What You Need to Know About AI ETFs

News May 26, 2023 at 05:00 PM

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As artificial intelligence's watershed moment quickly unfolds, financial advisory clients may wonder how to hop in and discover the technology's potential winners.

Many investors have rushed aboard the AI train already, driving the S&P 500's gains in the year's first half. One strategist noted in May that without intense investor hunger for artificial intelligence, U.S. stocks would have been down year to date.

Exchange-traded funds focused on AI represent an easy entrance for investors, although some promising players haven't landed in artificial intelligence ETFs at this point because they're privately owned or simply too small.

The Present and Future of AI Technology

AI has been in the works and in use in various forms for decades, but OpenAI's ChatGPT launch in November has brought waves of attention and forecasts for revolutionary change in business and everyday life through various AI applications.

Technology news site TechTarget defines AI as "the simulation of human intelligence processes by machines, especially computer systems."

While ChatGPT, a "generative AI" tool that allows computers to respond to queries in a human-like way and generate new content, may be sparking the buzz now, it's one in a sea of potential AI products and services that could change the way people work, shop, study, build, run businesses and perform research.

"There's not going to be one AI that is used. There are so many different applications," Bryan Armour, director of passive strategies research for North America at Morningstar Research Services, told ThinkAdvisor. "There will be a dramatic shift toward AI that will be felt across hundreds of companies, it won't be like there's just one."

Clients — or their advisors — trying to figure out how to select an AI ETF need to consider various points, including their reasons for investing in the arena. Even defining what constitutes an AI ETF, as with any thematic sector, depends on the criteria applied.

AI ETF Investing Strategy

"There are plenty of options out there for folks that want to get access to AI in a package," ETF expert Dave Nadig, financial futurist at investment data and research firm VettaFi, told ThinkAdvisor. "You should approach it as a theme like you would approach any other kind of thematic investment, which means it should not be a core holding, this should be a satellite holding.

"You should not be putting 45% of your money in a single thematic ETF that probably owns 30 global stocks or 100 global stocks … It's a headline theme that you're trying to get in on the ground floor of," as an investor would with clean water, energy or cybersecurity, Nadig added.

Understand the Reasons for Investing in AI

Clients should know why they want to invest in a theme, he said, suggesting "there are good reasons and bad reasons" for an advisor to invest in AI for a client. "The bad reason is because your client badgered you into buying it for them" because AI is hot and they think they should be in it, Nadig said.

If a client is genuinely interested in a theme, he continued, "the first answer should be 'Great, go use it.'" Investors should be paying attention to a space in which they're truly interested, and that will help them determine which ETF to focus on, Nadig said.

"A good advisor should then work with that client to help them understand what [it is about AI] that's exciting to them," he explained. If they're just chasing headlines, the client perhaps should be in a momentum fund instead, he added.

Morningstar, using the framework it applies to all thematic ETFs, has identified seven AI ETFs — tech funds with AI in their sub-themes, based on their prospectus filings and marketing materials.

Many funds beyond that group also focus on AI technologies, which include machine learning, robotics, automation, speech recognition, natural language processing, computer vision and artificial neural networks, among others.

Six of Morningstar's seven identified AI ETFs are passively managed index funds.

VettaFi has identified a longer list of AI ETFs.

8 Top AI ETFs in 2023

Like other thematic funds, artificial intelligence ETFs differ in focus and holdings, although there is often overlap among portfolios. Analysts use various criteria in identifying and categorizing AI ETFs, including these eight popular funds.

Year-to-date performance and assets under management data through the May 25 market close comes from Morningstar Direct. All expense ratio and top holdings data is from Morningstar.com.

Global X Robotics & Artificial Intelligence ETF (BOTZ)

Assets under management: $1.98 billion

Expense ratio: 0.690%

Inception date: 9/12/2016

Performance (YTD): 29.76%

Top 10 holdings: Intuitive Surgical, NVIDIA, Keyence, ABB, Fanuc, Dynatrace, OMRON, SMC, YASKAWA, Cognex

BOTZ aims to provide investment returns that generally correspond to performance of the Indxx Global Robotics & Artificial Intelligence Thematic Index (before fees and expenses), Global X says.

The firm, citing research from BCC Publishing, notes the global robotics market was valued at more than $55 billion in 2021 and that forecasts suggest it could reach $91 billion by 2026. BOTZ offers global exposure to multiple sectors and industries that may benefit from robotics and AI, the firm says.

ARK Autonomous Technology & Robotics ETF (ARKQ)

AUM: $894.9 million

Expense ratio: 0.75%

Inception date: 9/30/2014

Performance (YTD): 15.68%

Top 10 holdings: Tesla, Kratos Defense & Security, UiPath, Iridium Communications, Trimble, Teradyne, AeroVironment, Komatsu, NVIDIA, Deere

ARKQ is an active equity ETF seeking "thematic multi-cap exposure to innovation elements including robotics, autonomous vehicles,energy storage, 3D printing and space exploration," according to Ark Investment Management. The ETF has little overlap with traditional indexes and can complement value and growth strategies, the firm says.

iShares Robotics and Artificial Intelligence Multisector ETF (IRBO)

AUM: $323.6 million

Expense ratio: 0.470%

Inception date: 6/26/2018

Performance (YTD): 17.16%

Top 10 holdings: Meta, Spotify, Meitu, NVIDIA, iQIYI, Hello, HubSpot, AIchip, Kingsoft Cloud, Global Unichip

IRBO seeks to track the NYSE FactSet Global Robotics and Artificial Intelligence Index, which comprises "developed and emerging market companies that could benefit from the long-term growth and innovation in robotics technologies and artificial intelligence," BlackRock's iShares says.

First Trust Nasdaq Artificial Intelligence and Robotics ETF (ROBT)

AUM: $273.3 million

Expense ratio: 0.650%

Inception date: 2/21/2018

Performance (YTD): 18.14%

Top 10 holdings: BlackBerry, AeroVironmentt, C3.ai, Elbit, ServiceNow, Halma, Dynatrace, QinetiQ, UiPath, Synopsish

ROBT seeks to track the Nasdaq CTA Artificial Intelligence and Robotics Index, an equity index focused on companies involved in AI, robotics and automation as decided by the Consumer Technology Association.

This includes companies that develop the building block components of robotics or AI, including semiconductors, autonomous vehicles and machine learning databases; or that design, make or integrate AI or robotics products, software or systems, or provide value-added services in the AI or robotics ecosystem that aren't core to their businesses, a firm fact sheet notes.

Every stock in the index must have at least a $250 million market capitalization.

Global X Artificial Intelligence & Technology ETF (AIQ)

AUM: $194.8 million

Expense ratio: 0.680%

Inception date: 5/11/2018

Performance (YTD): 25.2%

Top 10 holdings: Meta, NVIDIA, Salesforce, Microsoft, Tesla, Alphabet, Apple, Amazon, Oracle, Siemens

AIQ aims to provide results corresponding to the Indxx Artificial Intelligence & Big Data Index. The fund focuses on companies that potentially stand to benefit from the development and use of AI technology in their products and services, and those providing hardware that supports use of AI for analyzing big data, Global X says.

Robo Global Artificial Intelligence ETF (THNQ)

AUM: $28.5 million

Expense ratio: 0.680%

Inception date: 5/11/2020

Performance (YTD): 23.32%

Top 10 holdings: Alphabet, NVIDIA, Microsoft, Amazon, Shopify, Advanced Micro Devices, Lam Research, Fair Isaac, Verisk Analytics, MongoDB

THNQ seeks to track the performance of the ROBO Global Artificial Intelligence Index.

The ETF invests globally in companies developing AI-enabling technology and infrastructure, including computing, data and cloud services, and in those applying AI for business processes in e-commerce, health care and other industries, the firm says.

WisdomTree Artificial Intelligence and Innovation Fund (WTAI)

AUM: $27 million

Expense ratio: 0.450%

Inception date: 12/7/2021

Performance (YTD): 23.58%

Top 10 holdings: AIchip Technologies, NVIDIA, Advanced Micro Devices, Cadence Design Systems, Meta, Infineon Technologies, Lattice Semiconductor, C3.ai, Taiwan Semiconductor Manufacturing, Synopsis

WTAI is designed to track the WisdomTree Artificial Intelligence & Innovation Index, a global equity index, and aims to provide investors access to the "AI megatrend" through companies involved in an array of technologies and applications.

TrueShares Technology, AI and Deep Learning ETF (LRNZ)

AUM: $19.1 million

Expense ratio: 0.690%

Inception date: 2/28/2020

Performance (YTD): 28.84%

Top 10 holdings: Snowflake, NVIDIA, Advanced Micro Devices, Samsara, Schrodinger, Mobileye Global, Crowdstrike, SentinelOne, Datadog, Okta

LRNZ is an active ETF offering a concentrated portfolio of technology companies "significantly involved in the application of advanced levels of artificial intelligence within their businesses," TrueShares says.

It holds positions in companies the firm believes "possess innovative AI and deep learning solutions that represent a distinct competitive advantage in a particular industry," and its focus on growth companies dampens correlation to broad market indexes, the firm says.

Its benchmark is the Nasdaq Total Return index, according to Morningstar Direct.

Risks of Investing in an AI ETF

AI ETFs have relatively short track records and almost all have small net assets, except for BOTZ, which is heavily tilted to robotics, Armour noted. Investors should look at the holdings to see if they align with why they're interested in AI, and consider fund fees, he said.

It's also critical to understand how a more volatile tech exposure fits within portfolios, Armour added. "You do tend to take on a pretty concentrated risk exposure which can definitely be more risky," he said.

The risk level is moderate, however, if the AI ETF represents a small place in a portfolio, Armour added. "This should not be a part of your core holdings," even for investors with a high risk tolerance, Armour said. "I don't think you need to go all in on one of these ETFs."

How to Pick an AI ETF

"You have to identify the right theme and then the ETFs have to provide exposure to that theme in the right way and then you have to be buying in at the right price," Morningstar's Armour said. "AI seems like a durable theme right now, so I think it's fair to be interested in investing in AI and trying to figure out how to do that."

The greater challenge is figuring how artificial intelligence ETFs are providing exposure to AI, Armour added. "AI is fast-moving and it's hard to pick which companies properly reflect AI or how to look at AI," he said.

While AI funds invest heavily in some of the world's biggest firms — Nvidia, Amazon, Microsoft (which has invested billions in ChatGPT developer OpenAI) and Apple — "you wonder how much of the revenues coming out of these holdings are going to be directly tied to AI," Armour said, noting that the big players are involved in many other products and services.

"That's not going to be direct exposure to AI that you're getting. So it's tough to pick out which ETF might best fit the theme," Armour said.

The exposure may be indirect, but so far this year, AI ETFs have posted strong returns "largely because they own the kinds of stocks that people would not be surprised to see doing well," including NVIDIA, Intuitive Surgical, Amazon and Microsoft, Nadig said.

Higher Exposure, Higher Risk

Investors may seek purer exposure to AI with a portfolio of more AI-centric companies rather than trillion-dollar multinationals with many other revenue streams, Armour said, noting that investors often already have exposure to the FAANG stocks (Facebook parent Meta, Amazon, Apple, Netflix and Google parent Alphabet) through index funds.

"I would look for companies that I see as potential AI leaders or companies that could really benefit from AI more so than the broader market and then I would see which ETF sort of fits that roster best," Armour said.

VettaFi's Nadig noted that pure-play investing is often more volatile, with smaller-cap companies bringing higher risk. "Those are the tradeoffs that you're going to have to make," he said.

Who Will Win the AI 'Arms Race'?

Keeping pace with AI's quick development can pose a challenge for investors.

"It's hard to even say month over month where it's going," Armour said. "I feel like so much happened last year in terms of AI that even just deciding who is at the forefront can be extremely challenging and ever-changing."

The AI gold rush, however, is centered more on individual companies rather than funds now, according to Nadig, who said the big ETFs won't necessarily capture the big moves.

Smaller companies that people may not be as familiar with are "where more of the interesting stuff is getting done," Nadig said, noting some firms are trying to wedge AI into business processes now and help make companies more profitable this year.

He cited, for example, Coveo, a publicly traded Toronto company with market cap under $700 million that's building AI for shopping carts and searches.

"But they're a tiny little company that isn't in any ETFs because it's still too small," Nadig said. "That's what's fun and exciting about a space like this, there is this opportunity to find these hidden gems, to find these smaller companies and potentially to get there a little early."

"The challenge I think is trying to find out as an investor whether you want to be investing [in] the picks and the shovels," or put money behind the prospectors who will use the picks and shovels or the companies doing the research to find the gold, Nadig said. (Two AI ETFs — ROBO and THNQ — are built on VettaFi indexes.)

The real AI beneficiaries may be the companies that best use the technology to boost productivity, Nadig and Armour suggested in separate interviews.

"How does this impact Pearson Publishing? How does this impact Barnes & Noble? How does this impact Disney? That's where this starts to get really interesting to me because I suspect we're going to discover fairly quickly that folks who are in some form of knowledge business, this is going to be a non-insignificant productivity increase," Nadig said.

"So there's a bit of an arms race. If you are in the textbook publishing business, if you get there before your competitors, it's not unreasonable for me to think you're going to get a 5% to 10% increase in productivity immediately, this year, doing it. That doesn't come along very often in business where you get these instantaneous productivity boosts simply for paying attention."

Morningstar's Armour similarly suggested that companies that can incorporate AI to give a better service or product to other companies should benefit.

One publicly traded company that has a place in four Morningstar-defined AI ETFs is Twilio, which offers customer service chatbots that integrate with other companies' AI solutions to provide service to clients, Armour noted. "Just being able to get AI in someone else's system is worthy of being included in AI ETFs," he said.

(Image: peshkov/Adobe Stock)

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