Adding AI to Your Portfolio

Separate truth from fiction in the hype surrounding artificial-intelligence stocks, and remain mindful of exposure

By James Blakeway

Investors who’ve been around the block—and their younger proteges who’ve done their homework—know something about the dot-com sensationalism of the late ‘90s and early 2000s.

Companies that claimed they were online or simply added “.com” to the end of their names generated intense interest in their initial public offerings or even in their established stock.

Something similar occurred in recent years with the rise of cryptocurrencies and an overzealous reaction to anything labeled “crypto” or identified with the “blockchain.”

Now, given the public’s fascination with ChatGPT, OpenAI and the AI zeitgeist, companies again appear eager to capitalize on the hype by proclaiming they’re shifting resources into AI.

Some will undoubtedly settle for a PR approach, prematurely changing their company names to include AI or simply switching their websites’ “.com” domains to “.ai.”

But that doesn’t mean investors should greet every corporate AI initiative with unwavering cynicism.

Big tech’s major round of investment is continuing with Microsoft’s (MSFT) funding of OpenAI, and Alphabet’s (GOOG & GOOGL) scramble to react to the explosion of new tech.

So, some investors may turn to buying stock in big tech companies as a way of investing in the future of AI. But it’s important to consider the other exposures of these behemoths.

Two factors might discourage investors from buying mega-cap stocks like Microsoft or Alphabet— particularly if they’re bullish about AI.

First, remember that each share purchased in the tech giants is a microscopically fractional investment in existing value. In late February, Microsoft was valued at just shy of $2 trillion. The investment in ChatGPT is only a slight portion of the company’s overall portfolio.

While it’s possible for Microsoft to double or triple in the coming years or decades, smaller firms staking their entire businesses and futures on AI projects are likely to grow more quickly.

Second, investors may want to think twice about shares in Microsoft or Alphabet because of the risk of overexposure.

Consider people in their early 40s who are invested entirely in a passive 401(k) like the Vanguard Target Retirement 2055 Fund. As with most target date funds, it blends stocks and bonds.

However, Microsoft and Alphabet are so big they can constitute a sizable portion of a large retirement fund, even the ones with both international and domestic stocks and bonds.

Investing in an AI ETF and AI stocks parallels betting on one horse and the whole field.

If a 401(k) had $250,000 invested in the Vanguard fund, $6,120 would be in Microsoft, while $3,658 would be split between Alphabet A and C share classes (GOOGL & GOOG).

When jumping into new positions in large U.S. firms, investors should consider whether they already have a stake in them in other forms.

So, branch out and look for opportunities in smaller firms that may grow exponentially by adopting and integrating AI. Keep in mind it can feel like picking a horse to win a race.

In other words, some companies will thrive in this new age of AI, others will survive but fail to innovate and thus grow at the same pace, and some will face obsolescence.

The earlier allusion to stock-based funds can also apply to AI technology. Several exchange-traded funds (ETFs) provide access to this market.

One to investigate is the First Trust Nasdaq Artificial Intelligence and Robotics ETF (ROBT). It’s designed to track the Nasdaq index of the same name (NQROBO). By using modified weighting for the companies’ association with AI and robotics, it splits exposure among “enablers” (25%), “engagers” (60%) and “enhancers” (15%).

Enablers build the fundamental AI technology, while engagers provide products and software built on that tech. Enhancers offer services or products related to AI or robotics but do not rely on it as their core business.

As a bonus, the First Trust ETF includes international stocks—only about 50% of the funds are allocated to U.S. firms.

Because the First Trust ETF focuses on companies with core product offerings dedicated to AI, it could serve as a strong investment for anyone who wants broad exposure to the sector.

Bear in mind that given the weightings, no single company accounts for a large percentage of the fund. Therefore, a stock that grows exponentially has only a muted impact on the overall fund. That said, it does stand out as a way to participate in the rise of AI.

Investors adamant about adding exposure to specific companies in the AI industry could take a more aggressive approach with a hybrid investment they can create by combining an ETF and additional shares of specific stocks.

The First Trust ETF provides a good starting point and eliminates a lot of the research needed to find stocks to invest in. If a company stands out, adding it to shares in an ETF naturally distorts the exposure and increases its weighting.

Anytime there’s an option to bet simultaneously on a single horse and all of the horses, it’s certainly worth exploring.

AI ascension

At press time, the First Trust Nasdaq Artificial Intelligence and Robotics ETF (ROBT) was still significantly below its February 2021 peak price but has already rallied 30% off the lows set in October of last year.

Weekly data courtesy of tastytrade

Some companies are changing their names to include AI or simply switching their website’s “.com” domains to “.ai.” Don’t be fooled.

James Blakeway, Luckbox technical editor. @jamesblakeway