AI Exposure to Balance Single-Stock Risk | ETF Trends

There’s no denying that artificial intelligence (AI) is captivating investors’ hearts and minds in 2023. Additionally, many market participants are eschewing stock picking, opting to use exchange traded funds as avenues for AI exposure.

There are plenty of dedicated AI ETFs for investors to consider and even more funds with less dedicated exposure to that theme. However, market participants need to understand that not all AI ETFs are cut from the same cloth. Some ETFs in this category are heavily concentrated in big names, such as Nvidia (NASDAQ: NVDA).

Obviously, that’s a winning approach when Nvidia soars, as it has this year. That said, intense concentration in a small number of holdings can present risks to investors. The WisdomTree Artificial Intelligence and Innovation Fund (WTAI) can potentially mitigate some of those risks.

Deep Dive on WTAI

WTAI turns two years old in December and follows the WisdomTree Artificial Intelligence & Innovation Index. As of August 11, Nvidia is the fund’s largest holding, but at a weight of just 2.63%, indicating that single-stock risk is relatively benign in this ETF.

“When evaluating thematic ETFs, we advocate always making sure to look at the underlying positions—particularly the top 10. In a simple way, this can give an investor a lot of information about the distribution of weight across companies,” noted Christopher Gannatti, WisdomTree global head of research. “If the top position is above 10%, for example, we view this as quite different to another strategy where the top position might be below 5%. No one knows what the forward-looking performance will be of any fund—but we would just note that 10% or more in any stock leads to a lot of the portfolio’s volatility coming from that stock over future periods.”

Put simply, many thematic ETFs boast heavy allocations to a small number of stocks. In some cases, those are large- and mega-cap names. That can diminish the potency derived from smaller companies, which are pertinent in thematic investing, including AI.

That’s not to say that WTAI is heavily dependent on speculative small-cap stocks. It’s not. The WisdomTree ETF allocates almost 63% of its roster to large-cap equities. Still, there are benefits with an AI ETF that’s not excessively exposure to a small number of components. Those include avoiding heavy allocations to stocks that may now be richly valued thanks to AI ebullience.

Additionally, as Gannatti noted, it’s possible that Nvidia could retreat while the broader AI theme continues generating positive buzz, in turn weighing on ETFs that sport big weights to that stock. WTAI wouldn’t be as adversely affected as some rivals in such a scenario.

For more news, information, and analysis, visit the Modern Alpha Channel.