Government intervention appears to have addressed concerns related to bank failures and inflation continues to show signs of cooling. While the interest rate-driven headwinds to the economy are unfolding in the near-term, the lower inflation readings suggest we are nearing the end of Federal Reserve’s interest rate hiking cycle (i.e. the cause of the headwinds) – investor attention is shifting to 2024 and beyond.
Perhaps the most obvious example of this shift in market sentiment is the recent euphoria around Artificial Intelligence (“A.I.”). The Technology sector is the most high-profile representation of A.I., and while I expect our technology investments (~30% of our portfolio) to serve as the sustainable gatekeepers for this innovation, I am most excited about the potential for significant investment returns from the application of this technology to the other 70% of our portfolio. One consideration that I believe is overlooked in the current A.I. mania is the lack of barriers to entry for the standalone technology developers and the eventual commoditization of the technology (i.e. lacking a business model with sustainable profit potential). For this reason, I believe the biggest beneficiaries of A.I. are dominant franchises outside of the traditional Technology sector, with significant barriers to entry and pricing power which will enable windfall profits from A.I. driven productivity.
Portfolio Update
The second quarter’s positive Fund performance was broad-based except for our Healthcare investments (~20% of the portfolio) which underperformed due to short-term issues. Ironically, our Healthcare investments might be the most significant beneficiaries of A.I. technology. Per the tables below, the largest contributors to performance were dominated by Technology companies, however, the case study below illustrates the framework for the windfall profit potential for the 70% of our portfolio outside of the Technology sector.
Elevance Health
Elevance Health (“ELV”) is one of the largest health benefits companies in the United States serving 48 million members (brands include: Anthem Blue Cross and Blue Shield, Wellpoint, Carelon). The company is leveraging its national scale and data to vertically integrate and win market share. The management team’s execution on their strategy is impressive with earnings more than doubling over the last five years. In March 2023, the company hosted an Investor Day and provided financial guidance through 2027 calling for earnings to double from 2022 (see column “Status Quo” below).
The current +7% cash flow yield and management’s guidance of doubling earnings by 2027 make this economically resilient franchise an attractive standalone investment. Furthermore, early A.I. testing suggests substantial productivity improvements which could drive profits to triple from 2022. Should this upward pressure on profitability prove out, I believe ELV could return several multiples of money on our investment. Below are some recent developments with very exciting implications for our thesis:
- July 18, 2023: Microsoft hosts Inspire Event
- Microsoft introduces official pricing for its new A.I. product “M365 Copilot” to corporate clients for $30 per user per month which is in addition to the $12.50-$57.00 subscription clients currently pay (representing +53%-240% pricing uplift)
- Per a recent J.P. Morgan survey, early users are experiencing 30% improvements in productivity suggesting clients are seeing significant value potential and willing to pay up for the new A.I. technology
- July 18, 2023: UnitedHealth Group earnings call (competitor to ELV)
- Dirk McMahon, UnitedHealth Group CFO:
- “we’ve really been applying a lot of artificial intelligence, machine learning, and natural language processing. Long-term, we think there’s great hope for those. And some of the short-term things that we’re working on in those areas, like using Generative AI to help more efficiently write medical appeal letters, things like optimizing our provider search and all of our digital properties with natural language processing and AI, doing a lot of work improving our payment integrity models using AI to detect waste, fraud and abuse, and then a lot in the G&A world to answer basic questions in our call centers, like leveraging our benefit bots to reduce the number of calls and the labor associated with that for simple questions like, is X, Y, or Z disease covered, or have I met my deductible? From a long-range perspective, however, I’m really optimistic about our significant data sets. Our ability to take advantage of whatever new technology comes down the pike to improve healthcare, I’m really excited about it.”
- Dirk McMahon, UnitedHealth Group CFO:
- July 19, 2023: Elevance Health earnings call
- Gail Boudreaux, Elevance Health CEO:
- “Automation remains an area of focus and opportunity across Elevance Health and deep datasets like ours are foundational for generative artificial intelligence. Our data is centralized and cleansed and we are in the process of scaling digital solutions for greater impact and testing the application of new technologies. We’re harnessing our adaptive artificial intelligence solution to promote identification and access to whole health services during physical health procedures like surgery. Our approach allows us to cast a broad net to perform initial screenings for depression and other social drivers of health, to ensure we are addressing our members’ whole health needs.
- Gail Boudreaux, Elevance Health CEO:
Our digital chronic Concierge Care program is a cloud-based care management platform that connects the patient’s entire care management team to triage, monitor, and engage with patients through convenient digital channels. Fully digital enrollment, engagement and support alongside key behavioral health components provides members with highly personalized proactive concierge-like experiences, while reducing the overall cost of care for members with chronic conditions. We’re also using large language models to assist our call-center agents, improving their efficiency, accuracy and quality. We’re excited about these opportunities and the positive impact they will have on consumers, care provider partners and the operating efficiency of Elevance Health”
The example above is a good representation of the potential I see across our portfolio – i.e. strong franchises with attractive status quo investment potential coupled with amplified returns should the A.I. opportunities come to fruition. My family balance sheet remains fully invested in our partnership and I am excited about our future. Thank you for your trust and please feel free to reach out anytime.
Your partner and fiduciary,
Faris Jafar, Chief Executive Officer
Phone: (734) 678-8562