The growing hype around artificial intelligence has spilled over from the technology world and into the financial industry, but a new report from Morningstar urges investors to proceed with caution before making a "narrow bet" by putting their money in thematic funds.
Excitement around AI has been a boon for companies such as Santa Clara, Calif.-based chipmaker Nvidia, which became a trillion-dollar company last month after shares skyrocketed 27% from May 22 to May 26, as investors rode the wave of excitement after Nvidia beat earnings estimates and revised its forecasts higher due to strong demand for its chips, which can be used for generative AI and large language models.
While Nvidia's stock price was booming, investors dumped $232 million into AI-focused ETFs, signifying the potential start of "a hot new theme in ETF investing," albeit one that currently has only $3.3 billion in assets under management for U.S.-based AI-focused ETFs, according to Morningstar's report, which was published June 13.
However, Morningstar has long maintained that investors should plug their ears to the "siren song" of thematic ETFs, writing in a May 2022 article that thematic funds have a "checkered past" with limited success, almost never outperforming the wider market.
An AI-focused ETF would be no different, according to Morningstar's latest report. It's author, Chicago-based research analyst Mo'ath Almahasneh wrote that betting on AI's lasting impact may seem obvious but could in reality be more difficult to predict.
"Experience tells us that most themes are transitory and do not translate into sustained returns for shareholders," Mr. Almahasneh wrote.
Mr. Almahasneh compared AI-focused ETFs to the Direxion Work From Home ETF, which invests in companies such as Adobe that facilitate at-home work. In December 2020, the ETF had $174 million in AUM — by May this year, that figure had plunged to $31 million.
"That said, AI seems more promising with plenty of possible use cases than most themes that make their way into the ETF market," Mr. Almahasneh said.
Despite Mr. Almahasneh's belief in the "potentially revolutionary innovations that AI can bring to markets," he recommends that investors focus instead on total market ETFs, such as the iShares Core S&P Total U.S. Stock Market ETF, which he said would inevitably include companies that would benefit from AI.
"If AI proves revolutionary, it will reverberate throughout the business world, and much of the market will benefit, not only Nvidia" Mr. Almahasneh wrote.