Is it too late to invest in AI-themed ETFs?

Analysts expect a meaningful correction as the sector is overhyped in the short term

Investors could consider broadening their exposure to AI by investing in robotics and automation, analysts say. Getty Images

Investment fund providers love to jump onto a hot new trend, so a surge in the number of exchange-traded funds (ETFs) investing in this year’s hottest sector, artificial intelligence, was inevitable.

It happens every time a new theme takes off. At the start of the millennium, investors couldn’t move for emerging market funds investing in Brazil, Russia, India and China, collectively known as the Brics.

More recently, fund management marketing departments were rushing out environmental, social and governance (ESG) funds to take advantage of a wave of eco-enthusiasm.

In both cases, the pattern was the same. After the initial burst of enthusiasm, the market was flooded, performance plunged and interest collapsed.

Neither emerging markets nor ESG are go-to investment sectors today. So, can the AI fad show a bit more staying power or have you already left it too late?

Probably the first thing to say is that if you want to make a fortune out of AI, you've left it too late.

The fast, early money has already been made. If you could invent a time machine, fly back to the start of the year and load up on shares in chipmaker Nvidia, you’d be celebrating a 245 per cent return today.

Buying it now is a much riskier proposition, as many fear it has flown too high, too fast.

Investing in an AI ETF instead could spread the risk but also limit the rewards. While performance has been solid, it hasn’t been life-changing.

The Global X Artificial Intelligence and Technology ETF is currently leading the pack, having risen 45 per cent to date, while the Robo Global Artificial Intelligence ETF is up 39 per cent.

This is more than double the return on the S&P 500, which is up about 18 per cent this year, but Nvidia has left them all in the dust.

Other ETFs have had a quite modest return, with the Roundhill Generative AI and Technology ETF up around 13 per cent year to date.

Investors who are kicking themselves for missing out on the AI boom shouldn’t be too hard on themselves, according to Jason Hollands, managing director of fund platform Bestinvest by Evelyn Partners.

“You may have exposure even if you don’t hold any of these funds,” he says.

“Many AI-linked stocks are widely owned US companies that have significant representation within broad-based US and global investment funds. So, by purchasing a specialist AI-themed fund today, you may simply be doubling up in many of your existing holdings.”

Another issue to consider is whether you want a simple tracker fund or an actively managed fund that aims to cherry-pick the winners.

Mr Hollands highlights the Polar Capital Artificial Intelligence Fund.

“Its portfolio of 60 holdings is predominantly invested in large, mature businesses rather than small, edgy, early phase companies, which could provide some balance,” he says.

For a passive option, he highlights the Legal & General Artificial Intelligence UCITS ETF, which tracks the 62 companies in the Robo Global Artificial Intelligence Index for ongoing costs of 0.49 per cent a year.

Polar Capital Artificial Intelligence Fund is up 23 per cent so far this year, while Legal & General Artificial Intelligence UCITS ETF is up 40 per cent. Passive beats active again.

Mr Hollands suggests that investors consider broadening their AI exposure by investing in the robotics and automation theme, as the two are intertwined.

The Global X Robotics & Artificial Intelligence UCITS ETF provides exposure to 44 companies and is up 20 per cent year to date, he says.

“While US-listed tech giant Nvidia has a whopping 15 per cent weighting in the portfolio, there are plenty of less familiar names, with 29 per cent of the portfolio invested in Japanese companies, reflecting the country’s huge strength in robotics,” he adds.

Mr Hollands says the obvious risk of buying an AI-themed ETF today is that valuations have become “quite frothy”.

“The Robo Global Artificial Intelligence Index is trading on a multiple of more than 33 times forecast earnings, which is around twice that of global equities as measured by the MSCI World Index,” he adds.

Many investors will be happy to pay a premium price in the expectation of generating superior growth in the long run, but Mr Hollands cautions: “They may be right, but the journey could be a volatile one on the way, given the legal and regulatory framework around use of AI is still developing.”

Luca Menozzi, next generation research analyst at Julius Baer, says we are only at the beginning of what is likely to be a long and difficult path towards the creation of broader regulatory frameworks for AI, which needs to support growth while protecting against the risks.

He remains “constructive” on AI. “Existing investors should thus stick to their positions, while new investors should use temporary setbacks to build up their positions,” Mr Menozzi says.

The rush to get AI-themed funds has hit a technical snag.

As Peter Garnry, head of strategy at Saxo Bank, points out, ETF providers are legally obliged to find at least 20 stocks for a specific theme for the purposes of diversification.

“There are not 20 stocks with pure exposure to AI technology, so investors end up getting exposure to other risk factors, too,” he says.

This means if you want a pure-play AI bet, an ETF isn’t for you.

Basically, you have to buy individual stocks, Mr Garnry says. Today, that means chip makers like Nvidia and Taiwan Semiconductor Manufacturing Company, although “new stocks will emerge as opportunities as AI moves up the value chain”.

Expectations for AI are high today but there is a danger the sector could fall short, so investors should tread carefully.

“The sector is overhyped in the short term and there will be a meaningful correction in AI-related stocks, but we remain pretty optimistic in the long term,” Mr Garnry says.

Vijay Valecha, chief investment officer at Century Financial, highlights three ETFs to consider buying if the sector dips, while warning they are likely to be volatile and investors should only buy them with a long-term view.

The First Trust Nasdaq Artificial Intelligence and Robotics ETF “has been meticulously designed to replicate the performance of the Nasdaq CTA Artificial Intelligence and Robotics Index”, Mr Valecha says.

“This index comprises companies actively engaged in the research, development and practical application of AI and robotics technologies,” he says.

Launched in February 2018, assets under management now total $405.8 million. This fund spans software, diversified machinery, semiconductors and other sectors. It’s up 13 per cent year to date and charges 0.65 per cent a year.

Mr Valecha also rates the actively managed ARK Autonomous Technology & Robotics ETF, launched in September 2014. It manages $917 million, charges 0.75 per cent a year and is up 25 per cent year to date.

Finally, he picks out the Global X Robotics & Artificial Intelligence ETF, one of the largest of all with $2 billion of assets under management. This passively managed ETF charges 0.69 per cent a year and is up 20 per cent in 2023.

AI may have more staying power than the Brics and ESG. History shows that red hot themes can grow cold pretty quickly, but over the past year, US tech has been the exception to the rule and could be again.