DeepSeek: A Case for Investment Diversification
DeepSeek: A Case for Investment Diversification
On Monday 27th January 2025, a Chinese-made artificial intelligence (AI) model called DeepSeek, which claims to match the performance of its Western rivals at a fraction of the cost while using supposedly outdated technology, rose to the top of the Apple Store's downloads. This surge triggered a significant drop in the stock prices of U.S. companies with AI exposure, most notably causing Nvidia shares to fall nearly 17% in a single day.
This sharp decline serves as a stark reminder of the inherent volatility of the stock market, particularly in individual stocks or investment themes like AI, and highlights the importance of diversification in investment strategies.
Why Diversification Matters
Diversification is a fundamental investment principle that involves spreading investments across various asset classes, sectors, and geographic regions. This approach aims to mitigate the risk of losing money, by reducing exposure to any single investment or market segment.
When a specific company or industry faces challenges, as evidenced by the downturn in Nvidia’s share price on Monday, a diversified portfolio can help cushion the impact. While losses in one area may occur, gains in others can offset them, leading to a more stable overall portfolio performance, not just at any given moment, but more importantly, over the long term.
Types of Diversification
Class Diversification: Investing in a mix of assets. Historically, this was a mix of equities and fixed income, but in recent years, many asset managers have incorporated alternative investments such as real estate, commodities, and hedge funds. These additions help balance risk and return, as different asset classes tend to react differently to economic conditions.
Sector Diversification: Spreading investments across various industries, such as technology, healthcare, energy, and financials. This reduces reliance on the performance of any single sector.
Geographic Diversification: Investing in different countries can help mitigate risks associated with specific regional economies or political events.
Examining Nvidia's recent share price movements compared to the S&P 500 and a general medium-risk portfolio (60% world equities and 40% UK gilts), Nvidia’s performance is visibly more volatile, even in relation to the S&P 500 where it currently comprises around 6% of the total market capitalisation, which in turn is visibly more volatile than the medium-risk portfolio.
Nvidia against the US Market and a medium-risk portfolio since the US election
Source: Bloomberg, Artorius
The above chart, although over a short time period, visually shows just how volatile Nvidia’s performance has been compared to the S&P 500 and a general medium-risk portfolio. While the medium-risk portfolio has performed slightly worse than the US market (a loss of 0.16% against a gain of 0.91%), it has been less volatile on its path to almost the same return, as shown in the table below:
Over a longer timeframe, Nvidia has significantly outperformed both of these comparators. However, attempting to predict when to buy low and sell high is notoriously difficult, if not impossible. While the allure of perfectly timing market peaks and troughs is tempting, consistently doing so requires a great deal of skill and, more likely, an even greater amount of luck.
Market movements are often driven by short-term noise, such as the release of DeepSeek, something even the most resolute Nvidia investor could not have foreseen. This makes it incredibly challenging to distinguish between temporary fluctuations and long-term trends. Furthermore, the very act of trying to time the market can lead to missed opportunities and increased transaction costs, often resulting in underperformance compared to a more disciplined, long-term investment strategy. In essence, market timing is often a costly and frustrating endeavour, with the odds stacked against the investor.
While no investment strategy can guarantee profits, diversification has proven to be a crucial tool for managing risk and increasing the potential for long-term investment success. Nvidia's recent stock price decline highlights the risks associated with concentrated investments. Investors heavily exposed to Nvidia would have experienced significant losses if they had sold on Monday, emphasising the importance of diversification. A well-diversified portfolio, spread across various sectors and asset classes, would have helped cushion the blow, limiting the overall impact on an investor's holdings.
An Expected Hold
As expected, the Federal Reserve (Fed) paused its recent interest rate cuts on Wednesday. This was the first decision on interest rates during President Donald Trump’s second term. The Fed has stated that it is waiting for further progress on inflation before making any additional decisions.
While Fed Chair Jerome Powell was resolute in stating that he would not comment on Trump or his political decisions, he emphasised that interest rate changes would be made solely based on economic data.
However, Trump responded by attacking the Fed on social media, saying, “The Fed failed to stop the problem they created with inflation. I will do it,” signalling that this may be a rocky presidential term for a body that takes its policy goals from Congress but is otherwise an independent decision-making policy setter.
Josh Young de Ferrer
Portfolio Manager
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Important Information
All expressions of opinion reflect the judgment of Artorius at 31st January 2025 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice. Artorius provides this document in good faith and for information purposes only. Reliance should not be placed on the information contained within this document when taking individual investments or strategic decisions.
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