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Investment Climate: Changing of the Guard

Markets corrected in volatile fashion in the last two months of the first quarter after establishing strong new highs in January. As we have stated previously, we believe this is ultimately healthy and sets the stage for a resumption in the positive trend for global equity markets later in 2018. There are plenty of “worries” for the market to digest currently such as the domestic political environment, threats of trade war and global geopolitical tensions. We have weathered many similar circumstances over the decades and have no reason to believe we won’t do so again with respect to all these concerns.

Of greater significance to us is what we believe is a sea change in computing architecture that is taking shape and stands to disrupt the status quo in the technology sector. Over the decades, the overall structure of computing has undergone many radical changes. During the late 1980s and 1990s, the computing platform based on the centralized mainframe that ruled in the heyday of IBM, Digital Equipment and Burroughs gave way to the distributed systems of the PC from Microsoft and Apple: a radical change. Over the past fifteen to twenty years, that newer computing architecture itself underwent a radical change, with the rise of “cloud” computing, with a return to centralized architectures housed at giant datacenter companies such as Google, Facebook and Amazon, which we access from anywhere using our laptops or mobile devices such as iPhones. Now, however, we see signs that this cloud model and the centralized structure it represents will be challenged by distributed ledgers and a new decentralized computing architecture based on Graphics Processor Units (GPUs) from Nvidia and Modem Processor Units (MPUs) from ASOCS, once again rearranging the entire computing landscape.

For years we have been positioning our portfolios for this, and in many ways we’ve been early in taking our stakes. On the other hand, we have harvested significant gains from some of our heroes of the last paradigm in the recent quarter. Amazon is now gone from our portfolios for the first time in almost ten years, and lesser- known but even more profitable Fiserv, a king in the payment processing space, was removed after over twenty years; both with venture capital-like returns for our portfolios. This is not to suggest these are bad companies. They are great companies. But we believe they are unlikely to provide the types of returns that they gave us in the past. And, they are part of the old paradigm now.

The new computing architecture is based on that which blockchain is based. The most important aspect of the Bitcoin phenomenon is not simply digital currencies (which we believe to be a significant disruption in how we think of money) but the decentralized blockchain on which it was built. Blockchain is a “distributed ledger” system which provides secure, transparent yet anonymous transactions that are dependent not on servers sitting in a central data center, but rather on the many distributed computers, or “miners,” out in the world -- who verify the transactions in order to “earn” Bitcoin for their efforts.

We do not intend in this update to get into a deep dive on blockchain and its merits. In fact, it isn’t even blockchain itself but distributed ledgers that are most crucial in this new paradigm. Currently, the primary economic power resides in the “hyper-scale” data center companies. The biggest, and purest “cloud-like” datacenter companies are Facebook, Google and Amazon. These companies are completely based on a closed, centrally-controlled silo which is not secure enough, has significant privacy issues, concentrates control in a frighteningly few hands, and has become perilously intertwined in “crony-like” regulatory quagmires. Two of them, Google and Facebook, have relied completely on the concept of “the Free,” in that their primary users do not pay for the services they receive from these companies. However, Google and Facebook still make billions of dollars – and they do it by delivering those “free” users to advertisers, who can use data analysis to target selected demographics. Therein lies a primary problem for these companies and how they manage their infrastructure. Since they are giving away their product, there is no price discovery mechanism to “regulate” demand for the services, thereby leaving these companies with an ever- elusive determination of how much infrastructure they need. This is problematic.

We admit that we missed the fantastic run in these companies. But we are skeptical of businesses based entirely upon the advertising model, and we believe that the future of the internet will be aligned with the advent of distributed-ledger networks being championed by the Bitcoin phenomenon and by the likes of Brendan Eich with his Brave browser and Basic Attention Token -- which gives people much more control over how they are approached by advertisers. In this new architecture, the things that are crucial are connectivity, massively parallel processing power and power management, sensors and sensor hubs and hardware advancements that will allow all these sub-categories to proliferate.

This changing of the guard will not necessarily happen overnight. It will very likely be uneven as well. But we believe the change is real and inevitable and while it is not likely to mean the end of these centralized titans like Google and Facebook, we do believe it will significantly reduce their dominance in the next decade or so. We also urge investors to learn more about this transition. Fortunately, our good friend and partner George Gilder’s upcoming book Life After Google does a fantastic job at explaining this new shift that is taking shape. George has been the preeminent voice that has predicted virtually every major technological change over the last 50 years. We’ve had the thrill of getting an early glimpse at George’s next great work and urge all to read it when it becomes available this summer.

Meanwhile, stay tuned as we continue to position our portfolios and further discuss these changes in the Investment Climate.

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