For those of you who have been living on the moon for the past few months, AI chat bots and specifically ChatGPT have been taking the world by storm. ChatGPT launched in November, and by the end of January reportedly had over 100 million active users. This milestone cemented its status as the fastest growing consumer application in history and shows the demand for a newer and potentially better way to seek information online. Whether or not this marks the beginning of a paradigm shift remains to be seen, but the emergence of this new disruptive technology raises the stakes for all companies that generate revenue via internet searches and ads.
Open AI (the private company behind ChatGPT) has sparked an arms race in the space, as Google recently rushed their own chat AI search product to market. Microsoft was an early investor in Open AI in 2019, and recently announced an additional $10B in funding for the company. The quick response by Google to demonstrate their own AI capabilities is a clear signal that they view ChatGPT as a threat. Google’s demonstration was fraught with issues, including factual inaccuracy. Despite its own shortcomings such as capacity and accuracy, ChatGPT currently appears to be miles ahead of the competition. Technology in this space is evolving quickly and will likely continue to improve as time goes on. Competition among new entrants will also likely increase, creating the potential for even more substitutes to Google’s search algorithm. Is this the beginning of the end of Google’s dominance?
“Googling” something for information has become the accepted standard. The company currently has a stranglehold on internet searches, with about 84% of total market share as of the end of 2022. Advertising represented about 80% of Alphabet’s (the holding company of Google) total revenue last year, and the majority of that is derived from its Google Search function – $162B of the total ad revenue of $224B came directly from Google search, with the remainder being generated from YouTube, Google Cloud, and Network Members. Despite the company’s continued efforts to branch out into other revenue centers, search remains its golden goose. A significant hit to growth and/or profitability within this segment of the business would likely be catastrophic for GOOGL investors and its stock price.
Early investors in Google are still very much in the black, despite the 45% peak-to-trough decline that began last February. Even after this swoon, retail investors who purchased shares near the time of its IPO are still up nearly 40x on their initial investment. For an early buy-and-hold investor who avoids periodic portfolio rebalancing to reduce taxes owed, it may well be that Google represents a substantial portion of their total wealth. The recent events that have transpired around AI chatbots raises the stakes for someone sitting on a concentrated position in GOOGL.
Numerous studies have shown that holding a concentrated position will eventually lead to underperformance versus the market. 1Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. ”The Journal of Wealth Management Winter 2022, jwm.2022.1.189; DOI: https://doi.org/10.3905/jwm.2022.1.189 2Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.” https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf 3Bernt Arne Ødegard, “The diversification cost of large, concentrated equity stakes. How big is it? Is it justified?” Finance Research Letters Volume 6, Issue 2. https://doi.org/10.1016/j.frl.2009.01.003 Trends change, new technologies emerge, and companies that once dominated a particular business eventually will be left behind. This isn’t a new phenomenon – history is littered with stories of companies that seemed invincible, only to give way to new trends and disruptors that discovered a better way to solve problems.
The good news for someone currently sitting on a concentrated GOOGL position is that there are ways to reduce their holding without getting bludgeoned by capital gains taxes. Options are often (and rightly) viewed in a negative light among retail investors, as they can be very risky and lead to substantial losses. Options are complex and can be intimidating to even the most seasoned investor. What many people don’t realize, though, is that options can also be powerful tools for tax optimization and hedging within a portfolio. When correctly implemented, an option overlay strategy may completely eliminate tax liability on certain concentrated positions, while simultaneously hedging downside risk. There are of course transaction costs involved, as well as advisory fees in the case of an overlay strategy, but the ability to exit these positions tax neutrally while also reducing portfolio volatility can have a substantial positive effect on long-term capital appreciation.
If you or a client are dealing with how best to address the tax liability and downside risk concerns that often accompany concentrated positions, feel free to reach out to the team at Exceed Advisory. Members of Exceed’s Portfolio Management Team have over 40 years of professional options experience and are well-versed in the tax code. These strategies can be tailored to fit specific investment goals and satisfy immediate needs. When executed properly, these option overlay strategies may reduce or eliminate tax liability, lower risk, and help you and your clients achieve their financial goals in an efficient manner.
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This blog post is for informational or educational purposes only and is not intended as investment advice. Any discussion of investment strategy or approach is intended only to illustrate investment concepts and in no case does the discussion represent Exceed Advisory’s investment performance or the results of any Exceed Advisory portfolio. We provide investment advice only to clients and only after entering into an advisory agreement and obtaining information concerning individual needs and objectives. We think the information provided is accurate, but accuracy is not guaranteed. All investing in securities involves risks, including the risk of loss.