Podcast: the fallout from DeepSeek
Investors Paddy Flood and Ankur Dubey give their views on the long-term impact of DeepSeek from a public and private markets perspective.
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[00:00:01.360] - Announcer
The value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested. Past performance is not a guide to future performance. The information is not an offer, solicitation or recommendation of any funds, services or products, or to adopt any investment strategy. This pod is marketing material issued by Schroder Investment Management Limited, registered number 189-3222 England. Authorized and regulated by the Financial Conduct Authority for informational purposes only. Please contact your financial adviser before making any investment decisions.
[00:00:40.390] - David Brett
Welcome to the Investor Download, the podcast about the themes driving markets and the economy now and in the future.
[00:00:54.000] - David Brett
I'm your host, David Brett. For investors in the theme of disruption, the start of 2025 has been one for the ages.
[00:01:09.280] - News Clip
There are growing fears of a major global trade war tonight after President Trump announced sweeping tariffs on imports from Canada, Mexico, and China starting tomorrow. He added that very substantial tariffs would follow for the European Union.
[00:01:30.520] - David Brett
Yet despite the column inches taken up by the new administration in the US, topping the list of disruptive events was the emergence of a formerly little known Chinese AI startup, Deep Seek.
[00:01:41.140] - News Clip
Technology shares on Wall Street have fallen sharply in response to the emergence of a low-cost chatbot built by a Chinese artificial intelligence firm. The chatbot launched by the Chinese firm Deep Seek has become the most downloaded free app in the United States since it was launched earlier this month.
[00:02:00.460] - Ankur Dobey
This has been in the makings for a while. While it hit the public conscience, almost with surprise, in the world of AI practitioners, the people who are making these models and testing and running them, our developer world. Deep Seek was a known entity.
[00:02:19.430] - David Brett
That's Ankur Dubey, an investment director in private markets. While Deep Seek's app wasn't a surprise to those in the know, the advanced nature of the technology was.
[00:02:30.980] - Paddy Flood
They essentially invented a new way of making the large language models that underpin things like ChatGPT. It's the way they did that that is so interesting because they did that in a very efficient and cost-efficient way versus the incumbent methodologies.
[00:02:48.310] - David Brett
That's Paddy Flood, an investor in the theme of disruption.
[00:02:51.640] - Paddy Flood
This led to quite a few questions about whether if you can now build something like ChatGPT in a far more efficient way, what does it mean for spending on AI infrastructure, which has been a really big driver of the markets over the last couple of years, as we've seen with areas like semiconductors.
[00:03:09.340] - David Brett
Competition for Silicon Valley, cost efficiencies, and the potential for a new world order in tech and AI, roiled markets.
[00:03:18.120] - News Clip
We've got a bit of a tech sell-off this morning, and it's being caused by Earth-shattering developments in the AI space. Let's take a look at this. You see the Dow down more than 140 points right now. The S&P is solidly lower, but the real action is over here in the Nasdaq, 600 points lower, nearly 3% on track for one of its worst days in the past two years. Here's why. There's a Chinese startup that few people had ever heard of until the past few days, and it has emerged as a real player in the AI arms race. It's called Deep Seek.
[00:03:53.160] - David Brett
A month on, and with the dust beginning to settle, Paddy and Ankur tell us from a public and private market's perspective, what's changed and what can investors learn from the experience about investing in AI?
[00:04:05.910] - Announcer
On Apple Podcasts, Spotify, or wherever you get your podcasts, you're listening to the Investor Download.
[00:04:12.780] - David Brett
When DeepSeek launched in January, it took the world by storm. Shortly after, it took over rival OpenAI's coveted spot as the most downloaded free app in the US on Apple's App Store. Rave reviews for its performance and the fact that it was open source so users could see how the app worked proved too hard for consumers to ignore.
[00:04:32.720] - Paddy Flood
I think it was quite evident early on that they'd done some quite interesting innovations around how you actually go about creating these large language models. Because it's open source, that is apparent quite quickly. I think it's clear that generally in the industry, costs to deliver AI have been coming down through time. Deep Seek's innovations, which everyone can now use or should be able to use will accelerate that cost-down curve. It's likely to mean that the cost of providing these services, people using Open AI, for example, will continue to fall.
[00:05:09.340] - David Brett
Deep Seek claims its engineers needed around $6 million in raw computing power to build their app. Roughly one-tenth of what Meta spent in building its latest AI technology.
[00:05:20.340] - Ankur Dobey
I think it leads down to Jevons paradox, which is a popular term used in the space. Any time as there are efficiency gains for any resource, the natural instinct is to think that that resource will not be as much in demand anymore. But what ends up happening is that because of the marginal cost of using that resource decreases, more and more people start to use that resource.
[00:05:48.660] - David Brett
If Deep Seek's claims are true, it could open the door to smaller competitors to participate in a market that's to date been dominated by the Mag 7 in the US.
[00:05:58.480] - Ankur Dobey
In this case, compute or computing power all the way from using from the Nvidia or any cloud computing capabilities. They have been a big hurdle for small companies, small founders to build AI applications because they're super expensive. Now, as efficiencies improve, as demonstrated by Deep Seek, and much of that is out of necessity because of the restrictions imposed on China from US. As those efficiency gains happen, more and more AI application producers or founders and companies that will start building on AI will start growing. Because of that, the overall volume of demand for those compute resources and infrastructure resources are expected to go up. So think of it in the era of mobile, when the data prices went down, bandwidth increases, there was almost an explosion in number of mobile applications out there.
[00:07:11.080] - David Brett
We have experienced a similar phenomenon in the Internet era. As bandwidth With increase from dial-up to high speed to fiber and beyond, the number of internet websites and internet use cases exploded. In AI, it would likely lead to a continued push and race for all these companies to make better and cheaper large language models.
[00:07:32.120] - Ankur Dobey
In this case, the number of applications are likely to go up. It will become more democratised in that sense. Then because of which, while the price per unit of compute will go down, the expected overall volume is likely to go up. Therefore, for the AI infrastructure space, overall, the addressable market is expected to increase.
[00:07:57.010] - David Brett
But as cost fall, it poses a question for investors in AI about the risks associated with those investments. That's coming up in part two of the show.
[00:08:07.440] - Announcer
Get in touch with us by email at schroderspodcasts@schroders.com or visit our website, schroders.com/theinvestordownload.
[00:08:18.570] - David Brett
Today, most investors, certainly retail investors, will have looked to the so-called Magnificent Seven in the US to gain exposure to the theme of AI.
[00:08:27.810] - Ankur Dobey
Magnificent Seven have been a public market proxy for exposure to AI because those are the ones who are doing all sorts of innovations, right from compute to applications.
[00:08:36.500] - David Brett
So big had the Mag7 become, that by the end of 2024, that accounted for more than a third of the S&P 500 and nearly a quarter of the MSCI world. But that would ignore the many other companies that operate in the AI space, in computing, foundation, infrastructure, or applications. And most of that investment is happening away from the public space and in private markets.
[00:09:00.150] - Ankur Dobey
But in the private market space, there's a lot more opportunities to invest because a lot of innovation is happening at every layer, right from compute. There are competitors to NVIDIA, competitors to Azure and Microsoft to all the way down right up there where OpenAI and Anthropic sit in the large language model space and a bunch of applications building on top of that. What this does specifically, and by this, I mean the deep seek innovation, is it brings into question the high capital intensive nature of the large language model itself. There have been questions raised over the last year and a half or two that this model of CapEx-intensive development of large language models, where is it going to?
[00:09:59.040] - David Brett
Where AI is going remains a big question that needs answering, especially given the amount of money that's being invested. The longer that question goes unanswered, the more the risk becomes attached to those investments.
[00:10:11.130] - Paddy Flood
I think it's just really important to contextualize that AI still has risks to investing in that theme. But I don't think deep seek has changed those risks. So deep seek has made it more efficient, and I think that will drive adoption. But what is the big unknown with AI is adoption. It's whether this technology will be used by businesses and people all over the world to do things that help them improve their productivity or whatever it may be. That was a question before Deep Seek, and that is still the question after Deep Seek, and one that I think will determine the success or otherwise investing in AI.
[00:10:42.900] - Ankur Dobey
Because the end use case is still in question, adoption is still in question of AI, how long can you keep spending on CapEx for large language models to figure out whether this technology has an adoption case or not? With this, there is at least, I mean, it's too early to say in private markets because typically, private markets lag public by six to eight months in terms of showing traction. But the discussions and ramblings have begun on being more efficient with the dollar in terms of how you want to develop this technology, how do you want to develop the models, and what it it's pushing into is the cost of experimentation with the cost of experimentation is going down, but you still want to be more careful with where you want to deploy those dollars.
[00:11:45.650] - David Brett
So how long can investors keep plowing in their money before they demand a payoff?
[00:11:50.590] - Paddy Flood
Well, I think from an investor perspective, you need to see a payoff in terms of people using this technology relatively soon. There has been a lot of investment going into the AI infrastructure, and the companies who are trying to monetise it haven't yet done so in a significant way. I think we just need to see over the next 12 to 18 months, more of those use cases coming out that will justify the spend, because otherwise, there will be a mismatch as we get big investments and not much return in terms of use yet. That always creates uncertainty for investors.
[00:12:30.760] - David Brett
Given the risks, how should investors approach investing in AI? That's coming up in the final part of the show.
[00:12:41.840] - David Brett
Deep Seek has shaken up the market in terms of the costs associated with building large language models and associated AI tools. It's also brought into focus the need for consumers and investors to see a payoff in terms of how this technology will be deployed and how it will be used in a way to benefit productivity and society. And with that, long-term value in their investments. With that in mind, how should investors approach investing in AI?
[00:13:07.390] - Ankur Dobey
Because the market in general still hasn't seen a host of products that have been adopted en masse by enterprise use cases or by consumer use cases. The faith in the return that will be delivered by each dollar spent on AI development is very low. So any shock news that the market sees, the reaction is going to be extreme, which was the case here. However, as investors, it's key to have a long term bigger picture and be thematically correct. So these short term volatilities are not of meaningful impact. Impact. But that being said, this disruption is always meaningful from an innovation perspective. Another thing I'll also add there is to Patty's point that innovation is happening all over the world. It's not centered into one region specific, which people believe that a lot of innovation is happening in one or two centers. But another layer it's added to the people's imagination is scarcity also drives a lot of innovation. In this case, much of the innovation deep sea has done is born out of a lack of availability of the resources. Purely because of the restrictions imposed by US on China in terms of availability of chips, they were able to extract much more out of those chips.
[00:15:01.620] - Ankur Dobey
The questions are, there's also a debate happening whether you need to spend that money to drive that innovation, or if sometimes restricting that capital is also good to maybe improve efficiencies.
[00:15:20.490] - David Brett
So don't fear disruption. It can be a good thing. But do be aware of the short term market ructions disruptors can cause. And the AI theme is not one that is dominated by just the US and China. This is a global race. As Deep Seek has shown, even the smaller innovators can produce game-changing products despite the hurdles put in their way.
[00:15:41.020] - Paddy Flood
I think it's always good to take a step back and think of the businesses that you think have very high defendable barriers to entry in this space that are really driving value to it and have long growth trajectories that aren't priced in by markets. It's a careful balance of assessing the fundamentals of the business versus the valuation to make sure that you're not paying exuberant prices for a company's destiny that might not be within its control or might be a destiny that is going to be increasingly competitive. That's how we tend to think about it.
[00:16:14.900] - David Brett
If you enjoyed the pod, you can find my full unabridged chat with Ankur and Paddy in its full technicolor glory on Schroders' YouTube page. There will also be an article to accompany this pod on Schroders' Insights pages at schroders.com.
[00:16:36.770] - David Brett
That was the show. We very much hope you enjoyed it. You can subscribe to the investor download wherever you get your podcast. And if you want to get in touch with us, it's schroderspodcasts@schroders.com. And you can find out much, much more at schroders.com/insights. New shows drop every other Thursday at 05: 00 PM UK in the meantime. In the meantime, keep safe and go well.
[00:17:03.190] - David Brett
The value of investments and the income from them may go down as well as up, and investors may not get back the amounts originally invested. Past performance is not a guide to future performance. The information is not an offer, solicitation or recommendation of any funds, services or products, or to adopt any investment strategy. This pod is marketing material issued by Schroder Investment Management Limited. Registered number, 18932220, England. Authorized and regulated by the Financial Conduct Authority for informational purposes only. Please contact your financial adviser before making any investment decisions.
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