Jensen’s Alpha

Betrayal is a key theme in the financial markets today with the unfolding drama of Jensen Huang, the resigned chief executive officer of NVIDIA.

What makes his story riveting is that Nvidia is one of the most valuable companies in the world and is responsible for the design and manufacture of coveted cutting-edge computer chips necessary for artificial intelligence (AI) technology. As the founder of the company, to investors, Jensen Huang is Nvidia.

However, it was reported this week that Huang had three extramarital relationships: two with Nvidia employees and one with an executive of a customer company. It is the last one that has shaken the market because the woman identified as Alice Huang (not related to Jensen) is suspected by some US officials of being a spy for China, and the relationship is being viewed as a possible honey trap operation.

Other officials have said the evidence is not conclusive, so this remains unproven. This is the John F. Kennedy and Marilyn Monroe story with a James Bond twist that involves “From Russia with Love” geopolitics and “View to a Kill”-level consequences.

Jensen’s Alpha can provide a more formulated way to view the situation in both name and concept. Jensen’s Alpha is a statistical measure of the performance of a portfolio manager conceptualized by Michael Jensen in 1968.

How do you know if your portfolio manager is truly skilled or not? As a performance measurement, Jensen’s Alpha computes abnormal returns or, more importantly, risk-adjusted returns.

In other words, after considering the amount of market risk a portfolio manager is taking, is the return better or worse than what the market would be expected to deliver for that level of risk?

While Jensen’s Alpha is normally used for fund managers, technically, it is applicable to decision-makers such as investor-managers as well.

Risk is probably one of the things that we often forget when we are distracted by the phenomenal returns and positive messaging from both the share price, earnings announcements and product launches.

Risk, without context, is neither good nor bad. It is a factor for businessmen when they make decisions. Entrepreneurs like Elon Musk and Steve Jobs are the kind of people who take the initial risk to bring us innovations like Starlink and the iPhone, respectively. For taking on the start-up risk, the expected returns must also be sufficiently high to justify the decision to move forward into the future.

However, risk contextualized by size, category and probabilities can be neutral or extremely bad. It can be argued that risk can be positive, and this is true particularly if the risk that harms your competitor can enhance your competitiveness. But for the sake of risk and performance management, it is the downside risk that investors should consider. Of these downside risks, the primary importance is the lookout for hidden risks.

What are the economic risks that have been revealed for Nvidia? There is discussion of key-man dependency risk, as Jensen Huang reportedly had an unusually large number of direct reports. With his resignation, how does this affect Nvidia’s operations?

There is also some discussion of regulatory risk on AI chips, as there is an identified potential national security concern given export bans on certain Nvidia products to China, although Nvidia has said it has no reason to believe that national security or company secrets were compromised.