After DeepSeek sent tremours across the markets a week ago, its success and impact have quickly become a point of national pride back at home.
The Chinese AI startup grabbed global attention when it released its open-source reasoning model, R1, alongside a detailed paper which explained how the model can offer a similar level of performance while being trained for a fraction of the cost compared to competing models from OpenAI.
On the eve of Chinese New Year, a day associated with the concept of renewal, People’s Daily – the news outlet considered the Chinese Communist Party’s official mouthpiece – published a piece referring to DeepSeek’s introduction to the international tech world as “a farewell to the old order”.
How true that statement remains over time is yet to be seen, but it is a reminder to investors that US exceptionalism which created stellar gains in equities and unprecedented market concentration cannot always be taken as a given.
Market concentration and the diversity dilemma
US equities were often quoted as the biggest return driver in multi-asset portfolios in 2024, and Nvidia in particular surged 171 per cent. The chipmaker alone accounted for almost a quarter of the S&P 500 index gain during last year.
“If you’ve been underweight Nvidia, you’ve lost this year,” said Mark Walker, chief investment officer of UK’s Coal Pension at the Oxford Fiduciary Investors Symposium in 2024. He highlighted the pressure from his trustee board in the past 12 to 18 months about investing more in US mega caps.
According to Ryan Giannottoo, manager of equity index research at LSEG, the US stock market has never been as concentrated at the top as it is now, with the top 10 stocks accounting for 33 per cent market cap weighting.
This raises a number of dilemmas for investors which are basically summarised as how to ride the wave on the way up (invest passively) but avoid losses on the way down (be more active). Many investors may turn to a multi-factor model in such circumstances.
Looking back at history there have been many periods of market concentration including the Nifty Fifty, the 1990s tech bubble, the FAANGs and now the Magnificent Seven. It’s all fine when they are on the rise but what about when the market conditions change?
According to research by Macquarie Asset Management since the end of 2005, the 10 largest companies in the Russell 3000 have outperformed the broader index, especially since early 2020. But extending that out another 10 years for a longer-term view (1995 to September 2024) returns of the top 10 companies are closely aligned with the broad index.
Relying on a few stocks can be great on the way up, but significant underperformance could arise if market conditions change quickly. The emergence of DeepSeek and the potential undoing of Nvidia’s dominance, even momentarily, is a stark reminder of the need for diversification and the fragility of markets.
‘This will not last forever’
So how are the largest institutional investors around the world tackling this?
Norges Bank Investment Management, invests 72 per cent of its giant $1.6 trillion in equities. Within its equities allocation technology stocks make up 25.8 per cent, by far the largest sector weighting, with financials the next largest at 15 per cent.
The Norwegian sovereign fund’s largest 10 holdings are Apple, Microsoft, Nvidia, Alphabet, Amazon (which sits outside its tech leaning as it classifies it as consumer discretionary), Meta, and Broadcom. It owns 1.3 per cent of Nvidia, making it the ninth largest investor in the company.
Norges was a beneficiary of last year’s tech rally, just reporting its largest ever annual profit ($222 billion), with 50 per cent of its return driven by tech stocks.
Wisely, chief executive Nicolai Tangen admitted “…this will not last forever” as reported by Reuters, but it’s unclear how it is mitigating against that eventuality.
Meanwhile the largest asset owner in the United States, CalPERS, owned 67,259,938 shares in Nvidia at the end of the 2024 financial year, about $8.3 billion worth of stock (and the 38th largest investor in the company). Similarly public equities was a big contributor to the fund’s returns with 17 per cent for the year, the fund’s overall return was 9.3 per cent. No surprises then that the top holdings were Microsoft, Apple, Nvidia, Amazon, Meta, Alphabet Class A, Alphabet Class C, Berkshire Hathaway, Taiwan Semiconductor Manufacturing and Broadcom. Public equities make up 42 per cent of CalPERS’ portfolio.
The story is largely the same looking at the holdings of the largest investors in different regions. The largest equities holdings for USS, the largest investor in the UK, are Microsoft, Apple, Taiwan Semi Conductor Manufacturing, Nvidia, Tencent, Visa, Alphabet, and on it goes.
CPP Investments, the largest investor in Canada, prides itself on a very active approach to equities. It held 2,719 shares in Nvidia at the end of March 2024, and while significantly less than Norges and CalPERS this still equates to about C$3.3 billion and is the largest holding in its $172.7 billion exposure to foreign publicly traded equities.
Vulnerable narrative
The DeepSeek-triggered jitters perhaps demonstrated how vulnerable the idea is that the drivers and beneficiaries of the AI revolution will only be a handful of US companies.
In an interview with Chinese press last July, DeepSeek founder and hedge fund manager Liang Wenfeng said a deeply held company belief is that China will not be a follower in the AI space forever.
“We think as the economy develops, China needs to gradually become a contributor [in AI], instead of hitching free rides all the time. Among waves of information technology in the past 30 or so years, we never truly participated in real technical innovations [Author’s translation from Mandarin],” he said.
While investors seem happy to ride the US tech boom for as long as they can, many are also keeping an eye on signs of a potential reset down the line, and that may come from outside the US.
“To be honest, right now we are comfortable with it and we buy into this idea of the winner takes all in AI,” CIO of Danish pension investor PFA, Kasper Lorenzen told Top1000funds.com previously. But he believes soon the beneficiaries of AI will move from hardware providers to those building and applying the software.
The real AI revolution may be when it transforms manufacturing and is used in industrial processes alongside consumer-facing product development, but predicting that transformation is an incredibly difficult task.
One important takeaway from DeepSeek’s emergence is that when technology disruption occurs, it happens fast and investors should be ready to re-evaluate their own assumptions.
