Nvidia just showed that some areas of the investment management industry have real questions to answer – and investors should not let fund managers get away with weak or softball answers.
The latest information available at the time of writing in the latest AI saga is that chief executive Jensen Huang has resigned after it was revealed he had two affairs – one with a director at the firm. Meanwhile, the chipmaker had announced an investigation into whether Huang had been the subject of a Chinese espionage attempt.
Nvidia’s shares have plummeted, down 27% in the past month. Yesterday, they opened more than 13% lower, although rebounded somewhat throughout the day. They ended the session down 4.3%.
This is because of the key-person risk at the company. With no chairman in place (something that was resolved with 20:20 hindsight yesterday afternoon with the appointment of Harvey Jones), there was a huge amount of reliance on Huang, who was also described as the firm’s best and most prominent salesman.
As one fund manager I spoke with this week said, Huang’s job was to go around the world “peddling the company’s wares”.
This episode highlights one thing: US mega-cap technology has a governance issue. That was one of the messages from Brunner investment trust managers Julian Bishop and James Ashworth.
“There is an issue with the governance standards across US tech, and there is the cult of the family,” said Ashworth, who noted that the trust is not an Nvidia shareholder despite owning other names in the AI ecosystem.
But Nvidia could end up becoming a litmus test for the active industry. And in my view, there are only a handful of managers that can claim to have made the correct decision on the stock.
In particular, there are two groups of investors that should be given a grilling over their decisions. The first is any fund stating they use environmental, social and governance (ESG) in their process.
For years, investors have used the catch-all term to invest in whatever they choose, but state they look at risks through these three lenses. Clearly, governance should have been an obvious problem at the company if correct due diligence was done.
Another group that should be forced to answer some tough questions is quality managers. The definition of quality has changed over the years, but broadly these funds should be investing in dependable companies with a long history where the cashflows are repeatable and defendable.
Throw in low or zero leverage, intellectual property and a strong barrier to entry, and you are on to a winner.
Nvidia (and all of its other AI brethren) tick some of these boxes. Some have been around for years and have strong IP in their businesses.
But investing in such nascent technology requires faith (or hope) that the numbers being used for future earnings are correct. This is the definition of growth investors, not quality. There is a difference, and managers should know what it is and defend why they own these AI names.
There are some funds that can absolutely defend their positions. Out-and-out growth funds I think should be invested in these stocks. As should any funds that claim to be ‘benchmark-aware’, or focused on relative performance – two phrases that have ballooned in use in recent years as active investors have struggled to beat indices.
These questions need to be asked, and managers need to take a look at themselves as soon as possible, because Nvidia is hardly a unique case in one aspect: key-person risk.
An obvious example is Elon Musk at SpaceX and Tesla (both on astounding valuations relative to the actual financials of the businesses due to the fanbase of the controversial entrepreneur). But there are others, such as Sam Altman at OpenAI (the company behind ChatGPT) or Mark Zuckerberg at Meta. The issue with these figures is that if they are removed, for whatever reason, the fundamental case changes.
Before this week, people would likely have said the risk was so small it was not worth highlighting. At least, I assume that is why despite thousands of analysts around the world looking at Nvidia, it was rare for managers to mention it as a huge risk, let alone be concerned by it.
Whatever the reason, it is a question that needs asking, and one investors should demand answers for.
Jonathan Jones is editor of Trustnet. The views expressed above should not be taken as investment advice.