ELMRI January 26 Monthly Report

Dear Investor,

During the month, the ELMRI ANZ Conviction Fund declined 3.1% and the ELM Responsible Investments Global Fund declined 4.5%. January saw continued volatility in technology and growth oriented equities as investors digested the implications of accelerating capital expenditure amongst the world's largest technology companies alongside persistent concerns about artificial intelligence's impact on software as a service business models and questions about the pace and profitability of artificial intelligence deployment. 

A significant headwind for investors in January was the rapid appreciation of the Australian dollar, which rose over 4% against the US dollar to surpass the US$0.70 mark for the first time since early 2023. This move was driven by a combination of a weaker greenback and a hawkish shift from the Reserve Bank of Australia, with markets increasingly pricing in a rate hike for the February meeting. For the Global Fund, this currency strength acted as a translation drag, materially depressing the AUD value and performance of our international holdings.  

Market Update

Global equity markets delivered positive headline returns in January, though performance was defined by a stark divergence across sectors. While the S&P 500 rose 1.5%, this masked a deep rotation out of growth and into cyclicals. The Energy (+14.4%) and Materials (+7.7%) sectors led the market, whereas the Information Technology sector lagged (-1.4%). Within tech, the divergence was even more pronounced:  semiconductor hardware remained resilient (SOXX index +15%), while high quality SaaS and software platforms faced broad based selling pressure (IGV index -15%). 

In Australia, the S&P/ASX 300 Accumulation Index rose 1.7%, similarly reflecting a continued shift toward energy +11.1% and materials +9.4%, while IT declined 9.1%. 

Technology stocks sold off broadly and indiscriminately in January, with both global and domestic SaaS and platform companies under pressure regardless of underlying fundamentals. Concerns ranged from hyperscaler capital expenditure to the perceived impact of artificial intelligence on traditional software business models, prompting a rotation into more cyclical and infrastructure oriented names. While this created near term volatility, we view the selloff as an opportunity to gain exposure to high quality, structurally advantaged companies at attractive valuations. 

At its February meeting, the Reserve Bank of Australia increased the official cash rate by 25 basis points to 3.85%, citing persistent inflation pressures and a resilient labour market. Financial markets are now pricing the possibility of at least one further increase in 2026, which could see the cash rate move modestly above 4% should inflation fail to moderate as expected.  

While higher interest rates affect discount rates and valuation multiples, recent share price movements have been shaped primarily by evolving sentiment around AI displacement, rather than by changes in the competitive positioning or cash generating capacity of our holdings. 

Fund Performance

Both funds underperformed their respective benchmarks in January, as investors rotated away from high growth and technology stocks toward cyclicals and resource oriented sectors. This rotation was largely driven by concerns around artificial intelligence’s impact on traditional software business models and elevated hyperscaler capital expenditure, which prompted broad based, short term pressure across both global and domestic SaaS and platform companies. We view this indiscriminate selloff as an opportunity to gain exposure to structurally advantaged businesses at attractive valuations. 

As noted above, the Global Fund encountered a notable currency translation headwind as the Australian dollar appreciated ~4% against the greenback. For domestic investors, this movement resulted in a negative translation effect, materially depressing performance figures in AUD. In USD terms however the Global Fund was flat for the month. 

The Global Fund’s relative performance reflected a divergence within the technology sector; while strength in semiconductor holdings provided a partial buffer, total returns were weighed down by the weakness across our SaaS / platform companies and select technology names. Microsoft declined following its announcement of a 66% increase in capital expenditure to $37.5B for the quarter, despite strong Azure growth and accelerating AI services adoption. ServiceNow faced pressure as investors debated the implications of generative AI for traditional SaaS models, notwithstanding continued platform expansion and robust commercial execution. Intuit experienced similar concerns regarding AI driven disruption in tax and accounting software, while Tesla weakened amid renewed concerns around EV pricing dynamics and margin sustainability, compounded by broader derating pressure across high multiple growth stocks as bond yields moved higher. 

The infrastructure being built today by hyperscalers is intended to support a structurally larger cloud and AI ecosystem, with revenue growth from inference driven workloads expected to become increasingly visible throughout 2026 and beyond. 

The ANZ Conviction Fund experienced comparable dynamics. Pro Medicus, Xero, WiseTech Global and Life360 were among the largest detractors as high quality Australian growth companies faced scrutiny around AI related disruption risks. This occurred despite strong underlying results: Pro Medicus continues to secure major hospital contracts and extend its AI enabled imaging capabilities; Xero is delivering accelerating subscriber growth alongside improving unit economics; and WiseTech offers durable growth through its AI advantaged CargoWise platform and expanding global logistics opportunity. 

Overall, near term concerns regarding AI displacement and elevated hyperscaler capital intensity have overshadowed the structural growth drivers underpinning both portfolios. We remain confident in the durability of these businesses, their embedded positions within mission critical workflows, and their ability to compound earnings over the medium to long term. Periods of sentiment driven weakness continue to provide attractive opportunities to add to high quality companies with clear multi year earnings growth trajectories. 

How AI Will Drive SaaS Leaders Over the Long Term 

Despite recent market volatility, AI is fundamentally enhancing the value of platforms that possess deep structural advantages. We believe companies that provide the mission critical workflow orchestration for enterprise operations are best positioned to translate AI adoption into durable revenue growth and compounding long term value through these primary pillars: 

1. Data Moats and Systems of Record  

Proprietary, first party data generated through daily customer activity is a durable competitive advantage. In a 2026 context, access to rich, domain specific data is more critical than model sophistication, as models have become commoditised while the structured data required to make them useful has not. By embedding AI directly within core systems of record, these platforms move from providing simple insights to executing autonomous actions, materially increasing customer dependency and raising barriers to entry. 

2. Trust and Embedded Distribution 

As AI agents move from assistive tools to autonomous actors, trust, security, and compliance become significant structural barriers. Enterprises will only permit autonomous workflows on platforms that meet strict governance requirements. Furthermore, established leaders benefit from entrenched distribution and high retention; they can roll out AI driven capabilities across existing networks at scale, reinforcing workflow integration while maintaining low customer acquisition costs. 

3. Outcome Based Monetisation  

AI is shifting the software value proposition from per seat access to per task outcomes. Leading platforms are transitioning toward transaction or value linked commercial models, such as ServiceNow’s premium AI tiers and WiseTech Global’s new "CargoWise Value Packs." By controlling the workflow orchestration, these businesses can capture a greater share of the economic value their software unlocks, supporting long duration compounding despite broader market uncertainty. 

Several holdings exemplify these traits. ServiceNow functions as a global "system of action," using agentic AI to manage end to end service delivery across IT and HR. Similarly, WiseTech Global has integrated an AI workflow engine into its CargoWise platform, moving customers to transaction based models that align revenue with productivity gains. We view the recent sector wide repricing as a compelling opportunity to concentrate capital in these structurally advantaged platforms, where the market is currently underestimating the potential for long term margin expansion.

Understanding Hyperscaler Capital Intensity and Long Term Value Creation

The current market environment warrants deeper examination of what is driving the hyperscaler investment cycle and whether concerns about capital intensity are well founded. 

For much of the past decade, the world's largest hyperscalers were defined by a combination of structural growth, strong free cash flow, and net cash balance sheets. Amazon, Microsoft, and Alphabet built global cloud platforms of extraordinary scale whilst maintaining financial flexibility and balance sheet strength. The current phase looks different. Capital expenditure has risen sharply, net cash positions have narrowed in some cases, and debt issuance has increased. This visible shift in capital intensity has unsettled investors, prompting concerns about overinvestment ahead of sustainable demand. 

However, several structural factors differentiate the present environment from prior infrastructure cycles where capacity was added speculatively. First, balance sheets remain robust despite elevated investment. Debt levels are modest relative to cash generation capacity, and credit metrics remain healthy. Second, investment decisions are being made with unusually high visibility into enterprise demand. Remaining performance obligations and contracted backlogs continue to expand across all major hyperscalers, indicating that workloads are growing alongside infrastructure capacity. 

Most importantly, the nature of AI compute demand differs fundamentally from prior technology buildout cycles. Training large language models requires intensive but episodic processing power. Inference, by contrast, represents sustained and recurring usage. As AI applications move from experimentation to embedded functionality within software, search, advertising, productivity tools, and enterprise systems, inference volumes are expected to rise materially. Infrastructure is not being expanded solely to support research or one off model training; it is being built to accommodate accelerating production usage. 

This distinction matters profoundly. Training expenditure can be volatile and project based. Inference is tied to daily user activity and enterprise workflow integration. If inference volumes inflect as expected over the next 12 to 18 months, cloud consumption should rise in a more durable and predictable manner. This would validate current infrastructure investment and support sustained revenue acceleration across the hyperscaler complex and, critically, the software companies that run on these platforms. 

Cloud revenue momentum supports this view. Microsoft's Azure business continues to grow at elevated rates, Amazon Web Services has shown signs of reacceleration, and Google Cloud has recently reported notable acceleration. These are not businesses experiencing demand weakness; they are businesses investing to eliminate capacity constraints and capture expanding workloads. 

An important structural element supporting this outlook is the shift towards custom silicon. Amazon, Microsoft, and Alphabet have each invested in proprietary chips designed to optimise AI workloads. These initiatives aim to improve performance per watt and performance per dollar relative to off the shelf components. As inference volumes scale, cost efficiency becomes critical. Improvements in chip design reduce operating costs per unit of compute, supporting margins even as usage expands. Custom silicon also mitigates supply chain risk and enhances differentiation. 

In effect, hyperscalers are not only expanding capacity but also refining the cost structure of that capacity. Over time, this should improve the return profile of AI related infrastructure, particularly if utilisation rises as anticipated. The current period is characterised by elevated capital expenditure and compressed near term free cash flow, but observable trends in cloud revenue growth, contracted demand, and AI monetisation suggest that infrastructure is being deployed to support genuine and expanding workloads. 

For long term investors with a five year or greater horizon, the distinction between short term capital intensity and long term revenue capacity is critical. The infrastructure being built today is intended to support a structurally larger cloud and AI ecosystem. If inference driven demand develops as anticipated, the relationship between investment and revenue growth should become increasingly visible throughout 2026. 

Company Spotlight: Microsoft Corporation 

Microsoft reported record results for the second quarter of fiscal year 2026 in January, with total revenue reaching $81.3 billion, representing a 17% increase year on year. The results were driven by Microsoft Cloud revenue, which exceeded $50 billion for the first time in a single quarter. Net income rose to $38.5 billion, a figure that includes a $7.6 billion gain relating to the recapitalisation of the company's investment in OpenAI. Capital expenditure increased to $37.5 billion during the period, reflecting a 66% rise as the organisation continues to expand its artificial intelligence infrastructure and data centre capacity. 

The Intelligent Cloud segment remained the primary growth driver, Azure and other cloud services grew by 39%, supported by enterprise demand for traditional cloud migrations and generative artificial intelligence workloads. This growth rate was slightly lower than the 40% recorded in the previous quarter, which management attributed to capacity constraints. The company indicated that demand for artificial intelligence services currently exceeds available supply and expects these bottlenecks to persist through the remainder of the fiscal year ending in June. 

Microsoft is currently in the initial stages of "AI diffusion", prioritising the conversion of substantial infrastructure investments into long term operational efficiency. To mitigate existing capacity constraints, the company is diversifying its hardware through custom silicon and proprietary Maia 200 accelerators, which have already contributed to a 50% increase in OpenAI inferencing throughput. This strategic focus on "tokens per watt per dollar" is designed to lower the total cost of ownership and improve margins as workloads scale, supported by increased data centre investments across seven countries. 

Despite immediate margin pressure from a quarterly capital expenditure of $37.5 billion, the long term trajectory is supported by a 110% surge in commercial remaining performance obligations to $625 billion. This record backlog, influenced by long term contracts with partners such as OpenAI and Anthropic, suggests sustained enterprise commitment to the Azure platform and confirms the market's transition from experimental AI pilots to large scale production 

While near term free cash flow is compressed by elevated capital expenditure, we view Microsoft’s current investment phase as a deliberate effort to support structurally higher AI driven cloud demand rather than speculative expansion. Azure’s sustained growth, record remaining performance obligations, and evidence of capacity constraints suggest demand is real and supply limited. As inference workloads scale and utilisation improves, the substantial infrastructure being deployed today should translate into durable revenue growth, operating leverage, and expanding AI monetisation across productivity, enterprise software, and cloud services. For long term investors, Microsoft represents a high quality platform compounding at scale, with AI acting as an accelerant to an already dominant cloud and software ecosystem. 

Company Spotlight: ASML 

In January 2026, ASML reported record financial results for the fourth quarter and full year of 2025, driven by a substantial increase in demand for artificial intelligence infrastructure. The company achieved total net sales of €32.7 billion for the 2025 fiscal year, representing a 16% increase compared to 2024. Net income for the year reached €9.6 billion, with a gross margin of 52.8%. The fourth quarter was particularly strong, contributing €9.7 billion in net sales and record net bookings of €13.2 billion. This surge in orders was largely attributed to customers expanding capacity for AI related demand, resulting in a total backlog of €38.8 billion at year end. 

Extreme Ultraviolet (EUV) lithography remained the primary growth driver, with EUV revenue increasing 39% year on year. During the fourth quarter, ASML recognised revenue for its first two High NA (Numerical Aperture) systems, marking a significant milestone in the deployment of its most advanced technology. The company also reported strong performance in its installed base business, which generated €8.2 billion in annual revenue through services and upgrades. While sales in China are expected to normalise to approximately 20% of total revenue in 2026 due to export restrictions, the expansion of EUV layers in advanced logic and memory chips is expected to offset this decline. 

For the 2026 fiscal year, ASML provided a positive outlook with expected total net sales between €34 billion and €39 billion and a gross margin between 51% and 53%. Management noted that improved market visibility and the sustainability of AI demand have prompted customers to accelerate medium term capacity plans. Furthermore, ASML announced a new share buyback programme of up to €12 billion to be executed by the end of 2028, alongside a proposed 17% increase in the total dividend for 2025. 

As the sole manufacturer of EUV lithography systems essential for producing the most advanced semiconductors, ASML maintains an unassailable competitive position. The company's technology is critical to the continued advancement of semiconductor manufacturing, and we believe ASML will remain a key enabler of innovation across AI, computing, and electronics for decades to come.  Understanding Hyperscaler Capital Intensity and Long Term Value Creation

ANZ Conviction Fund Reporting Season

As the ASX Reporting Season commenced during February 2026 we will share company updates in subsequent reports.

Innovation and Sustainability as Growth Drivers

Our conviction remains grounded in the belief that long term value is created by innovative, high quality companies that provide structural solutions to global challenges, rather than lower quality cyclical businesses. Unlike lower quality cyclical businesses that rely on commodity price swings, our holdings provide mission critical solutions that improve outcomes for their stakeholders. This impactful innovation is a core component of our sustainability framework, as these businesses drive the productivity gains of the future.  

Several of our core holdings exemplify this transition: 

• Pro Medicus (PME) and ResMed (RMD) are revolutionising healthcare delivery; PME’s AI-enabled imaging platform reduces diagnostic bottlenecks for overstretched hospital systems, while ResMed’s digital health ecosystem improves long-term patient adherence and lowers the cost of chronic disease management. 

• WiseTech Global (WTC), Xero (XRO), and ServiceNow (NOW) provide the digital infrastructure that streamlines global supply chains, small-medium business and enterprise operations. By automating complex manual workflows and digitising the system of record, these platforms drive the operational efficiencies required for a more sustainable and resilient global economy. 

• ASML (ASML) and Microsoft (MSFT) represent the foundational infrastructure of this new digital era. ASML’s lithography technology is the essential bottleneck for producing the advanced semiconductors required for global progress, while Microsoft’s cloud and AI "superfactories" provide the scalable, energy-efficient compute power that enables the next decade of sustainable industrial and technological growth. 

We enter 2026 with high conviction in these innovation leaders, as their ability to deliver measurable benefits to their customers creates a far more durable earnings trajectory than their cyclical peers 

Looking Ahead into 2026

We expect 2026 to be a year of transition where significant capital expenditure into artificial intelligence infrastructure translates into visible revenue acceleration. This shift will be driven by improved hyperscaler utilisation and the transition of enterprise AI from pilot programmes to production systems. Global holdings such as ServiceNow, ASML, and Microsoft are well positioned to benefit as inference driven revenue becomes a recurring feature of cloud consumption and AI driven workloads deliver measurable productivity gains. 

In our domestic fund, we see significant value in healthcare and technology leaders. High conviction holdings including Resmed, Cochlear, and Fisher Paykel benefit from structural demographic tailwinds and innovation pipelines that remain independent of economic cycles. Similarly, global category leaders like Pro Medicus, Xero, and WiseTech Global offer durable revenue streams and exceptional unit economics, with further growth potential from AI driven product enhancements that we believe are not yet fully reflected in current valuations. 

Conclusion 

January presented challenges as markets rotated away from high quality growth companies in response to concerns regarding hyperscaler capital intensity and AI disruption fears. However, we believe these concerns reflect a structural misunderstanding of the current cycle, as the market overestimates the risk of AI led displacement for structurally advantaged platforms while failing to distinguish between episodic model training and the recurring infrastructure required for production level inference. This creates a significant disconnect between short term volatility and the long term earnings durability of AI advantaged companies that possess the proprietary data and embedded workflows necessary to capture the economic value of this transition. The infrastructure being built today is not speculative; it is a necessary expansion to support a structurally larger cloud and AI ecosystem defined by recurring inference workloads rather than episodic model training. 

The companies in our portfolios are exceptionally well positioned to navigate this transition as either critical enablers of infrastructure or as AI advantaged beneficiaries of enterprise adoption. By controlling proprietary data and mission critical workflows, these firms possess the enduring barriers to entry required to convert AI innovation into durable margin expansion. We remain confident in their ability to deliver superior returns through operational excellence and disciplined capital allocation. 

We thank you for your continued support and trust in ELM Responsible Investments and look forward to engaging with you throughout 2026. 

Kind regards,

Jai Mirchandani
Founder, CIO and Portfolio Manager
ELM Responsible Investments

This note has been prepared by ELM Responsible Investments (‘ELMRI’) ABN 70 607 177 711 AFSL 520428, for Australian wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth).

The information is not intended for general distribution or publication and must be retained in a confidential manner. Information contained herein consists of confidential proprietary information constituting the sole property of ELMRI and its investment activities; its use is restricted accordingly.

This note is for general informational purposes only and does not purport to be comprehensive or to give advice. The views expressed are the views of the writer at the time of preparation and presenting and all forecasts, assumptions, opinions, data and other information are not warranted as to accuracy or completeness and are subject to change without notice. This is not an offer document and does not constitute an offer or invitation of investment recommendation to distribute or purchase securities, shares, units or other interests to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this note. Any potential investor should consider their own circumstances and seek professional advice.

ELMRI funds, its directors, employees, representatives and associates may have an interest in the named securities.

Past performance is for illustrative purposes only and is not indicative of future performance.