XT - XT: Forget ARKK This Is The Better Innovation ETF (Rating Downgrade)

2024-01-08 12:11:21 ET

Summary

• I continue to place iShares Exponential Technologies ETF near the top of my risk-on equity ETF watch list, but lower its rating to hold due to broader market conditions.
• I still like the XT ETF much better than ARK Innovation ETF, which in my view is overhyped.
• XT has the feel of a venture fund, which is part of its appeal.

iShares Exponential Technologies ETF ( XT ) has been a favorite of mine for a while now. I view it as the exchange-traded fun or ETF, I'd rather own than Ark Innovation ETF ( ARKK ) when I want to try to juice up the potential upside of my portfolio. As with many ETFs I track (about 100 I consider for potential inclusion in my portfolio models that I put my own money into), I treat equity ETFs of all shapes and sizes as rentals, not buy-and-holds. That won't change until the market has proven to me that it is in the process of truly starting a new bull market. Every time the S&P 500 Index (SP500) backs down from the 4,800 level, I dig in a bit more in that view.

But there is never a time when I just close my eyes to equity upside potential, or delete all the "offense-minded" ETFs from my watch list. Markets can turn on a dime.

So with that in mind, I look at XT as one of my short-list ETFs that I am always looking for a chance to buy. And while that time is not now, and thus I rate it a hold, I can say that I continue to believe that in comparison to ARKK, I have and will rate XT over it. That doesn't mean either is a screaming buy now.

But as noted below, XT has a lot going for it, and when "risk on" ETFs are a more urgent priority for me, I'll be looking toward that fund and away from ARKK. At times like this, I look to ARKK more as a place to buy put options after it rallies hard, since those rallies often fail miserably. And the excess volatility of ARKK makes it one of those ETFs that I can take a shot with as a profit center in a sudden market decline, without putting up much capital, via owning way out of the money puts.

That's all the time I want to spend on ARKK. XT is my focus here. It is up 13% since I placed a buy rating on it back on April 7, 2023. ARKK has outperformed it handily since that time. If that period covered all history, I would think differently. But buried in that 9-month time frame was this:

Even with my earlier statement about renting equity ETFs until further notice, I want to minimize my exposure to wild rides. That's why at a time when "risk on" ETFs are truly crashing, I can live with declines in the 15-20% in the smaller, more aggressive part of my portfolio. These are the types of exercises I hope investors will go through and personalize for themselves. Because it is part of what one believes in as an investor, which is a prerequisite to going at these markets with intention and discipline, not chaos and lack of structure. Call me old-fashioned, but I still think investing is an art and a science.

Early 2024: keep the bar high with risk-on investments

As noted in multiple articles I've written here recently, I am less enthusiastic about the first 3-6 months of 2024. But as with everything I write, there is absolutely no attempt to tell any other investor what to do with their money. This is sometimes lost on investors, who personalize the research, analysis and opinions they read here and elsewhere, and assume that it is being written directly for them. That's what fiduciary investment advisors do. This is not that.

And so, even though I am in a "show me" mode when it comes to a continuation of the strong equity market rally since last October. I am perfectly willing to participate, as I have been. But this does not appear to be a time to try to be some type of bullish superhero.

But that doesn't mean I don't have my favorite long equity ETFs. The longer an investor's time horizon, the more they can afford to let the short-term stuff go. And that brings us to a review of why I like XT, not only on a relative basis to ARKK and many small-mid cap growth ETFs, but because of how it handles its own business.

XT: what's to like

XT invests in "exponential technologies" as its name implies. It is a $3.3 billion ETF that feels a bit like a venture fund. It owns about 200 stocks, which would normally be a detractor for me. With its top 10 holdings accounting for just 6% of assets.

That is because XT equally weights its holdings, and those holdings cover a wide swath of technologies that point toward future innovation. So to me, this is innovation, rather than placing big bets on a few "star" businesses. As with venture capital, this mix of over 200 stocks provides an opportunity to hit some "big ones" as well as hop aboard a long-term trend in tech. I like Morningstar equity research, and it is their innovation index on which XT is based. So that adds to the attractiveness here.

From software, to manufacturing, to the new idea of AI, technology has completely shifted the business world and the financial markets. This probably isn't breaking news to anyone, but it is here to stay. XT holds dozens of stocks that have been beneficiaries of the AI boom. Companies within XT are the leaders and startups within industries like computer chips, semiconductors, cybersecurity, cloud-based software and much more.

Why this type of technology ETF can be a source of alpha

Gone are the days of ceiling high stacks of documents, which won't come back. Cloud-based technology and software can hold and organize infinite amounts of data, making it much more accessible and convenient. Computer chips and their memory capability affect and benefit millions, if not billions of people every day. The exciting part about XT is that several of those next up-and-coming tech stocks are amongst the holdings, and it may only be a matter of time until we see future market icons emerge from this big basket of potential technology stocks.

XT may be what it has been in the past: a very interesting hedge to the risk of having many technology companies in your portfolio, considering the economic concerns heading into 2024. XT is a global ETF and has 34% of its holdings in companies outside the United States.

Final thoughts on XT: technology doesn't have to be uber-volatile

I can imagine some devoted ARKK holders have read this far and still don't understand why I prefer XT to that The chart above is the final piece of my argument for now. The top part of the chart shows how ARKK became a market darling coming out of the pandemic. We are now clear of that unique period of time, and apparently, investors are keen to this, since ARKK peaked at nearly $28 billion, and its assets under management now sit at under $9 billion.

The chart shows that the purple line for XT is highly correlated to the orange line for ARKK, except for the wild spike in 2020. It has also been shot down like a clay pigeon multiple times. XT hangs in due to its diversification and low level of single-stock risk. In a core part of my portfolio, I don't need that. Here, in this pseudo-venture ETF, I see it as an advantage.

The last thing to point out is the bottom part of that chart above. The 2 ETFs have been highly correlated, except when ARKK implodes, and XT doesn't. This is all past performance, but there is enough to like about XT that makes it my top choice in this part of the equity space. But my buy rating needs to be lowered to a hold here, as long as the stock market overhang exists.

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