Why you shouldn't fall for the name of a thematic fund

Vyacheslav Dvornikov

Sep 18, 2024

Artificial intelligence (AI) continues to push up the American stock market, notes BlackRock. Meanwhile, some ETFs that promise investors the opportunity to bet on the AI theme are bringing them losses.

In 2024, the shares of at least three thematic ETFs, including those from financial industry giants, the Wall Street Journal (WSJ). Meanwhile, the S&P 500 has increased by 16.6% since the beginning of the year, and the Nasdaq by 14.6%. Shares of the main beneficiary of AI implementation, chip manufacturer Nvidia, have risen by 115% since the beginning of the year — the best performance in the S&P 500.

This demonstrates why investors should not be swayed solely by a fund's marketing positioning. Firstly, the direction in which these funds invest matters. At the beginning of the year, Morgan Stanley a review of the largest ETFs that allow investment in the AI theme without mentioning the words "artificial intelligence" in their names. It showed that one fund primarily invests in companies implementing AI in the software they sell. The second invests in chip manufacturers. The third in beneficiaries of AI implementation from various sectors, including consumer staples and durables, industry, and healthcare. The fourth only in companies benefiting from automation as a result of AI implementation.

Secondly, attention should be paid to how the fund constructs its portfolio. For example, one fund holds a small number of stocks (40 companies) in its portfolio, while another holds stocks of 115 companies with an average weight of 95 basis points, and it is a very concentrated portfolio in a few stocks. The division by countries may also differ.

Ironically, the main reason many funds lag behind the market is the continued rise in Nvidia shares, notes WSJ. Since the beginning of the year, the company's shares have risen by 140%. The fact is that many ETFs give companies equal shares in the portfolio and/or limit the maximum weight of one stock. Nvidia's share in the S&P 500 capitalization exceeds 6%, while the portfolios of many funds positioned as an AI bet have a smaller share of the company's shares compared to the indices. Here are three funds that have lost value since the beginning of the year:

• In the First Trust fund, which attracted $457 million for investments in AI and robotics, Nvidia accounts for only 0.8%. This is slightly more than half the weight of BlackBerry, which develops cybersecurity software.
• The WisdomTree fund, with $213 million in capital, specializing in AI and innovation, divides the portfolio among stocks in equal proportion, so Nvidia accounts for only 3%.
• The iShares Future AI & Tech fund from BlackRock, with $610 million under management, also had an equally weighted portfolio three weeks ago. Then it also became a robotics and AI fund, changed its ticker, and began tracking a market-cap-weighted index. Nvidia's share in the portfolio increased.

ETF results show investors that it is not enough to correctly choose a theme that will push markets up. At a minimum, one needs to study how the portfolio composition is determined. Moreover, thematic funds are often launched after the theme has already been fully played out by the market. However, new AI funds are likely still to come. As Bloomberg, the search for AI implementation beneficiaries is now spreading to areas beyond chip and software production, such as energy.