We regularly check in on a relatively small US listed exchange traded fund with a unique twist: it uses IBM Watson-powered artificial intelligence to pick US stocks. With just $145 million in assets under management, the AI Powered Equity ETF (symbol AIEQ) has 0.1% of the AUM of the largest US ETF (the SPY). But if AI-enabled stock picking really is the “Next Big Thing”, then AIEQ is worth watching. So we do…
First, a quick performance review:
- AIEQ is +17.1% in 2019. Since its holdings are currently 57% US large caps and 26% US mid caps, a blend of these indices is the right benchmark. Year-to-date the S&P 500 is up 11.7% and the S&P 400 Mid Cap Index is +11.5%. By either measure, AIEQ is off to a good start in 2019.
- As we noted in our January check in on AIEQ, the fund underperformed in 2018 by 390 basis points. There was also an outsized dividend payment in December (8% of total assets), which would have made taxable returns lower for some shareholders.
- Bottom line: AIEQ has managed to erase its 2018 losses in 2019, so looking at its current portfolio is a useful exercise. Part performance is no indication of future results, of course, but if the fund’s AI investment approach has found some tradable/investable signal just now we’re curious about what it likes at present.
Now, here is a list of AIEQ’s top 10 stock holdings:
- #1: Alphabet (GOOGL): 4.0% of the portfolio
- #2: NetApp (NTAP): 2.7%
- #3: SS&C Technologies (SSNC): 2.1%
- #4: Motorola Solutions (MSI): 2.0%
- #5: Amazon (AMZN): 1.9%
- #6: Costco (COST): 1.9%
- #7: Aaron’s (AAN): 1.9%
- #8: Brown-Foreman (BF.B): 1.8%
- #9: SVB Financial (SIVB): 1.7%
- #10: Discover Financial (DFS): 1.7%
- Aggregate weighting of top 10 names: 21.4%.
- The fund currently has 116 stock positions in total.
Also worth noting:
- AIEQ is noticeably overweight Technology, with a 26% portfolio position. This is a larger allocation to the sector than either the S&P 500 (21%) or S&P 400 Mid Cap (17%).
- The fund is most notably underweight Health Care, at 8% of the portfolio versus a 15% allocation in the S&P 500 and 10% in Mid Caps.
- It has a larger growth factor allocation (67%) than either the S&P 500 (60%) or S&P 400 Mid Cap (50%) indices.
- The fund currently holds 6.6% of its portfolio in cash, higher than at the end of its September 30 2018 fiscal year (1.7%). Fund operations may be the cause of that uptick, or it may be the AI system holding cash in reserve because it sees fewer investment opportunities. The AIEQ prospectus does allow for the possibility that the fund might hold “a significant portion” of the portfolio in cash and cash equivalents.
The bottom line: the AIEQ portfolio strikes us as distinctly bullish, but quirkily so. It is overweight Tech, for example, but owns no Microsoft (3.9% of the S&P) and is underweight Apple (1.2% of AIEQ, 3.7% of the S&P) and Amazon (1.9% vs. 3.2%). At least it does like Alphabet/Google (4.0% vs. 3.1%).
If this were a human-powered portfolio or index, you could just ask the PM or refer to the index rules for an explanation on why the portfolio looks as it does; in an AI powered decision making process, however, neither is possible. Artificial intelligence programs evolve as they receive new information. With market prices changing on a daily basis, in theory the code will deliver different answers on different days. This problem is not unique to AIEQ – every AI powered system has trouble explaining why it decides what it does.
And that might be the toughest hurdle for AIEQ to cross in terms of further significant asset growth, even if the rest of the year goes as well as Q1 has thus far. Institutional investors need to know they can get an answer to the “why do we own this?” question.