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Tuesday, October 16, 2018

How Artificial Intelligence is Changing ETFs

A new category of exchange-traded funds that incorporate artificial intelligence to predict market outcomes has arrived, along with ETFs composed of AI technology leaders. Should you invest?

The robots have arrived.

They’re making decisions in your stock portfolio, and in more and more of the companies you invest in. Artificial intelligence (AI) is here to stay. Is there cause to be wary, or does this present a new set of investing opportunities?

Exchange-traded funds (ETFs) are a staple of many stock portfolios. With generally lower expense ratios than mutual funds and the ability to maintain diversification by investing in a basket of stocks, they’re among the most popular investment vehicles. It’s no wonder that AI and ETFs have intersected to create novel products for today’s investor.

What Defines Artificial Intelligence

First, let’s talk about how to define AI. On a basic level, it’s a computer science field that builds smarts into electronic systems. An AI system is capable of perceiving data, learning and then taking action to reach specified goals. 

There’s no emotion involved. An AI asset management system will never engage in panic selling, and it won’t buy high when euphoria strikes the market. It will never go on gut instinct, either. Its key advantage lies in its superhuman ability to process massive amounts of data and make investment decisions based on that information. 

AI systems never make the same mistake twice, because they learn as they go. Based on statistical probabilities, they are able to analyze past reactions to economic events and calculate likely outcomes for a stock or industry under present circumstances.

Human investors can benefit from using AI to make better trades. These networks can aggregate large volumes of data to make continuous portfolio adjustments based on various market indicators, while incorporating new signals without human bias.


There are a couple of ways to invest in artificial intelligence via an ETF. You can either invest in companies that are working on AI and robotics projects, or find an ETF that uses AI to select stocks. Here’s a list of some of the top ETFs in each category:

  • Invesco QQQ (QQQ) Focused on the big tech FAANG stocks. Apple (AAPL) and Amazon (AMZN) headline 104 holdings and nearly $68 billion in assets.
  • Technology Select Sector SPDR Fund (XLK) Tech tied to AI. With assets of about $22 billion, its top two holdings are Microsoft (MSFT) and Alphabet (GOOG).
  • Vanguard Information Technology ETF (VGT) Broadly diversified with over 350 names and $21 billion. The largest holdings are Apple (AAPL) and Microsoft (MSFT).
  • Global X Robotics & Artificial Intelligence Thematic ETF (BOTZ) Small ($2.3 billion in assets) and focused. BOTZ’s largest holdings are Nvidia (NVDA) and Intuitive Surgical (ISRG), while Japanese companies and those headquartered in Asia make up most of the rest.

Not all AI is Created Equal

It used to be that AI investment systems were considered “black boxes” where information got jammed into a conceptual box that then spit out recommendations. Current systems are much more flexible and suitable for constantly changing inputs and market conditions. Each of them is unique.

When analyzing current offerings among funds, an effort must be made to understand the system being used. Each investment platform design can differ in meaningful ways that affect performance output. An AI system is only as good as the team that designed and maintains it. Investors should attempt to understand what drives the algorithms and which opportunities they are programmed to find.

Use It or Lose Out

No long-term data is yet available to judge how well these systems work. Around 90 percent of electronic data was created within the last two years, and in another couple of years, we will likely be saying exactly the same thing. Investing without using AI will quickly become obsolete.

AI is disrupting the ETF industry by assisting fund managers in making subtle tweaks to their baskets of stocks in search of better returns. There are currently a growing number of ETFs that either promote the use of AI to balance the fund, or are made up of stocks that lean heavily on AI, such as robotics. 

ETF management is enhanced by AI without raising expense ratios exorbitantly. While the research that goes into AI development isn’t cheap, there are no known cases of a computer demanding a raise or insisting on a bonus.

It’s unlikely that AI will replace investment advisors, human managers and fund analysts right away. Currently, it allows them to work more efficiently as the machines do the dirty work of wading through masses of market data. But that could be changing.

Chida Khafua is the co-founder and CEO of EquBot, the first firm to introduce an AI-powered ETF, and the first to offer an AI-powered ETF focused on international equity. 

“As AI investment products produce out-performance numbers, we anticipate the same type of shift we saw from taxis to Ubers,” Chris notes. “As you consider the future shape of the investing landscape, ask yourself this question: Are there taxis in your portfolio?”

Click below for the other articles in the October 2018 Senior Spirit