Artificial Intelligence, a promising gamechanger for the portfolio

On 25 May, Nvidia shares closed 24% higher. In percentage terms, it was not the biggest rise by a listed company ever, but in terms of market capitalisation it was. The company became $185bn more valuable in a single trading day. An extraordinarily strong outlook for revenue and earnings, well above analysts' consensus estimates, fuelled the rally. The company's leading position as a supplier of GPU chips has put the company in a position to reap maximum gains from increased investments into AI research and deployment. Nvidia’s outlook confirmed that the AI hype was real and it put AI on the map like never before.

What is artificial intelligence?

Artificial intelligence (AI) is the simulation or approximation of human intelligence by machines. It is the ability of a system to correctly interpret external data, learn from this data, and use these lessons to achieve specific goals or tasks.

AI basically has two forms: weak and strong. Weak AI is concerned with research and the development of applications in limited subfields in which behaviours are possible that appear intelligent but are not truly intelligent. Examples include chess computers, chatbots and search engines.

Strong AI deals with research related to creating a computer or software that can reason and solve problems as well as possibly having self-awareness. ChatGPT and generative AI tools are potentially closer to the strong form of AI.

In a nutshell, business processes can be automated and optimised using AI. For example, complex petrochemical companies like Dow Chemical or DuPont de Nemours can use AI to determine when and where maintenance is needed. We also see AI in the form of high-performance surgical robots and it can support doctors in making the right diagnoses, thereby improving treatment plans.

However, there are many more applications. For instance, AI can help detect fraud, but it can also recommend music (Spotify) and movies (Netflix) based on your previous interests and ratings.

In short, AI is everywhere in our daily lives and it is likely that AI will be an integral part of almost every sector in the future. This offers opportunities for investors looking to capitalise on the growing demand for AI technologies and applications.

Investing in a new technology

The sector is expected to see high growth. In the report 'Global artificial intelligence market size 2021-2030', research firm Statista has calculated that the market will grow from $100bn in 2021 to $1.8trn in 2030, equivalent to a 38% annualised growth rate. One should note that this is just one forecast, projecting growth rates for a new technology that we have never observed before.

One way to get exposure to AI is through the 'Magnificent Seven' - Amazon, Alphabet (Google), Apple, Meta, Microsoft, Nvidia, and Tesla. These companies all play a key role in the development and application of AI, but it is worth remembering that the key driver of their earnings is still not AI. Investors should also recognise that investing in individual stocks is generally riskier than diversified investing through a mutual fund or ETF.

There are two UCITS ETFs tracking AI-related stocks that are well-diversified and have acceptable costs: the L&G Artificial Intelligence UCITS ETF and the WisdomTree Artificial Intelligence UCITS ETF. Both ETFs score, at minimum, three out of five globes on Morningstar’s Sustainability Rating. However, neither of these ETFs have an overall score yet from Morningstar.

The AI ETF from L&G currently holds 68 well-known and lesser-known positions such as Alphabet (Google), Global Unichip, Nvidia and Shopify, while WisdomTree's ETF holds 62 stocks. These include Blackberry, C3.AI, Nvidia and Upstart. Running costs are 0.49% (L&G) and 0.40% (WisdomTree) per year, respectively. Both ETFs are traded on several exchanges with euro and dollar denominations available.

The primary objective of L&G's ETF is to track the performance of the ROBO Global® Artificial Intelligence Index TR, while the WisdomTree ETF tracks the Nasdaq CTA Artificial Intelligence NTR Index. So far, both ETFs have done what they are supposed to do: closely tracking the benchmark, excluding costs.

The dividend yield is between 0.25% and 0.75% annually for both ETFs and is automatically reinvested in both cases, as both ETFs are accumulating. The underlying dividend yield across these stocks is naturally low because this sector has very high equity valuations and many of these companies are reinvesting their cash flows into growth.

The key risks to consider when investing in AI-related stocks are naturally the market risk itself, but also the elevated equity valuation for this sector, which could be triggered should interest rates rise further. Growth expectations are very high for these companies, which means that the upcoming Q2 earnings season poses a key test of those expectations. . Most of the AI-related companies are US-based and thus there is a considerable USD risk in this theme. Additional information on the risks, historical returns, costs and currency spreads of L&G's ETF can be found here; for WisdomTree's ETF, use this link.

The AI theme has undoubtedly been the biggest surprise this year in global equity markets, and in this article we have highlighted different ways to get exposure to this new technology, which is likely seeing some of the most optimistic expectations for the future since the early days of the internet.