AI has posed an "existential threat" to software developers. How does a top 1% fund invest?

Application software is facing an existential threat from AI, according to Polar Capital manager Nick Evans. His fund has outperformed 99% of its peers over the past year and 97% over five years, notes Bloomberg. Polar Capital sold off the securities of software developers such as SAP and Adobe before the "software apocalypse," than outperformed most of its competitors. Now most of Polar Capital's positions come from semiconductor makers.

The Polar Capital fund, which manages $12 billion in assets, got rid of shares of IT companies before the global sell-off of software developers' securities, outperforming most of its competitors. Asset manager Nick Evans closed positions in shares of German enterprise ERP developer SAP, US business process automation platform ServiceNow, creative and marketing software maker Adobe, and CRM and marketing solutions provider HubSpot. "We're not going back to those companies," Evans said in an interview with Bloomberg. He also warned investors looking for "bargain" deals: most software developer securities are still toxic because few companies will survive.

"We believe that application software is under existential threat from AI," Evans said. He explained that programs that help users perform tasks like document preparation or payroll management are particularly vulnerable.

According to the fund manager, AI tools for writing code are so advanced that they are already capable of replicating and modifying much of the existing software. This means that established companies face much tougher competition from startups, as well as - their own customers, who will develop internal solutions to reduce costs.

Companies like SAP that create sophisticated software packages are likely to prove more resilient, Evans says. But as AI tools "become significantly more powerful," uncertainty remains high about their long-term valuation.

Therefore, Polar Capital kept only a small position in the securities of IT companies and call options on Microsoft, writes Bloomberg. As of the end of January, seven of the fund's ten largest positions were in semiconductor manufacturers, including the largest position - shares of chipmaker Nvidia (almost 10% of the portfolio). Evans is also positive on companies that make networking equipment, fiber-optic infrastructure, and provide power and energy infrastructure for data centers.

There are software segments that Evans considers less vulnerable. In January, he increased his investments in infrastructure software companies that create the foundation for systems that support consumer and enterprise applications. His investments in this segment include Cloudflare and Snowflake.

In terms of cybersecurity companies, Evans takes a neutral stance because he doesn't see an immediate threat from AI. Still, infrastructure software and cybersecurity companies account for less than 7% of his fund's portfolio, Bloomberg writes. Outside of those two segments, Evans expects only a small number of companies to survive the painful shakeup. He predicts that most will repeat the fate of newspapers in the 2000s, when print media were displaced by the Internet.

Investors should "keep the proportion of stocks of application software companies in a portfolio substantially below their holdings in benchmarks (like the S&P 500) and react quickly because as models improve, the negative impact of AI will increase," Evans emphasized.

Fears that advanced AI tools like Anthropic's Claude Cowork will undermine software developers' business models have brought down their stocks. The iShares Expanded Tech-Software Sector ETF, which tracks the U.S. software sector, is down 22% since the start of the year. That's a stark contrast to the shares of semiconductor makers, which have surged amid demand for computing power spurred by the development of AI.

On Wall Street, the debate over the scale of the threat is heating up. JPMorgan strategists said last week that software stocks could recover from recent "extreme price action," Bloomberg recalls. They favor such securities as Microsoft and ServiceNow.

Recent reports from infrastructure companies Datadog and Fastly have shown that demand for "Internet infrastructure" is skyrocketing, Bloomberg notes. Datadog shares added more than 10% last week, while Fastly shares more than doubled.

This article was AI-translated and verified by a human editor