IRBO - IRBO: Low-Cost Diversification Pays Off - Even In AI/Robotics

2023-12-20 13:22:22 ET

Summary

• High-growth tech themes like AI and robotics have rebounded strongly this year.
• As we head into a lower rate environment and with the AI/robotics runway more extensive than ever, stocks look poised to recoup their 2021/2022 losses.
• IRBO, a thematic vehicle that rightly optimizes for diversification and low cost, should outperform.

Publicly listed thematic funds have been all the rage in recent years, helped by the outperformance of Ark's group of actively managed ETFs. More recently, lower-cost, passively managed vehicles have emerged, offering investors access to a similar basket of stocks and, in some cases, even better performance for a fraction of the price. Within artificial intelligence ('AI') and robotics, two of the most exciting themes in tech right now, iShares' Robotics and Artificial Intelligence Multisector ETF ( IRBO ) is about as good as it gets.

Not only is IRBO the lowest-cost play on both themes, but it also better diversifies its holdings via an equal-weighted stock selection (rebalanced semi-annually) spanning different sectors and geographies. In contrast, comparable ETFs like the passively managed Robotics & Artificial Intelligence ETF ( BOTZ ) and the actively managed ARK Autonomous Tech. & Robotics ETF ( ARKQ ) skew heavily toward more obvious beneficiaries, many of which have already seen their market caps expand significantly in 2023. So while the IRBO portfolio certainly isn't cheap at an underlying earnings multiple of 23.8x, it trades over twenty turns below key comparable, BOTZ. All in all, equal-weighted IRBO remains best placed to capture incremental optionality as we enter the next stages of AI/robotics development.

IRBO's Overview – Cost and Diversification Stand Out

The US-listed iShares Robotics and Artificial Intelligence Multisector ETF tracks, before fees and expenses, the total return performance of the equal-weighted NYSE FactSet Global Robotics and Artificial Intelligence Index, a basket of global companies across the AI/robotics value chain ('developers' and 'enablers') selected based on the FactSet Revere Business Industry Classification System (RBICS). Like the index it tracks, IRBO is subject to a periodic rebalancing (semi-annual) and reconstitution (annual) process. The ETF held ~$574m of net assets at the time of writing and maintains the lowest expense ratio within the AI/robotics ETF universe at 0.47%. By comparison, BOTZ, the fund's larger passively managed comparable, charges 0.69%, and actively managed ARKQ charges 0.75%.

The fund is spread across 113 holdings (including a small cash position) and a range of geographies and sectors. Perhaps unsurprisingly, the fund skews heavily toward the United States at 53.8% - despite adopting an equal-weighted approach. China, Japan, and Taiwan come next at 12.4%, 9.6%, and 7.9%, respectively. BOTZ has a similar US allocation, though its outsized Japan (27.7%) and limited China exposures (1.5%) are notable. ARKQ, on the other hand, has virtually all of its assets in North America (91.1%), making it the most highly levered to the US fiscal and monetary policy changes.

While IRBO's largest sector allocation is unsurprisingly Information Technology, the size of the exposure, at 56.3%, is a differentiator. The rest of the portfolio is mainly Communication (19.6%), Industrials (15.4%), and Consumer Discretionary (7.3%), though many of the holdings classified under these sectors are tech/tech-enabled anyway (e.g., Alphabet ( GOOG ) is listed under 'communication'). Interestingly, BOTZ and ARKQ feature lower tech allocations and comparatively larger exposures to Industrials. For the most part, though, these funds are all very much tech-focused.

Where IRBO really sets itself apart, though, is its single-stock allocation, spread equally across all of its holdings. The default allocation is generally ~1%; as the fund is only rebalanced quarterly, however, outperformers can overshoot (and vice versa) in the interim. Atos SE ( OTCPK:AEXAF ) is currently the top holding at 1.2% after a big Q4 rebound, followed by Snap Inc ( SNAP ) and Silicon Laboratories ( SLAB ). By comparison, BOTZ skews heavily toward Nvidia ( NVDA ), the pick of the 'Magnificent 7' this year, at 14.6%. Together with the rest of its top-five list, all global leaders in automation, the BOTZ top-five contributes ~45% of its overall portfolio. Actively managed ARKQ is just as concentrated, with its top-five making up ~46% and its top holding, Tesla ( TSLA ), sized at 12.8% within a smaller 30-50-stock portfolio.

In addition to hedging its bets better, IRBO's diversification also allows for a more reasonably priced portfolio. At current levels, IRBO is priced over twenty turns below BOTZ on earnings (23.8x vs. 44.1x) and over three turns on book value (2.1x vs. 5.2x). A well-spread-out portfolio also helps dampen IRBO's volatility, with its equity beta far lower than passively managed peer BOTZ at 1.11 relative to the S&P 500 ( SPY ).

IRBO's Performance – Equal-Weighted Approach Outperforms

Following a challenging 2022, IRBO has rebounded strongly this year, returning +34.3% YTD. As a result, its annualized track record over the last three and five years has improved to -3.4% and +9.3%, respectively. In comparison, higher-priced thematic ETF comparable BOTZ has underwhelmed at -5.7% and +6.8% annualized NAV returns over similar time frames. IRBO has also outperformed actively managed ARKQ over the last three years but has lagged by about one percentage point over a five-year horizon. The latter is mostly down to the contribution of TSLA's uptrend to ARKQ's performance; IRBO, by contrast, hasn't relied too heavily on any single holding. Going forward, IRBO should also continue to be boosted by its narrow tracking error, which, after accounting for fees, has been minimal relative to its benchmark NYSE FactSet Global Robotics and Artificial Intelligence Index.

Like other thematic AI/robotics ETFs, the distribution yield is low at 0.38%. This probably won't be moving higher anytime soon, given that most of the fund's holdings are high-growth names with extensive runways globally. For these companies, reinvesting excess cash makes a lot more sense than returning capital to shareholders.

Low-Cost Diversification Pays Off – Even in AI/Robotics

Given where we are today in their development cycles, predicting the future path for tech's two fastest-growing themes, robotics and AI, is a near-impossible task. Thus, a passive indexing approach makes a lot of sense - particularly for those with room in their portfolios for a higher risk/higher reward growth allocation. Among the growing list of thematic ETFs, IRBO stands out for its cost (lowest for US-listed robotics/AI-themed ETFs) and diversification (no sector/geographic limitations and equal weights for all of its holdings) – essential ingredients for a successful passive investment strategy. Plus, IRBO boasts one of the 'cheapest' portfolios available (by robotics/AI ETF standards) at ~24x earnings, along with a peer-leading track record. Having already outpaced broader equity indices this year, expect more good things from IRBO as monetary easing gets underway in 2024.

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