Stan Druckenmiller made a lot of money investing in Nvidia (NASDAQ: NVDA)but he finally took some of his profits off the table.
The former hedge fund manager and George Soros lieutenant first invested in Nvidia in late 2022 for his portfolio at his Duquesne Family Office. He added a significant amount of money to his position after launching OpenAI’s ChatGPT on November 30 that year. He continued to build his position almost quarterly in 2023, with stock and call options representing over 16% of his portfolio at the end of 2023.
At that point, he had invested nearly $550 million in the artificial intelligence (AI) chip leader. That big bet continued to pay off in early 2024 as Nvidia shares climbed higher. But as the stock price rose above $900, Druckenmiller noted in an interview with CNBC, “A lot of what we recognized has now been recognized by the market.”
As such, he sold some of his shares and all of his call options. He ended the first quarter with just $159 million worth of Nvidia stock, cutting his position by about 84%. Druckenmiller’s stake in Nvidia helped boost his portfolio value by more than $1 billion in the first quarter alone, compared to about $3.4 billion at the end of 2023.
But now he is working on the next investment. And it’s a big one.
Bet big on small caps
As of the end of the first quarter, Druckenmiller’s largest position was call options in the stock market iShares Russell 2000 ETF (NYSEMKT: IWM). At the end of March, he owned about $664 million in options.
The iShares Russell 2000 ETF is a simple index fund that tracks the price Russell 2000which consists of the 2,000 smallest companies in the Russell 3000. It is the most commonly used index to track small-cap stocks.
Small-cap stocks have lagged their larger peers. While megacaps 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 largely languished.
The Russell 2000 has yet to surpass 2021’s all-time high. It is still 14% below that level. Meanwhile, the S&P500 zoomed past the previous high in January and has risen further this year.
There are good reasons why small caps have fallen behind the market as a whole.
First, smaller companies are more sensitive to interest rates than larger companies. Russell 2000 companies have a total of $832 billion in debt, 75% of which must be refinanced by 2029, according to a Bloomberg report. By comparison, only 50% of the debt of companies in the S&P 500 will have matured by then.
Smaller companies are also more likely to take on variable-rate debt rather than issue fixed-rate bonds. As a result, small businesses have found themselves in dire straits in this high interest rate environment.
In addition, small-cap stocks are more sensitive to economic downturns. It is easier for a large company to survive a recession than for a small company. And as fears of a recession mounted in 2022 and 2023, small-cap stocks felt the pain.
But it looks like we’re turning a corner on both fronts. The Federal Reserve expects to start cutting interest rates later this year. Meanwhile, hopes for a soft landing – i.e. avoiding a recession – are increasing. That could be welcome news for small-cap investors, and Druckenmiller now counts himself among them.
The argument for investing in small caps now
Despite their underperformance in recent years, small caps have historically outperformed over the long term. The reason for this is that the shares of smaller companies demand a larger risk premium because they are more likely to face hardship due to economic downturns 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 in decades. The Russell 2000’s price-to-earnings ratio is less than half that of the S&P 500. The small-cap’s forward price-to-earnings ratio S&P600 The index (which only tracks profitable companies) is 30% lower than 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 over the next few years.
Investors who want to follow Druckenmiller’s example can invest in the iShares Russell 2000 ETF. However, you may be better off focusing solely on small-cap value stocks. Or even better, profitable small capitalization value stocks. Small-cap value companies have historically been the best-performing segment of the market, while small growth stocks as a group have been the worst performers. As such, an index fund like the Vanguard S&P Small-Cap 600 Value ETF (NYSEMKT: VIOV) or actively managed Avantis American Small Cap Value ETF (NYSEMKT: AVUV) might be a better bet.
Druckenmiller thinks the prospects for small caps are good anyway. And there are many signs that he is right. It now seems like a smart idea to add a small-cap tilt to your portfolio, and an ETF is the easiest way to do it.
Should you invest $1,000 in iShares Trust – iShares Russell 2000 ETF now?
Before you buy shares in iShares Trust – iShares Russell 2000 ETF, consider the following:
The Motley Fool stock advisor The analyst team has just identified what they think is the 10 best stocks for investors to buy now… and iShares Trust – iShares Russell 2000 ETF wasn’t one of them. The ten stocks that survived the cut could deliver monster returns in the coming years.
Think about when Nvidia created this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $580,722!*
Stock Advisor provides investors with an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates and two new stock picks per month. The Stock Advisor is on duty more than quadrupled the return of the S&P 500 since 2002*.
View the 10 stocks »
*Stock Advisor returns May 13, 2024
Adam Levy holds positions in American Century ETF Trust-Avantis Us Small Cap Value ETF. The Motley Fool holds positions in and recommends Nvidia. The Motley Fool has a disclosure policy.
Billionaire Stan Druckenmiller Sold Nvidia and Buy This Undervalued ETF Instead, originally published by The Motley Fool
