Gnostic Portfolio Return for the Quarter Ended 03/28/2024.

For Q1, 2024 the 3 US representative indexes posted the following returns.

DJIA: 5.6%.
S&P 500: 10.2%
NASDAQ Composite: 9.1%

For Q1, 2024, the Gnostic Global Portfolio started the year off with a valuation of $845.43 per share and closed out March with a value of $1,009.15, a return of 19.3% on the quarter.

As for the Gnostic Portfolio, it was very much a business-as-usual quarter, with a twist.

Noteworthy equity outperformers for the quarter included Adyen (+31.2%), BJ’s Wholesale (+13.4%), Canadian Pacific Kansas City Southern (+11.5%), eBay (+21%), Eli Lilly (+33.4%), Grupo Comercial Chedraui (+33.8%), Mastercard (+12.9%), Microsoft (+11.9%), Novo Nordisk (+24.1%), Palantir (+34%), Taiwan Semiconductor (+30.8%) and Cigna Group (+21.3%).

The twist?

When the portfolio was constituted in August 2000 and investors provided with an opportunity to climb aboard, the initial individual investment was set at $1 million USD. This was broken down into 100,000 units priced at $10. At a unit value now in excess of $1,009, the portfolio has now breached the 100-Bagger territory.

This valuation represents the defined end-point of the account, per the initial terms of service (TOS).

ETF, passive funds and indirectly active funds (passive funds that disguise themselves as active) have clearly won the momentum and marketing battle for investor capital globally.

An actively managed professional investment and hedge fund industry, lumbering through decades of mediocrity, seem quite defenseless against the asset gathering actions of passive investments. This is due to a active fund manufacturing process which features high structural costs, all the while delivering a substandard product.

A seismic shift in global allocation from active to passive investment styles, one that is entirely transactional, based on market cap and subcategory, suggests a structural employment dislodging is likely to develop in financial services.

The former dominant paradigm was that of a requirement by professional investment managers to sit astride investment capital, serving as oversight and to a great extent, acting as gatekeepers. This created significant overemployment in financial services, paid for by investors through a variety of fees, some upfront, some hidden, all ongoing.

A displacement of active management, in favor of passive management, when taken to its logical conclusion, should mean a massive downsizing of employment within the investment industry. With pressures upon equity funds to reduce annual up-front annual costs of managing portfolio, levied by active managers, in favor of hidden execution fees and spreads levied at passive funds, the number of investment managers and analysts required to oversee the remaining active capital within the global industry may need to fall by more than 1/2, in the coming decade, to better balance actual demand. I consider equity fund management to be the most overemployed service industry on the planet, relative to needed personnel, at this time.

Any AI algorithm can conduct the brute force work needed to populate an ETF portfolio, at an expense equal to the marginal kilowatt hourly cost of electricity.

Another AI algorithm can forward the instructions to reconstitute a portfolio, again, at the nominal cost of electric power + hardware depreciation & software amortization with a third algorithm executing the actual transaction. New technology is currently, and will further, alter the cumbersome production process of manufacturing a packaged equity investment, eliminating the most expensive fixed/variable cost, the human element. I denote that the staff cost is both fixed and variable because investment personnel expect to receive a generous wage (fixed) plus a percentage of the profits produced in the form of bonuses or equity awards (variable). AI algorithms on passive funds can do away with both expenses, and in the process, the staffing requirement. That, by definition, represents a new paradigm.

According to fund flow data supplied by Morningstar, roughly 53% of active funds in the 3000 fund US sample failed to outperform index and ETF peers in 2023.

It is clear that not only do retail individual investors fail to outperform as a group, so too, do professional investors underperform. Yet, active funds at the end of 2023 still controlled roughly 55% of the entire fund market, with 45% held by passive funds. Nevertheless, with a numeric advantage of 5300+ passive funds competing against 3000+ active funds, both momentum and return favor passive investment. Given trends, it would appear that by the end of 2025 at the latest, ETF and passive fund AUM will match or exceed active fund management AUM and then, the industry shakeout should begin in earnest.

As with GLP-1 adoption leading to disruption in certain aspects of the health care industry and not proactively modeled by professional managers, it is my suspicion that very few investors are looking at the logical targets for AI to disrupt, but tech knows exactly where they intend to go with it.

All the talk about AI shaving a few cents off an electricity bill by learning when people enter and leave a room is an altruistic misdirection. I will place real money on an assumption that Microsoft and Open AI’s plan of investing $100 billion in the “Stargate Supercomputer” data center may, instead, wreak direct havoc in the professional money management industry, as well as others, by storing, collating and mining ALL data for a profit motive. Stargate represents the largest forecast capital project in the history of Microsoft and money management is ripe for a shakeup on human OPEX; an element that, on the whole, based upon return, hinders, rather than aids, performance.

Were I throwing $100 billion into an AI supercomputing grid, a high priority target would be an evaluation of how much better off investors would be, on a cost perspective, if human managers were entirely eliminated from the money management OPEX structure.

A $100 billion capex project for Microsoft needs to generate about $57 billion annually in EBITDA to meet the current hurdle for the the overall Microsoft business. $57 billion in incremental EBITDA for Microsoft adds as much as $1 trillion to a market cap, but a lot of that EBITDA could come at the direct expense of whomever or whatever industry MSFT chooses to disrupt with AI.

Tech will protect itself from AI, because tech savings are not the low hanging fruit. Rest assured, Microsoft will not be training AI artillery shells, bought and paid for by Microsoft, upon itself. There isn’t enough incremental margin to be had at Microsoft’s existing businesses to make a $100 billion supercomputer pay off. No, spending at this scale strongly suggests, to me (if to nobody else) that the AI algorithms and data conclusions are going to be directed elsewhere, to other industries that are unable to fight back.

Money center banks and the multitrillion AUA and AUM managers outsourcing all their data to Microsoft server farms, I consider them to be very much in harm’s way of AI competition. These businesses let it happen through a ridiculous outsourcing of what was already the lowest cost part of their business, data, for nominal savings; all the while stubbornly maintaining the highest legacy cost, white collar personnel. Banks and investment managers truly believe, to this day, that Microsoft is their data partner. I think otherwise.

https://www.theinformation.com/articles/microsoft-and-openai-plot-100-billion-stargate-ai-supercomputer

Don’t fret for me, as this is a problem within the high cost, active, investment management industry. On a directly comparable basis, I represent the absolute lowest cost producer, likely anywhere, not just within active equity, but also among passive equity and indexers. Ongoing annual transaction costs for my portfolio are expressed as fractions of a single basis point.

My modeling is more than fine under an inexorable global shift to passive management, an entire industry whose capital deployment is largely based upon fund flows needed to maintain equity population integrity. Such brute forcing of capital allocation creates arbitrage potential for those who understand limitations, requirements and restrictions by passive investing funds.

https://www.morningstar.com/etfs/active-funds-fell-short-passive-peers-2023