Now that ChatGPT has passed law and business school exams, programmed well enough to get Google listings, and even written a story for CNBC’s Make It, you might be convinced it’s only a matter of time before artificial intelligence conquers the world.
While that thought may be scary for some, for others it raises an interesting question: How do I invest in what I believe will be the technology of the future?
Your instinct might be to pick a few stocks that you think look promising and buy them. But if you look back at the dot-com era, you might realize that it’s a risky proposition. For every investor who has become rich by buying early on Amazon, there is another who has lost a fortune betting on Pets.com.
This is where a thematic exchange-traded fund can come in handy. These ETFs invest in a basket of companies that revolve around a specific theme. It can range from a specific technology or business like cloud computing to something as broad as the shift to working from home.
The first step in making a selection is determining whether a theme is resilient or whether a fund company is simply trying to attract investor money by launching a fund around something zeitgeist, says Kenneth Lamont, Morningstar’s senior manager research analyst for passive strategies .
Remember when wearables were the future of technology? People who bought the now-defunct ETF are doing it. AI feels it has a chance to become a bigger business, says Lamont.
“Artificial intelligence is a technology that is likely to be extremely disruptive,” he says.
From there, you need to think carefully about which funds you choose. Here’s what experts recommend.
The first thing you’ll notice when buying a thematic ETF is that there’s no shortage of funds with AI in their names. These generally fall into two camps: funds that invest in AI companies and funds that use AI to pick stocks.
The latter type of fund “can hold just about anything,” says Todd Rosenbluth, director of research at research firm VettaFI. “It’s a question of whether you believe in AI’s ability to spot potential winners in the broader stock market.”
Even if you do, such funds are unlikely to benefit your portfolio as AI companies theoretically become more profitable. Also, what exactly an “AI company” is will differ from fund to fund.
Some funds invest in large, established companies with an AI component in their business. For example, the Global X Artificial Intelligence & Technology ETF ranks Tesla, Meta Platforms, Apple, and Amazon among its top holdings. While these companies may be making significant investments in AI, the technology isn’t what is primarily driving their business.
Other ETFs try to “play AI in” more by investing in companies that derive a certain portion of their revenue from artificial intelligence. But because this method looks at past data for a technology of the future, still others choose AI companies based on analyst forecasts for future sales.
Figuring out which approach is right for you takes some research. As a rule of thumb for AI, if the stocks with the largest weights in the index are names you know, you’re likely to get less “pure play.”
Also, each fund should clearly state its investment strategy on its website. “Look at the selection criteria – how are the stocks selected for this portfolio?” says Lamont.
Thematic ETFs give you diversification versus picking a few individual stocks. If you think AI is on an uptrend, investing in a basket of 20 or 30 AI stocks can help you achieve those returns while mitigating somewhat the risk of a single company and your entire company collapsing strategy could fail.
But thematic ETFs still come with unique risks. For one thing, diversification within a particular topic doesn’t do you much good if the entire topic takes a hit. Just ask any investors holding blockchain ETFs in 2022.
“This type of fund is highly concentrated,” says Lamont. “Sometimes the returns turn your stomach.”
Additionally, thematic ETFs tend to charge higher expense ratios than broader strategies. Because of this, it’s important to consider what you’re paying for a basket of AI stocks. If the fund’s holdings more or less overlap with what you might get from a tech stock fund or even a broad index fund, you may be overpaying for that exposure, Lamont says.
“They cost more because they give you a narrative,” he says. “Also, a lot of them are making big active bets. They come in passive packaging, but they really are active funds.”
Because of the risks involved, it would be wise to view any thematic ETF as a complement to a broadly diversified core portfolio strategy, Rosenbluth says.
“This should serve as a ‘satellite’ position or as part of a broader portfolio. We tend to see investors allocate 5% to 10% of their equity allocation to higher-risk, high-return thematic ETFs.”
If it works, you could earn returns that boost your portfolio’s performance over the long term, he says. And if it doesn’t work out in the short term, “it doesn’t take years to make up for the losses.”
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