Exploring the Impact of AI ETFs on Investment Trends

Path to success wtih new technology implementation concept. Vector of a robot hand drawing a graph line leading to the goal.

The advent of AI-powered technologies has ignited a global fascination with artificial intelligence, propelling it into the spotlight of mainstream and financial conversations. Access to powerful AI models and tools, such as OpenAI’s ChatGPT and Google’s Bard, has become more accessible and affordable than ever before. The impact of AI, while challenging to quantify, is undeniably a technological breakthrough with the potential to reshape society, reminiscent of the internet’s transformative influence.

Investors have swiftly recognized the growth prospects offered by AI-related companies. In May 2023, Nvidia made headlines as it outperformed earnings expectations and revised its forecasts upward. Nvidia’s focus on graphics processing units (GPUs), essential for generative AI and large language models like ChatGPT, signified the financial viability of AI-related ventures. This prompted a surge in Nvidia’s stock price, driving its market capitalization past the remarkable $1 trillion mark.

AI ETFs Gain Momentum

The surging interest in AI and its financial potential has not been limited to individual stocks. In the period from May 22 to May 26, 2023, investors poured approximately $232 million into exchange-traded funds (ETFs) that specifically target companies involved in AI development and applications. This influx of capital may herald the emergence of a compelling new theme in ETF investing, albeit one that is currently underrepresented with only $3.28 billion in assets across U.S.-domiciled AI-focused ETFs. This amount represents a mere fraction of the total U.S. ETF market as of May 2023. Below, we list some of the largest AI-focused ETFs:

  1. Global X Robotics & Artificial Intelligence ETF (BOTZ)
    • Assets: $2,116 million
    • Expense Ratio: 0.69%
    • YTD Return: 32.43%
  2. iShares Robotics and Artificial Intelligence Multisector ETF (IRBO)
    • Assets: $338 million
    • Expense Ratio: 0.47%
    • YTD Return: 20.16%
  3. First Trust Nasdaq Artificial Intelligence and Robotics ETF (ROBT)
    • Assets: $294 million
    • Expense Ratio: 0.65%
    • YTD Return: 22.34%
  4. Global X Artificial Intelligence & Technology ETF (AIQ)
    • Assets: $219 million
    • Expense Ratio: 0.68%
    • YTD Return: 29.32%
  5. WisdomTree Artificial Intelligence and Innovation (WTAI)
    • Assets: $47 million
    • Expense Ratio: 0.45%
    • YTD Return: 29.25%
  6. Robo Global Artificial Intelligence ETF (THNQ)
    • Assets: $31 million
    • Expense Ratio: 0.68%
    • YTD Return: 28.24%
  7. TrueShares Technology, AI & Deep Learning ETF (LRNZ)
    • Assets: $22 million
    • Expense Ratio: 0.69%
    • YTD Return: 35.09%

The Three Bets of AI ETF Investing

Investing in thematic ETFs, such as AI-focused funds, often entails a focused bet. These funds typically concentrate on specific sectors and maintain a small number of holdings. AI, with its vast potential applications, carries a risk of missing out on companies poised to benefit. If AI proves to be truly transformative, its impact will reverberate across various industries, not limited to just Nvidia.

While AI ETFs are currently in the spotlight, investors should approach them with the same level of scrutiny as any other thematic ETF. Successful thematic investing requires a three-fold wager:

  1. The Theme’s Durability: Investors must determine if the theme is both real and likely to endure.
  2. Proper Theme Representation: The chosen ETF should accurately represent the theme and include companies well-positioned to benefit.
  3. Untapped Growth Potential: The theme’s growth prospects should not be already factored into its price.

Betting on a theme’s success, such as AI, may appear obvious but can be more complex than it seems. History has shown that most themes are transient and do not yield sustained returns for investors. For example, the Direxion Work From Home ETF, designed to invest in companies facilitating remote work, lost assets rapidly as lockdown restrictions were lifted. AI, however, presents a more promising outlook with numerous potential applications, making it a compelling theme in the ETF market.

Selecting the Right AI Investments

Thematic funds, including AI ETFs, face the challenge of pinpointing the companies poised to benefit from nascent technologies. The absence of a consensus on this matter is evident, as the two largest AI ETFs, Global X Robotics & Artificial Intelligence ETF (BOTZ) and iShares Robotics and Artificial Intelligence Multisector ETF (IRBO), primarily focus on robotics, yet they share only 12 holdings in common as of May 2023.

Investing in companies at high valuations can dampen expected returns. For instance, Nvidia’s price-to-earnings (P/E) ratio surged from 179.17 on May 22, 2023, to 202.84 on May 26, 2023. To justify such lofty valuations, the company must substantially increase its earnings beyond already high expectations. Buying stocks at rich valuations poses challenges for investors.

A Broader Perspective: Total-Market ETFs

Investors might question whether AI ETFs provide adequate exposure to the broader implications of the AI revolution. The concentrated nature of these portfolios raises the risk of missing out on companies poised to benefit from AI developments. Attempting to actively position a portfolio to capture companies reaping the benefits of AI can be time-consuming and challenging.

One alternative approach is to consider cost-effective total-market ETFs, which offer exposure to a wide range of innovations, not limited to AI but encompassing all themes. These ETFs include all stocks and weigh them based on their market capitalization, reflecting the collective market view on the relative value of each stock. Companies poised to benefit from AI advancements are naturally included in the portfolio, and their allocation increases in tandem with their performance.

Here are three notable total-market ETFs to consider:

  1. iShares Core S&P Total U.S. Stock Market ETF (ITOT)
    • Assets: Gold
    • Expense Ratio: High
    • Dividend Yield: Above Average
    • YTD Return: Above Average
    • Expense Ratio: 0.03%
  2. Vanguard Total Stock Market ETF (VTI)
    • Assets: Gold
    • Expense Ratio: High
    • Dividend Yield: Above Average
    • YTD Return: High
    • Expense Ratio: 0.03%
  3. Schwab U.S. Broad Market ETF (SCHB)
    • Assets: Gold
    • Expense Ratio: High
    • Dividend Yield: Above Average
    • YTD Return: Above Average
    • Expense Ratio: 0.03%

The Future of AI Investing

Predicting the potential of an evolving theme is akin to forecasting the weather five years from today – a challenge only a market oracle might surmount. For the rest of us, the next best option is to invest in a low-cost, well-diversified total-market index fund. This approach ensures that investors do not miss out on the revolutionary innovations that AI can usher into various industries and markets.

As AI continues to mature and extend its influence, both AI-focused ETFs and total-market ETFs offer viable investment options. The choice ultimately depends on an investor’s risk tolerance, time horizon, and belief in the sustained growth of AI. In this era of rapid technological advancement, embracing AI in your investment portfolio can be a prudent step towards participating in the AI revolution’s potential benefits.

The AI ETF landscape is continuously evolving, and as more companies harness the power of artificial intelligence, the investment options will likely expand. Whether you opt for AI-specific funds or embrace the broader scope of total-market ETFs, your investment journey in the AI era promises to be an exciting and transformative one.