The Blue Whale Shift: Tech Divestments Reflect AI Skepticism

In a bold move that has captured the attention of the investment community, Peter Hargreaves’ Blue Whale Growth Fund has significantly pared down its exposure to the "Magnificent Seven" — the seven largest US tech companies by market capitalisation. This decision reflects a cautious stance on the surging capital expenditures in artificial intelligence (AI) infrastructure, which fund manager Stephen Yiu fears may dampen returns on invested capital (ROIC).

Yiu’s reasoning is clear: while the promise of AI-driven growth dominates headlines, the immediate financial burden of these investments could weigh on profitability. Blue Whale’s sharp reduction in its Microsoft stake — from 8% of the portfolio in January to just 2% today — is emblematic of this broader scepticism. The fund’s Microsoft exposure, a cornerstone since its 2017 launch, was notably absent from the top 10 holdings by Q3 2023.

AI’s Costly Promise

The Magnificent Seven — Microsoft, Nvidia, Apple, Alphabet, Meta, Amazon, and Tesla — have enjoyed meteoric valuations, comprising nearly one-third of the S&P 500’s market capitalisation. Yet, the group’s collective capital expenditures are projected to surpass $200bn this year, a daunting figure that raises concerns about when (or if) the ROI will justify this outlay.

Yiu’s view aligns with growing caution among other marquee investors. Warren Buffett has steadily reduced Berkshire Hathaway’s Apple stake, while UK-based Terry Smith exited Apple entirely in a similar timeframe. Both moves reflect an increasing wariness about whether current valuations accurately price in the risks associated with AI-driven spending.

In Yiu’s words, the capital intensity required for AI infrastructure could make most of the Magnificent Seven “a drag on the market.” Blue Whale’s focus has shifted to Nvidia, the leader in AI-enabling chips, which now accounts for nearly 10% of the fund. This allocation, coupled with Broadcom’s inclusion as a beneficiary of AI spending, signals a more selective tech exposure strategy.

Analysing the Divestments

Blue Whale’s recent moves reveal a two-fold strategy:

1. Profit-Taking in Overvalued Stocks: Meta, for example, has seen its fund weight reduced from 5% to 3% due to concerns about its aggressive AI ramp-up. Meanwhile, the fund exited Amazon (2021) and Alphabet (2022), underlining Yiu’s belief that their cash burn outweighs future cash generation potential.

2. Targeted Exposure to AI Beneficiaries: Nvidia and Broadcom are the fund’s preferred AI plays. Nvidia’s dominance in GPU technology and Broadcom’s role in AI infrastructure position both firms to capture substantial value from the broader tech industry’s AI investments.

This shift appears prescient given Blue Whale’s 24% return to November 2023, outpacing rival funds’ average 15%. By reducing exposure to high-risk AI spenders and concentrating on direct beneficiaries, Yiu has demonstrated strategic clarity in a market where sentiment often trumps fundamentals.

Broader Implications for the Sector

The divestments signal a broader inflection point for Big Tech. For years, these firms have enjoyed unparalleled dominance, leveraging network effects, low borrowing costs, and sky-high valuations. However, rising interest rates, competition, and soaring capex demands are now challenging this paradigm.

In particular, Microsoft’s declining ROIC as it ramps up AI investments underscores a critical question: will these expenditures translate into shareholder value, or are they merely table stakes for staying competitive? Similarly, Meta’s metaverse pivot and AI ambitions face mounting scrutiny as investors await tangible returns.

MY ANALYSIS

Yiu’s strategy reflects a shrewd, forward-looking approach that prioritises cash flow visibility and disciplined allocation. While AI remains transformative, not all players will emerge unscathed. Microsoft and Meta’s heavy AI spend without clear profitability milestones is a stark reminder that the narrative-driven growth of Big Tech faces structural limits.

From an investment banking perspective, Yiu’s decision underscores the importance of bottom-up analysis over blind sectoral optimism. His allocation toward Nvidia and Broadcom demonstrates a sharp eye for businesses that create value across supply chains, rather than those merely absorbing capital.

That said, I question whether the fund’s reduced exposure to Alphabet was too conservative, given its strong cloud business and dominant digital ad model. Similarly, Tesla’s exclusion may overlook its AI advancements in autonomous driving — a potential game-changer.

Closing Thoughts

Blue Whale’s divestment from most of the Magnificent Seven signals a pivotal recalibration in tech investing. As AI reshapes the landscape, investors must discern between short-term capex burdens and long-term value creation. Yiu’s selective approach is commendable, but in my view, a nuanced reassessment of Alphabet and Tesla might be warranted to fully capitalise on their differentiated growth avenues.

For the broader market, these shifts remind us that valuation discipline and cash flow predictability remain critical amid the AI frenzy. Investors would do well to follow Blue Whale’s example: tread carefully, back winners selectively, and stay nimble in an evolving landscape.