One top-performing fund manager has been selling Microsoft shares, citing concerns about the tech giant’s future profitability amid advances in artificial intelligence. Stephen Yiu, chief investment officer of Blue Whale Growth Fund, revealed that his fund has been reducing its holdings in Microsoft over the past six months. Blue Whale Growth Fund has held Microsoft since its establishment until August this year. The fund is up 16.6% this year. In 2023, the fund returned 30.7%, significantly outperforming its benchmark and the S&P 500 (up 26%). Yao’s decision stems from his belief that Microsoft’s business model is about to undergo major changes with the rise of generative artificial intelligence. MSFT 1Y line Earlier this month, Yao told CNBC Pro at the Quality Growth Investor Conference in London: “With the support of generative artificial intelligence, Microsoft’s business model will undergo a huge change.” Microsoft on generative artificial intelligence has been leading the way in smart adoption. The company has invested billions of dollars in ChatGPT owner OpenAI, which has been at the forefront of artificial intelligence research and development. Microsoft is also actively integrating artificial intelligence into its own services, such as developer platform GitHub and productivity software suite Office 365. USD per user per month in addition to a standard Office 365 subscription. While this may look like revenue growth, Yao said it could actually cause Microsoft’s profit margins to decline. Microsoft has reported rising profit margins in its Productivity and Business Processes segment, which includes Office 365 services, over the past seven years. Operating margin rose to 52.2% this year from 36% in the year ended June 2018, according to FactSet data. The sector has also continued to grow at double-digit percentages annually, from $35.9 billion in 2018 to $77 billion this year. Yao believes that although Microsoft may achieve higher gross profits, the profit margins of new artificial intelligence services may be significantly lower than those of traditional software subscriptions. “In the next five to ten years, the quality of Microsoft’s (profit) will decline compared to before,” Yao explained. Outperforming fund managers say the crux of the problem is the rising cost of providing AI services. Unlike traditional software, artificial intelligence requires a large amount of computing power and investment in hardware infrastructure. This shift is largely driven by the need for expensive AI chips (such as graphics processing units) to power AI functions, which are either purchased from companies like Nvidia or developed in-house. Nvidia’s chips, while easily available, allow the Silicon Valley company to generate most of its profits from generative artificial intelligence services. While in-house AI chips may save Microsoft money in the future, they will incur greater costs for the company in the short term. Nvidia is currently one of the top ten holdings of the Blue Whale Growth Foundation. Additionally, the constant need to retrain and update AI models means these costs are ongoing rather than a one-time investment. “They need to forever invest in hardware or AI infrastructure to give us (artificial intelligence) capabilities. Because of (artificial intelligence) learning and retraining, it’s always very demanding. The feedback (loop) never stops,” Yao emphasize. While Yao acknowledged that Microsoft’s absolute dollar profits will likely grow, he believes the company’s return on invested capital will decline. However, the consensus among Wall Street analysts is that Microsoft’s shares will rise 20% in the next 12 months, according to FactSet.
