2023-08-16 16:44:48 ET
Summary
- The AI Powered Equity ETF is an actively-managed ETF that uses artificial intelligence to select U.S. stocks with high potential for success.
- AIEQ's returns through 2020 were solid and slightly beat SPY with higher volatility. However, it's performed poorly since, coinciding with an excessive turnover rate that topped 1,700% in 2022.
- A hefty 0.75% expense ratio, minimal AUM, and a poor track record against virtually every passive size and style segment means investors should avoid AIEQ.
Investment Thesis
I first covered the AI Powered Equity ETF ( AIEQ ) in May, concluding that based on its poor track record against nine passive funds tracking various segments of the U.S. market, there was no reason to pay its elevated 0.75% expense ratio. Since that article was published, AIEQ has lagged the SPDR S&P 500 ETF ( SPY ) by 2.50%, but its holdings are 79% different, so I wanted to provide readers with an update. In addition, I will also address the concept of paralysis by analysis, which this ETF suffers from. Simply put, AIEQ evaluates too many data points, and this lack of focus will lead to at best mediocre returns for shareholders moving forward.
AIEQ Overview and Performance
AIEQ is the product of very data-intensive models, summarized in the graphic below, which is the ETF Managers Group's pitch for why investors should consider purchasing:
ETF Managers Group
Daily financial, news, management, and macro signals help inform changes to AIEQ's holdings, which are frequent. Portfolio turnover was 100-300% between 2018-2020, 540% in 2021, and 1,708% for the fiscal year ending September 30, 2022. Per the statement above describing an "investment system that perpetually grows in value," it seems the more frequent changes since 2021 indicate AIEQ's models are gaining confidence. It's one of the most actively-managed funds you'll find.
The problem is that the results are getting worse. The following table highlights AIEQ's annual returns compared with SPY since November 2017.
Portfolio Visualizer
For the three full years between 2018-2020, when turnover was relatively low, AIEQ averaged a 16.36% annual gain compared to 15.01% for SPY. Given the difference in expense ratio (0.75% vs. 0.09%), it wouldn't have been unreasonable to think the strategy had merit. But turnover picked up in 2021, and AIEQ lagged by 8.64%. AIEQ trailed SPY by another 13.73% in 2022 and is behind by 5.60% in 2023. Over the entire period, AIEQ gained an annualized 6.66% vs. 11.87% for SPY and did so with higher volatility.
Portfolio Visualizer
Furthermore, investors can't rely on any mean reversion because today's fund differs from when it underperformed. It's not like a traditional Index ETF that targets a group of stocks that meet a specific set of criteria. To illustrate, large-cap dividend ETFs substantially underperformed in the post-pandemic bull market, but those who held on were eventually rewarded when stocks declined last year. With AIEQ, there's no expectation that this will happen because the fund could target different size segments (small, mid, large) and styles (value, blend, growth) at any time.
Also, consider how AIEQ has underperformed every single one of the following passive ETFs representing these sizes and styles. The table below shows how AIEQ ranks #10/10 on CAGR, standard deviation, Sharpe Ratio, and Sortino Ratio, #9/10 on Worst Year and Maximum Drawdown, and #4/10 on Best Year. That's a lot of downside risk for only a 0.02% outperformance over SPY in 2019, AIEQ's best year.
Portfolio Visualizer
AIEQ Analysis
Paralysis By Analysis
Paralysis by analysis is caused by information overload and leads to an inability to make a decision. It might seem strange to apply that to AIEQ, given how its portfolio turnover rate suggests its model has no difficulty deciding. However, there are only so many stocks to choose from, and AIEQ's 1,700% turnover rate indicates the model has likely changed its outlook at least a few times on the same stocks over the years. For example, DoorDash ( DASH ) was AIEQ's second-largest holding on March 22, 2023, but it was not included in the portfolio when I published my analysis on May 30, 2023. Now it's the second-largest holding behind Roku ( ROKU ) , another high-beta stock present in March but not May. Below are the current top ten.
ETF Managers Group
Consider how on its fund page, AIEQ claims its models identify 30-200 companies out of 6,000 with the "greatest potential over the next twelve months for appreciation." Currently, AIEQ holds 113 stocks or less than 2% of its available universe, so it's a fairly exclusive group. That said, one must wonder how strong each stock's investment thesis is if it can be broken in three weeks because that's what a 1,708% turnover means. Imagine how much confidence you would have in an analyst who changes their buy and sell recommendations that frequently. High turnover is a feature of actively-managed funds, but in AIEQ's case, it's extreme and has yet to reward shareholders.
Current Portfolio Fundamentals
The following table highlights selected fundamental metrics for AIEQ's top 20 industries, totaling 86.52% of the portfolio. Unsurprisingly, it's much different than in May, when Semiconductors and Semiconductor Materials & Equipment stocks controlled 30.56% of the fund. Today, AIEQ primarily holds Regional Banks (17.51%), Biotechnology (8.70%), and Movies & Entertainment (7.16%) stocks.
The Sunday Investor
This table shows a mix of mid- and large-cap industries, but AIEQ's 1.27 five-year beta is high, consistent with its elevated realized volatility mentioned earlier. I think it's the wrong time to take on more risk, given that SPY is already up 18% on the year. According to Yardeni Research , the aggregate S&P 500 earnings surprise was 7.7% in Q2 vs. 7.1% in Q1, and although this is above the 5-7% historical average, it represents stalled earnings momentum. Similarly, SPY's 6.19/10 EPS Revision Score has pulled back from its 6.40/10 high score in May, so the upside is likely limited.
AIEQ doesn't adhere to any specific style. There are several industries with discounted forward earnings valuations, like Regional Banks (8.25x) and Diversified Banks (9.10x), but others with high sales and earnings growth potential, like Oil & Gas and Communication Services. However, it's more tilted towards value than growth at the moment. AIEQ trades at 19.41x forward earnings, 3.95x trailing sales, and 18.27x trailing cash flow, all cheaper than SPY. It beats on estimated sales growth (9.87% vs. 8.43%), but estimated EPS growth is roughly half (4.57% vs. 9.09%).
Finally, AIEQ also has a lower Seeking Alpha Profitability Score (7.38/10 vs. 9.32/10) and a lower Quant Score (5.63/10 vs. 6.19/10) than SPY, which gives me further pause. I calculated these scores by normalizing individual Seeking Alpha Factor Grades on a ten-point scale, and although Seeking Alpha does not provide these grades for ETFs, its system assigned a poor 1.63/5 Quant Score based on momentum, expenses, dividends, risk, and liquidity factors.
Seeking Alpha
Investment Recommendation
I've reiterated my "strong sell" rating on AIEQ for three main reasons:
1. AIEQ has underperformed every size and style passive ETF I compared it with since its October 2017 inception. It also ranked last on volatility and risk-adjusted returns and second to last on its "worst year" and "maximum drawdown" figures.
2. Portfolio turnover is excessive even for an actively-managed ETF. Contrary to the fund manager's claim that selections are made with a twelve-month outlook, the evidence suggests AIEQ frequently moves in and out of holdings without good reason. I wonder if the model is too sensitive and if it would benefit by applying strict buffer rules to limit turnover.
3. The current portfolio's fundamentals indicate too much speculation, and I prefer investing in high-quality companies over the long term, even if it means paying more on valuation. Since that's not the case today, and there's no way to forecast changes in the short term, there's no compelling opportunity.
AIEQ has amassed $110 million in assets under management in six years, down from $168 million in September 2021. The downward trend is concerning, and at this point, prospective investors should factor in liquidation risk if results don't improve. A liquidation would force upon shareholders a taxable event, and it's not worth putting yourself in that position given AIEQ's poor track record and high 0.75% expense ratio. Thank you for reading, and I look forward to the discussion in the comments section below.
For further details see:
AIEQ: 3 Reasons To Avoid This High-Risk AI-Powered ETF