AIQ For AI Exposure: Pay Attention To Value, Growth And Quality

Summary

• AIQ’s investment mandate is to track the Indxx Artificial Intelligence & Big Data.
• Since May 2018, AIQ had delivered a compound annual growth rate of almost 24%.
• As of January 3, the fund was long 87 stocks, with the key ten accounting for 35.6% of the portfolio. NVDA was its top investment with ~4.5% weight.
• Valuation is uncomfortable, but quality is fine.
• Almost 30% have Growth grades of B- or better. Digging deeper, I found out that close to 57% of the firms have at least 20% revenue growth (YoY), while 35% have the exact same forward revenue growth rate.

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Today, I continue my series of articles covering the Disruptive Technology cohort of the Global X Thematic Family with a note on the Global X Artificial Intelligence & Technology ETF (NASDAQ:AIQ), a fund with an AUM of around $189 million.

Since May 2018, AIQ had delivered a compound annual growth rate of almost 24%, which is certainly impressive compared with the U.S. blue-chips' (IVV) CAGR of just 19.2%. However, when compared to QQQ, this impression fades, as the Nasdaq 100 cohort has advanced by ~27.7%. Precisely like in the case of its peer Global X Cloud Computing ETF (CLOU), 2020 was a banner year for AIQ as its price has surged by almost 53%. Tech investors were exceedingly rapturous during the first year of the pandemic, but the tables turned in 2021. Mammoths like Microsoft (MSFT) and Apple (AAPL) continued shining, while smaller tech lost its appeal, partly because the growth premiums began to dissipate, as tightening was looming on the horizon (it is still the case). As a consequence, AIQ underperformed IVV and QQQ.

Source: Portfolio Visualizer. Returns measured from 31 May 2018 to 31 December 2021.

When assessing what 2022 might hold for AIQ and its peers that oversee portfolios cramming much-hyped tech players, we should understand a few principal things. Valuation is number one, as we all want a stock with a price that properly reflects its future potential. Growth is the second component. When growth stories prove to be a flop, valuations crater. Quality is another essential part of my favorite factor trio. If a company's growth plans encounter temporary headwinds, strong margins and a healthy balance sheet are what can save it from total collapse.

Harnessing the power of the Quant data (though with certain limitations given the versatility and complexity of the AIQ portfolio), I will illustrate that investors who buy into the fund get exposure to a cohort of stocks with robust growth, though with bloated valuations. Quality is not impeccable, but fine.

Now let us proceed to the analysis to discuss all these in greater depth.

Investment strategy

According to the prospectus, AIQ's investment mandate is to track the Indxx Artificial Intelligence & Big Data Index.

In essence, this benchmark is a portfolio of companies that are anticipated to

benefit from the development and utilization of Artificial Intelligence ... in their products and services, as well as companies that produce hardware used in AI applied for the analysis of Big Data.

According to the index provider, there are two large cohorts (or "categories") encompassing those names most exposed to the theme, with the AI developers and AI-as-a-Service in the first category, and AI hardware and quantum computing in the second. As explained on page 4 of the methodology, in its stock-selection process, Indxx uses the FactSet industries classification.

The index provider puts much more emphasis on the first group as the 60 key players from it are selected for the final version of the benchmark, while the second category adds only 25.

The selection pool consists of companies from the advanced and emerging markets, with one crucial caveat: they must be listed in a developed market (GDRs and ADRs are welcome). The full list of eligible countries can be found in the summary from Global X or in the full methodology document linked above. Please take notice that Korea is also considered an advanced economy. As I discussed in my articles in the past, different index providers have conflicting views on the classification of this market.

It is worth noting that the market cap criterion is looser for the category 2 companies, as they must have a market value of only $500 million, while the AI developers and AIaaS players must be valued at no less than $2 billion. The liquidity rule, namely average daily turnover no less than $2 million over the previous six months, is valid for both.

Apart from market capitalization, the exposure score is a factor influencing a stock's weight in the index. Names with an ES over 20% cannot have greater than 3% weight, while those with a score less than 20% have a 1% limit.

The next reconstitution is scheduled for the last trading day of January. Necessary adjustments to constituents' weights (rebalancing) will be made on the last trading day of July.

Among funds with a similar focus are the recently debuted WisdomTree Artificial Intelligence and Innovation Fund (WTAI) that oversees a portfolio of ~$1.24 million (that is not a typo), with 75 holdings and an expense ratio of 45 bps. WTAI mimics the WisdomTree Artificial Intelligence & Innovation Index, which has a completely different opinion on what companies better reflect the theme. For example, AIQ has exposure neither to Grid Dynamics (GDYN) nor to DENSO (OTCPK:DNZOF), which are the top investments of WTAI.

Holdings

What is inside the AIQ portfolio? As of January 3, the fund was long 87 stocks, with the key ten accounting for 35.6% of the portfolio. Nvidia (NVDA) was its top investment with ~4.5% weight. Its presence in the portfolio is no surprise, considering the role its GPUs play in the data science workflows. Though I cannot say for sure, NVDA is probably classified as the category 2 stock (AI hardware).

The members of the $1 trillion league that certainly have a sizeable footprint in the AI and big data technologies are also present. Amazon (AMZN), AAPL, Alphabet (GOOGL), and MSFT combined had ~13.2% of the net assets.

In terms of country exposure, most stocks in AIQ are American (~67.4%), with the Chinese companies in second place with a ~8.4% weight. The fund does have exposure to currencies other than the U.S. dollar, like the euro, yen, franc, etc., but I believe their impact on the NAV is moderate.

What about the factors? An important remark is that the Quant rating was available only for ~80% of the portfolio (I did not make any ticker adjustments this time). In this 80% group, ~55% have lackluster Valuation grades (D+ or worse), like Uber (UBER) and Snap (SNAP). Just ~9% look underappreciated. Overall, that is better if compared to other thematic ETFs I have analyzed recently.

Almost 30% have Growth grades of B- or better. Digging deeper, I found out that close to 57% of the firms have at least 20% revenue growth (YoY), while 35% have the exact same forward revenue growth rate. 36%, including GOOGL and Adobe (ADBE), have delivered a 3-year sales CAGR above or equal to 20%. Next, 55% have the YoY EBITDA growth of at least 10%, with Shopify (SHOP) boasting a staggering 512% rate. Forward EBITDA growth is north of 10% for ~58%. So, does AIQ have a growth tilt? I think so.

Finally, as the equity mix is dominated by mega and large caps, quality is fine. I see over 71% of the net assets allocated to companies with a Profitability rating of at least B-.

Final thoughts

In conclusion, the AIQ portfolio mixes expensive AI and big data players boasting robust growth potential from all around the world. Its trading history is short, so extrapolating historical returns does not make sense here.

There are a few things to dislike about AIQ. Advantages certainly exist too.

First, compared to other thematic funds, this ETF has a relatively adequate expense ratio of 68 bps; truth be told, investing in a specific hyped tech theme has never been cheap, regardless of active or passive investment strategy. But compared to the sector equity asset class median of 47 bps, it still looks expensive. Another issue is that AIQ has weak momentum, with 6-month and 1-year returns only in line with the class. This reflects the challenges the disruptive technology and Industry 4.0 stocks overall faced last year. Dividends are expectedly an Achilles' heel, but it's barely surprising for a growth portfolio. Next, Asset Flows metrics are mixed, so the grade is only C.

Turning to advantages, Risk is a silver lining, as the fund scores nicely against every single metric factored in the rating, including tracking errors and standard deviation.

This by no means implies AIQ is riskless. In my notes on OGIG and CLOU published in December, I outlined the main challenges growth stocks will face in 2022. In short, interest rates are to watch.

Summing up, AIQ has delivered robust performance since inception, beating both IVV and QQQ in 2020, though lagging in 2021. What does 2022 hold for the fund? Pay attention to valuations and do your own due diligence. I am neutral.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in AAPL, MSFT, NVDA, SHOP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.