Stan Druckenmiller made a lot of money investing in Nvidia (NASDAQ:NVDA)but he ultimately took some of his profits off the table.
The former hedge fund manager and George Soros lieutenant first invested in Nvidia for his portfolio within his Duquesne Family Office in late 2022. He added a significant amount to his position after the launch of OpenAI’s ChatGPT on November 30 of the same year. He continued to add to his position almost every quarter in 2023, with call and stock options accounting for more than 16% of his portfolio at the end of the year.
At that point, it had invested nearly $550 million in the artificial intelligence (AI) chip leader. This big bet continued to pay off in early 2024 as Nvidia stock soared higher. But as the stock price rose above $900, Druckenmiller noted in an interview with CNBC, “A lot of what we recognized is now recognized by the market.”
He thus sold part of his shares and all of his call options. He ended the first quarter with just $159 million worth of Nvidia shares, reducing his position by about 84%. Druckenmiller’s stake in Nvidia helped increase the value of its portfolio by more than $1 billion in the first quarter alone, up from about $3.4 billion at the end of 2023.
But now he’s moving on to the next investment. And that’s a big problem.
Bet big on small caps
At the end of the first quarter, Druckenmiller’s largest position consisted of call options on the iShares Russell 2000 ETF (NYSEMKT:ETC). He held about $664 million in options at the end of March.
The iShares Russell 2000 ETF is a simple index fund which follows the Russell 2000which brings together the 2,000 smallest businesses in the Russell 3000. It is the most commonly used index for tracking small-cap stocks.
Small-cap stocks are lagging their larger-cap counterparts. While mega-caps like Nvidia and the rest of the “Magnificent Seven” have fueled overall stock market returns over the past year and a half, small-caps have, for the most part, withered.
The Russell 2000 has not yet surpassed the all-time high it reached in 2021. It is still 14% below that level. Meanwhile, the S&P500 surpassed its previous high in January and has continued to climb this year.
There are good reasons why small caps are lagging the broader market.
First, small businesses are more sensitive to interest rates than large businesses. Russell 2000 companies hold a total of $832 billion in debt, 75% of which needs to be refinanced by 2029, according to a Bloomberg report. For comparison, only 50% of S&P 500 companies’ debts will be due by then.
Small businesses are also more likely to take out variable-rate debt rather than issue fixed-rate bonds. As a result, small businesses have been hurt in this high interest rate environment.
Additionally, small-cap stocks are more sensitive to economic downturns. It is easier for a large company to survive a recession than a small one. And as recession fears grew in 2022 and 2023, small-cap stocks felt the consequences.
But it appears we are turning a corner on both fronts. The Federal Reserve plans to begin cutting interest rates later this year. Meanwhile, hopes of a soft landing – that is, avoiding a recession – are growing. This could be good news for small-cap investors, and Druckenmiller now counts himself among them.
Why invest in small caps now
Despite their lackluster performance over the past few years, small caps historically outperform over the long term. The reason is that stocks of smaller companies require a higher risk premium because they are more likely to face difficulties during an economic downturn or changes in their industry.
After a long period of underperformance, the valuation gap between small and large caps is at one of the lowest levels seen in decades. The price-to-sales ratio of the Russell 2000 is less than half that of the S&P 500. The forward price-to-earnings ratio of small-cap stocks S&P600 (which only tracks profitable companies) is 30% lower than that of the S&P 500. These are levels not seen since the early 2000s.
The last time the gap was this wide, small-cap stocks outperformed large-cap stocks in subsequent years.
Investors looking to follow Druckenmiller’s lead could invest in the iShares Russell 2000 ETF. However, you might be better off focusing exclusively on small-cap value stocks. Or better yet, profitable small-cap value stocks. Small-cap value stocks have historically been the best-performing segment of the market, while small-growth stocks have, as a group, been the worst performers. Thus, an index fund like the Vanguard S&P Small-Cap 600 Value ETF (NYSEMKT:VIOV) or active management Avantis US Small Cap Value ETF (NYSEMKT:AVUV) might be a better bet.
Druckenmiller believes the outlook for small caps is good across the board. And there are plenty of signs that he’s right. Adding a portion of small caps to your portfolio now seems like a good idea, and an ETF is the easiest way to do it.
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Adam Levy has positions in the American Century ETF Trust-Avantis Us Small Cap Value ETF. The Motley Fool Ranks and Recommends Nvidia. The Motley Fool has a disclosure policy.
Billionaire Stan Druckenmiller Sold Nvidia and Bought This Undervalued ETF Instead was originally published by The Motley Fool
