Now that ChatGPT has passed exams from law and business schools, coded well enough to be hired at Google and even penned a story for CNBC Make It, you may be convinced that it's only a matter of time before artificial intelligence takes over the world.
While that thought may be scary to some, to others it raises an interesting question: How do I invest in what I believe will be the technology of the future?
Your instinct may be to pick a few stocks you think look promising and buy those. But if you look back to the dotcom era, you may realize that's a risky proposition. For every investor who got rich buying into Amazon early, there's another who lost a fortune betting on Pets.com.
This is where a thematic exchange-traded fund can come in handy. These ETFs invest in a basket companies centered around a particular theme. It can range from a specific technology or business, such as cloud computing, to something as broad as the shift to working from home.
The first step in choosing one is determining whether a theme is robust, or if a fund company is merely trying to capture investor dollars by creating a fund around something zeitgeisty, says Kenneth Lamont, senior manager research analyst for passive strategies at Morningstar.
Remember when wearables were the future of tech? People who bought the now-discontinued ETF do. AI feels like it has a chance to be a bigger deal than that, says Lamont.
"Artificial intelligence is a technology that's likely to be extremely disruptive," he says.
From there, you'll have to be discerning about which funds you choose. Here's what experts recommend.
Examine the holdings and strategy
The first thing you'll notice when shopping for a thematic ETF is that there are no shortage of funds with AI in the name. These generally fall into two camps: funds that invest in AI companies, and funds that use AI to pick stocks.
The latter type of fund "can hold just about anything," says Todd Rosenbluth, head of research at research firm VettaFI. "It's a question of whether you believe in AI's ability to spot potential winners in the broader stock market."
Even if you do, such funds probably won't benefit your portfolio as AI companies theoretically become more profitable. Plus, what exactly an "AI company" is will vary from fund to fund.
Some funds invest in large, established companies with an AI component to their business. The Global X Artificial Intelligence & Technology ETF, for instance, counts Tesla, Meta Platforms, Apple and Amazon among its top holdings. While these companies may have significant investments in AI, the technology is not what is primarily driving their business.
Other ETFs try to provide more of a "pure play" on AI by investing in firms who derive a certain portion of their revenue from artificial intelligence. But because that method looks at past data for a technology of the future, still others select AI firms based on analyst projections for future sales.
Determining which approach is right for you is going to require some research. As a rule of thumb when it comes to AI, if the biggest-weighted stocks in the index are names you recognize, you're likely getting less of a "pure play."
Plus, any fund should spell out its investment strategy clearly on its website. "Look at the selection criteria — how are stocks chosen to be in this portfolio?" Lamont says.
Be cognizant of the risks of thematic ETFs
Thematic ETFs give you diversification when compared with picking a few individual stocks. If you think AI is on an upward trajectory, investing in a basket of 20 or 30 AI stocks can help you capture those returns while somewhat mitigating the risk that a single company could crash and derail your whole strategy.
But thematic ETFs still come with a unique set of risks. For one thing, diversification within a particular theme won't do you much good if the whole theme takes a hit. Just ask investors who held blockchain-themed ETFs in 2022.
"These kinds of funds are highly concentrated," says Lamont. "Sometimes the returns can be stomach-churning."
What's more, thematic ETFs tend to charge higher expense ratios than broader-based strategies. That's why it's important to consider what you're paying for a basket of AI stocks. If the fund's holdings more or less overlap with what you could get from a technology stock fund or even a broad index fund, you may be overpaying for that exposure, says Lamont.
"They cost more because they're giving you narrative," he says. "Plus, many of them are making big active bets. They come in a passive wrapper, but they're really active funds."
Due to the risks, you'd be wise to treat any thematic ETF as a complement to a broadly diversified core portfolio strategy, says Rosenbluth.
"This should serve as a 'satellite' position or a slice of a broader portfolio. We tend to see investors putting 5% to 10% of their equity allocation toward higher-risk, high-reward thematic ETFs."
If it works out, you could realize returns that boost your portfolio's performance over the long term, he says. And if things don't work out over a short period, "you're not needing years to recoup those losses."
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