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Investor Update for April 2024

Magnificent utilities

The next leg of AI may broaden peak market concentration

As we’ve written about before, global equity markets today are at their most concentrated for over 50 years. The rush for AI exposure has pushed the mega-cap technology names ever higher, which due to their ever-increasing size, means there has never been a time when the largest stocks account for so much of the world’s equity indexes.

Historically, spikes in market concentration have always unwound. We believe we might be seeing green shoots of that today.

AI needs power

When reviewing year to date returns, it should come as no surprise that Nvidia and another tech stock SBC are amongst the best performing securities in the S&P 500 Index. What perhaps is surprising, is that three electric utility companies are also amongst the best stocks to have owned so far this year.

Source: Bloomberg, Wheelhouse. Calendar year returns to 17/5/24

Aside from the remarkable news that a utility has appreciated more than 100% within 5 months, it’s also worth highlighting the move in copper which is up over 25% year to date. To some extent this explains why the S&P500 has slightly outperformed the tech-heavy Nasdaq year to date.

The AI theme is broadening. Investors have realised how energy intensive AI actually is, with the chart below from Dominion Energy highlighting just how much more energy is required for an AI equipped datacentre, versus a legacy version.

Source: Dominion Energy via zerohedge

When combined with an underinvested energy generation and transmission grid, it’s no wonder forecasters are calling for a boom in capital expenditures in the utilities sector. This represents investment in power plants & generation, transmission lines, infrastructure… steel, concrete, power management technology and infrastructure… many ‘old economy’ industrials might just do okay as well out of AI.

Source: Goldman Sachs

Market broadening

The last time the market was anywhere near this concentrated was during the tech bubble, from which the subsequent collapse saw a powerful reversal of market concentration.

“This time is different” is a refrain we often hear when making comparisons to March 2000. The companies driving the current boom are universally regarded as awesome, with balance sheet strength, huge profits and monopolistic market positions. We don’t disagree that the mega-cap tech names are for the most part, magnificent.

However, there are laws regarding large numbers and the challenges of maintaining super-normal growth rates. It just becomes much, much harder to maintain high growth on already super-sized revenues. Forecasts from RBC suggest that earnings growth differential is set to slow in coming years.

Source: RBC via TME

When put together, the broadening of the AI demand thesis, plus the increasingly high hurdles that mega-cap growth companies (of any persuasion) have in terms of maintaining high growth rates, we don’t believe this time is different. At least from a market concentration unwind perspective.

When high market concentration unwinds, equal weighted index exposures always outperform cap-weighted exposures. The mega-cap tech names don’t need to crash like Cisco and AOL did 20-odd years ago, they simply need to underperform relative to the rest of the market.

In our view, the only thing better than an equal weighted exposure in the current environment is an equal-weighted exposure paired with a cap-weighted short. As we discuss in our commentary below, this combination has been a powerful headwind for our Global fund returns the past 12-18 months, but one that may prove a powerful tailwind for future years.

Peak concentration?

Alastair MacLeod talked to Juliette Saly from ausbiz about how demand for AI is now filtering through to other corners of the market.

Wheelhouse Global Fund

 1 mo3 mo6 mo1 yr3 yrs (pa)5 yrs (pa)S/I (pa)
Total fund return-2.7%-0.1%6.0%-0.1%3.7%4.8%5.9%
Risk (volatility)6.8%7.3%7.4%7.6%

* The Fund’s benchmark is RBA +2.5% and is used for all time periods shown. From the Fund’s inception to 31 August 2023 the Fund’s benchmark was MSCI World ex Australia Index (AUD). The change in benchmark does not impact any fees the manager may earn and the Fund’s investment objective has not changed.

Performance figures are net of fees and expenses. Inception date is 26 May 2017. Past fund performance is not indicative of future performance.

Global performance commentary

The market concentration build over the past 18 months has had a marked impact on the Global fund’s returns.

The equal-weighted quality index that we own has materially underperformed the cap-weighted global indexes. All equal-weighted indices have been similarly affected during this period due to market returns being driven by several mega-cap names.. Secondly, the index-based buywrite strategy we use to overwrite the portfolio is cap-weighted which has added additional drag to our performance.

We strongly believe that this is not a permanent impairment. Spikes in market concentration have always unwound and we do not expect this recent spike to be any differerent. AI fervour needs not stumble or fall out of favour for this concentration to unwind and when it does, we believe the strategy is exceptionally well placed to exploit this dynamic.

Wheelhouse Australian Fund

 1 mo3 mo6 mo1 yrS/I pa^
Total Return-3.1%1.9%15.6%9.1%8.2%

Performance figures are net of fees and expenses. Since inception numbers include 30bps exit spread.

* Income includes cash distributions and the value of franking credits and special dividends. Cash distributions are paid quarterly.

** Benchmark is the S&P/ASX 200 Franking Credit Adjusted Daily Total Return Index (Tax-Exempt).

^ Inception date is 09/03/2021. Since inception figures are calculated on a p.a. basis. Past performance is not an indicator of future performance.

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