AI MENACE:
Application software grapples with peril from artificial intelligence, asserts Nick Evans, manager of a top-performing global technology fund
Anticipating the downward trajectory of software stocks has proven advantageous for Nick Evans, a fund manager at Polar Capital LLP. He cautions prospective investors: the majority of shares remain perilous, and few enterprises are likely to endure.
“Application software is confronting a profound existential threat from AI,” remarked Evans, whose $12 billion global technology fund outperformed 99 percent of its competitors over the past year and 97 percent over five years.
Concerns regarding advanced artificial intelligence (AI) tools—such as Anthropic PBC’s Claude Cowork—provoked a steep decline in software stock values this year. An exchange-traded fund that tracks the U.S. software sector has experienced a staggering 22 percent drop, starkly contrasting the surging momentum of semiconductor stocks buoyed by heightened demand for computing power due to AI.
Evans identifies application software—which facilitates tasks like document creation and payroll management—as particularly vulnerable. Aside from a modest stake and certain call options in Microsoft Corp, he has liquidated all other holdings in the sector, which include major players like SAP SE, ServiceNow Inc, Adobe Inc, and HubSpot Inc.
“We have no intention of returning to these companies,” he asserted in a recent interview.
In his assessment, AI coding tools have advanced sufficiently to not only replicate but also modify existing software. This evolution means that established firms are now contending with heightened rivalry from their own clientele, which is hastening the development of internal tools aimed at cost reduction, alongside entrepreneurial AI start-ups.
Evans believes that companies such as SAP, which produce intricate software packages, may exhibit greater resistance. Nonetheless, with AI tools becoming “dramatically more powerful,” significant uncertainty looms over their enduring valuations.
As of last month’s end, seven of the fund’s top ten positions were held by semiconductor companies, with Nvidia Corp topping the list—constituting almost 10 percent of the portfolio.
Beyond chip manufacturers, Evans expresses optimism for firms engaged in networking equipment, fiber optics, and those supplying energy infrastructure for data centers.
The market upheaval instigated by the threat of AI disruption could exacerbate challenges for software enterprises. With employees often receiving stock as part of their compensation, managers might have to offset the eroded equity value with increased cash payouts, Evan noted. Any pursuit of AI start-ups to invigorate growth could further exacerbate financial burdens.
“Current valuations do not reflect the uncertainty regarding terminal value or the strain on free cash flow,” he stated.
A spirited debate surrounding the extent of the threat is unfolding on Wall Street. Strategists at JPMorgan Chase & Co expressed last week that software stocks might rebound following recent “extreme price movements.” They advocate for investments in companies like Microsoft and ServiceNow.
There are software segments that Evans deems less susceptible to disruption. Last month, he boosted investments in infrastructure software firms providing the essential backbone for consumer and enterprise applications. His portfolio now includes investments in Cloudflare Inc and Snowflake Inc.
Recent performance reports from infrastructure software companies such as Datadog Inc and Fastly Inc demonstrate soaring demand for Internet infrastructure. Datadog’s stock surged over 10 percent last week, while Fastly’s value more than doubled.
Evans maintains a neutral perspective on cybersecurity software, perceiving no imminent threat from AI. Nevertheless, less than 7 percent of his fund is allocated to infrastructure software and cybersecurity stocks.
Apart from these sectors, Evans foresees that only a scant number of companies will emerge from the impending tumult. He likens this shakeout to the fortune of newspapers in the 2000s, which faced severe decline amid the rise of the Internet.
Investors ought to be “significantly underweight in application software,” he advised, urging them to respond rapidly, as improving models promise to accelerate disruption.
Source link: Taipeitimes.com.
