by AI attract more competition and faster innovation, while those disadvantaged by it are often fighting over a shrinking pool of opportunities.
• Their operations are complex, human-led and rules-based. Banks are a good example: lending criteria are clearly defined, yet the process remains complex and heavily reliant on humans. Supply chain management is another: moving materials efficiently depends on rules-based decisions about where goods need to be, and when. In both cases, AI can improve execution without redefining the market itself.
• Finally, the benefits of any AI-enabled improvement need to accrue to customers and shareholders in a durable way, rather than being competed away through lower prices, higher investment requirements or rapid imitation by competitors.

Add to this the markets that entities such as OpenAI and Anthropic, the source of many AI disruption fears, are unlikely to target, and a clearer picture starts to emerge. Running regulated banking services, developing consumer staples such as personal care, delivering healthcare, and building power and water networks are all examples of industries that can benefit materially from AI adoption without necessarily facing increased competition or direct disruption.

Overall, the most attractive AI opportunities may not be the obvious winners or losers, but the companies that can use AI to improve productivity, decision-making and customer outcomes without facing fundamental disruption to their end markets. These businesses are more likely to convert AI into durable economic value. This is especially true where regulation, operational complexity, trusted customer relationships and physical infrastructure create barriers to rapid competitive imitation. Now we have three AI categories: winners, losers and users.

Now we have three AI categories: winners, losers and users.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. Reference to any security is for information purposes only and should not be considered a recommendation to buy or sell.

The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change. Forward looking statements are subject to certain risks and uncertainties. Actual outcomes may be materially different from those expressed or implied.