Nvidia's Meteoric Rise: A Double-Edged Sword for Investor Portfolios

When diversifying one's portfolio, striking a balance between riding the wave of success and mitigating risk is critical, especially with high-flying stocks like Nvidia (NASDAQ: NVDA) creating bittersweet dilemmas for investors. Known as a reference point in the AI chip market, Nvidia has seen its shares skyrocket by a staggering 785% since the beginning of 2023 and 160% this year alone, though this success story carries a possible downside.

In June, Nvidia briefly dethroned Microsoft to become the world's most valuable company, only to relinquish the title shortly afterward. As its stock price climbed, so did asset managers' stakes in the company. According to Morningstar, 355 actively managed funds had Nvidia positions comprising 5% or more of their assets at the end of Q1 2023, a considerable jump from just 108 funds a year earlier.

The rationale for holding such robust positions varies. Some aim to amplify profits, while others follow a strategy to align with index benchmarks. According to Jack Shannon, a senior analyst at Morningstar, some portfolio managers are reluctant to miss potential AI growth, echoing their apprehensions about missing out on historical gains from tech giants Apple and Microsoft. "They don't want to sell," Shannon notes.

This hefty concentration on Nvidia underscores investors' growing inclination toward a limited number of high-growth stocks, bringing about one of the most concentrated market advances on record. Notably, Nvidia alone contributed to nearly a third of the S&P 500's 17% rise this year, with only 24% of S&P 500 components outperforming the index in the first half of 2024, according to strategists at BofA Global Research.

Funds holding Nvidia have enjoyed fruitful times, as evidenced by the actively managed U.S. equity funds. Nvidia surged 16.3% on average in the first half of 2024, in contrast to a mere 5.7% for those without exposure to the stock. Yet, the flip side is the potential hurt when Nvidia falters. Analysts project a modest 3% uptick from its current price, with mounting competition, harmonizing supply-demand dynamics, and rich valuations as credible points for a possible downtrend. Currently, Nvidia trades 39.3 times its forward earnings, around 50% higher than the industry median, as per LSEG.

Phil Orlando, Chief Equity Market Strategist at Federated Hermes, sums it up plainly: “Does having 6% or more of your portfolio in one stock create outsized risks? The answer is, obviously, yes.” Recent activity underscores the two-way street of concentrated stock positions. A single day of cooling inflation data triggered a steep sell-off in Big Tech, shaving nearly 6% off Nvidia and dragging the tech-heavy Nasdaq 100 down by 2.2%. Both indices recovered the following day, but the incident is a reminder of the inherent volatility.

Nvidia allocations are particularly pronounced in technology-sector funds; notably, four Fidelity funds each have more than 18% of their assets tied up in Nvidia. Diversified funds are also joining the fray, with the Baron Fifth Avenue Growth Fund holding nearly 15% and the Fidelity Blue Chip Growth Fund at about 13%. Both entities have opted not to comment on their positions.

Ironically, long-time Nvidia holders such as Anthony Zackery of Zevenbergen Capital Investments—who initially invested in 2016—handle the stock with periodic trims to adhere to his firm's risk parameters. In contrast, those like Kevin Landis of Firsthand Capital Management, who prudently took profits in 2020, sometimes reflect on the gains they've relinquished. "I can’t look at any of my screens now without feeling a twinge of regret," Landis confesses.