Two fund managers have shared how they look to exploit psychological biases in their portfolio construction and the behavioural traits at work as investors flood into Nvidia.
Technology company Nvidia, which manufactures high-end graphic processing units for artificial intelligence (AI), has seen its share price balloon in the past year. This month, its valuation has soared to US$2 trillion and it has made several of its own strategic investments into other AI companies.
As a result, fund managers and retail investors alike have been rushing into the stock in the hope of strong gains on the back of the boom in AI.
Shares in Nvidia have risen 264 per cent in the year to 06 March versus returns of 25 per cent by the S&P 500 over the same period.
However, two fund managers believe it is a clear case of herd mentality and “fear of missing out”, particularly in the age of social media when people’s investment decisions are much more public. It is also an example of regret minimisation where people are hesitant to opt out of a trend even if they are aware they could lose money because everyone else is also losing money.
Over at Forager, the firm defines itself as a value investor seeking undiscovered opportunities and those where growth prospects are underappreciated. This includes by spotting patterns and trends and understanding investor behaviour across markets and sectors.
On the company’s podcast, Forager’s chief investment officer Steve Johnson and co-portfolio manager Gareth Brown, said: “The pull of social proof is an important influence in stock markets at the moment, even more so than usual, and definitely more so than six months ago when there was a bit more pessimism around.
“Nvidia is a real profitable business, but the frenzy has just affected everything. Nvidia made five or six very small investments in other AI companies and their share prices were all up 30–40 per cent. It’s got the same feel as the meme rally environment where things were running like crazy and everyone is jumping on the bandwagon.
“The story at the moment is about AI and the world’s demand for what Nvidia produces and its dominant position in the provision of those specialist chips. That narrative is irrefutable and that is the position the business is in, but the question to ask as an investor is, does that justify the share price? That’s a much harder question to answer.”
Another detractor is Andrew Fraser, principal and portfolio manager at Merlon Capital, who aims to invest in undervalued companies where participants have become too pessimistic by identifying and exploiting misperceptions about risk and future growth prospects. The firm also seeks to minimise exposure to behavioural vulnerabilities.
He said: “We believe people are motivated by short-term outcomes, overemphasise recent information and are uncomfortable having unpopular views.
“We try to exploit those behavioural biases and be contrarian in nature, so we want to invest in companies that are typically unpopular but have a good history of generating free cash flow to investors. We express that through a bull or bear case valuation, and typically our best investments are the ones that are trading at or around the bear case with a good upside to a base case valuation.
“When you look at the likes of AI and the share price performance of Nvidia, then that could be a good example of where the expectations of the market may not be fulfilled by the earnings of the company, notwithstanding what is a huge opportunity or growth area in technology going forward.”
Brown added: “We’re not sitting here claiming the share price is wrong. It’s more the phenomenon of how people are getting sucked into it from here. They may do all right, but it’s not a game we want to play, and it’s hard to not play, especially for institutional investors.”
