The Evolving Landscape of AI ETFs: A Shift in Focus to Industrials

Exchange-traded funds (ETFs) tied to the artificial intelligence (AI) boom have been lauded as top performers in the first half of 2023. However, there is a shift in momentum as investors grapple with the tech-driven hype and the impact of higher interest rates. While interest rates are causing the market to pause, a closer examination of the components within these AI-focused ETFs reveals their inherent strength and synergy.

Global X operates two AI funds, with one being the Robotics and Artificial Intelligence ETF (BOTZ). Although Nvidia is the largest holding in this fund, BOTZ also holds industrial robotics and automation companies such as Intuitive Surgical, Keyence, and Dynatrace. It is crucial to note that industrial firms play a significant role in enhancing the efficiency of other businesses. Therefore, the focus should not solely be on artificial intelligence, but rather on the broader landscape of industrial support systems.

BOTZ has been a major benefactor of the AI advance, attracting $594 million in inflows this year, according to FactSet. The ETF has experienced year-to-date gains of over 25%, reaching its peak in July 2023 before tapering off. While many investors consider AI as primarily a tech play, Todd Sohn, ETF and technical strategist at Strategas Securities, suggests that the positive impact of industrials is an underappreciated narrative that deserves further consideration.

Industrials, as a sector, have performed exceptionally well in the past ten months, according to Sohn. The Industrial Select Sector SPDR Fund (XLI) has achieved an almost 8% increase this year, with over $903 million in inflows. In contrast, broad thematic tech ETFs are experiencing outflows. The iShares U.S. Technology ETF (IYW) has seen a net outflow of more than $551 million in 2023, while the Technology Select Sector SPDR Fund (XLK) has recorded nearly $2.06 billion in outflows.

Market Perception vs. Behavior

Sohn suggests that the behavior of investors does not align with the market’s performance. Despite the Nasdaq 100’s 40% year-to-date increase, there is a lack of enthusiasm this time around compared to 2020 and 2021. Some investors may be pulling back due to concerns about higher interest rates and inflation. As a result, they are pivoting towards more focused exposure plays, such as AI.

Although tech still occupies a significant place in Global X’s more mainstream Artificial Intelligence & Technology ETF (AIQ), the fund holds no more than 3% of the largest mega-cap tech companies. While the concentration in these names may be lower, they remain vital within the AI space. AIQ has achieved a year-to-date increase of nearly 37%, attracting $344 million in inflows in 2023. Larger companies like Amazon, Alphabet, and Meta Platforms retain significant exposure because data is the driving force behind AI.

For investors seeking to diversify beyond the tech wave, Sohn asserts that industrials are poised to benefit from the rise in AI-induced efficiency and productivity in robotics and automation companies. The industrial sector represents approximately 9% of the S&P 500, making it relatively easy to overweight this area. In contrast, information technology comprises 28% of the index, making it more challenging to skew towards industrial exposure.

While AI ETFs have been in the spotlight, there is a growing recognition of the importance of industrial companies within this investment theme. As interest rates impact market sentiment, investors are reevaluating their strategies and seeking exposure to sectors that can benefit from AI-induced efficiency. By diversifying portfolios to include industrials alongside tech, investors can harness the full potential of the AI revolution. As the landscape continues to evolve, understanding the changing dynamics and capitalizing on the breadth of opportunities is key for long-term success in the AI ETF space.

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