The rise of Nvidia and the market's herd mentality

Nvidia: the stats  

The rise of Nvidia has been extraordinary. In less than two years, it's increased by around 8 times in value and by 160% year to date. That is remarkable for a company currently worth over $3 trillion in value. From a benchmark and diversification perspective, Nvidia is now about 7% of the S&P 500 and 5% of the MSCI World Index. This one sector of the global economy is a dominant force within markets. Megacap tech is a huge driver of returns, including all these AI names, which comprise about a third of the S&P 500 and a fifth of the MSCI World Index.

Should we be worried about the rise?

Nvidia’s meteoric share price rise is not without risks. To many, its share price performance looks like a risk-free investment — nothing can go wrong. However, many of these companies are also customers of each other, with Microsoft, Meta Platforms, Amazon and Alphabet estimated to be among the top four customers based on revenue. All four are looking to compete directly by designing their own AI chips — the powerhouse behind AI. We're asking how much underlying revenue and capital expenditure there is to justify these valuations across this cohort of companies.

Innovation is key, but concentration is a risk  

Generative AI is a crucial factor in the future of the global economy and a driver of market returns, but we need to be conscious of the associated risks. We think about position sizes, risks, and concentration, which are critical to the thought process. This meteoric rise in Nvidia's share price leads us to question what's fair value for this company. For many, buying is based on benchmark risk rather than the appropriate price and historically that behaviour can sometimes result in a meaningful correction. We want to ensure we appropriately manage our risks and position sizes. One of the most important investing principles is that the price you pay for something determines the return you get. 

Focusing on the fundamentals 

While the markets focus on the US tech market and Nvidia, we are finding opportunities elsewhere to maintain balance in our portfolios. It's important to consider fundamentals to unlock some of the value we see elsewhere. The UK is an interesting opportunity set compared to peers on a valuation basis. The UK’s price-to-earnings ratio (P/E) is about 11 times while the US market’s is closer to 21, indicating that the US market could be overvalued.

Market participants have already recognised the UK's attractiveness, with mergers and acquisitions on the rise. Another promising factor for the UK is that it's a good diversifier, including more defensive-style investments: healthcare, financials and energy stocks. 

Balancing risk and reward 

Our approach is to look for scenarios where assets can outperform. Then we build portfolios around those metrics where we see more fundamental value to offset some more momentum-driven behaviour. We look to the broadest opportunity set, focusing on fundamentals. While we've seen a lot of market concentration, especially now, we want to reassure our investors that we seek adequate portfolio diversification and a balance between value and growth styles in order to achieve the best risk-adjusted returns possible.

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