2023-07-26 06:02:24 ET
Summary
- iShares U.S. Tech Breakthrough Multisector ETF is a portfolio of major tech players, and it's not a coincidence that many have a dog in the AI race.
- To some extent, corporates paying the AI-option premium will not exercise them which will kill the hype.
- On the other hand, AI will create huge value among a couple of the winning players which could drive a portfolio of them like TECB. Valuation is a worry though.
- The trouble is by taking a scattershot approach you need to pay a 0.4% expense ratio which is not that great. We think there's wisdom in TECB's uniform distribution approach compared to other tech ETFs.
- On the broader macro side, big tech earnings are beating, and corporate demand still seems strong, assuaging recession fears.
The iShares U.S. Tech Breakthrough Multisector ETF ( TECB ) is a pretty uniform exposure of some of the best known tech names in the US market. While other ETFs are value weighted or some variation of being value weighted, TECB goes for the uniform exposure and we think it's wise considering the uncertainty around which stocks are going to take the AI crown. While there may be several winners, there will be losers too, and while the 0.4% expense ratio isn't negligible, a more involved strategy to skew allocations less makes sense. It also reduces the dependence on the very biggest four tech names. On the other hand, there is a lot of hype and the extent of the substance is unclear, as are economic conditions. However, on the macro side we still see strength in corporate demand based on initial tech earnings. Still, valuations make it hard to bet on TECB.
TECB Breakdown
Let's have a look at some of the top holdings :
Many familiar FANG names can be seen, but as you go down the exposure allocations don't decline much at all. Allocations end up being pretty even on the first page and only start to rapidly decline when the exposures become more marginal. The majority of the portfolio is on the first page, and the majority of the exposures in the ETF are IT picks.
Some of the exposures are also squarely in the generative AI race, namely Microsoft ( MSFT ), Google ( GOOGL ), Meta ( META ) and Nvidia ( NVDA ). Nvidia stands a bit apart as an infrastructure to AI processing, and actually it is a good example of what we are worried about in the AI race. Businesses are buying processing power to train AI hand over fist, but this is a lot of businesses just paying option premiums in case AI becomes big in their industries. They're not necessarily going to have all that much use for AI, the use cases are likely to be more narrow than hoped in the short term. The hype there may die. However, big tech are also big buyers of NVDA and need the chips to try to stay ahead in the race which does have some winner-take-all dynamics, at least in principle based on network effects intrinsic to neural networks.
The other picks are competing to see which can deploy the best model, specifically LLMs are in the picture, and which can take advantage of LLMs the best in their business models. All of them have some tech-based comms apps and services, and Google and Microsoft compete in search. Uniformly picking at least takes a scattershot approach where there is likely to be only one winner, consistent with scale free dynamics in AI and anything else that relies on network effects.
Bottom Line
The magic dust of AI has rocketed these stocks ahead of the rest of the market, which only until recently started showing signs of rallying, after the inflation data started speculation suddenly over a soft landing, which was not consensus before. Still, even their traditional businesses seem to be performing well. Google is beating expectations in its businesses, and their cloud solutions continue to gain traction. MSFT also beat estimates and matched cloud growth. This is important because outside of AI picks are a lot of corporate facing tech stocks, like Salesforce ( CRM ).
If corporate conditions are good, consumer conditions are also likely alright, which covers a lot of the other major tech exposures in TECB. Apple ( AAPL ) seems to be doing pretty well ahead of earnings according to third party data providers.
While TECB's allocation principles aren't a problem and don't have us questioning the 0.4% expense ratio too much, there is the issue that these stocks are extremely highly valued on a PE basis at 30x. While we think AI will be a net addition to productivity and value in the economy, if AI leadership concentrates on only one stock rather than being able to be shared by several, the effect of lots of stocks coming back down to earth could be a mitigating factor for the long-term growth of TECB. Even outside of the AI picks, valuations are remarkably high when we have a high standard for the risk free rate nowadays, a standard which we expect to persist for another year as the last leg of inflation will be tough to break. It's very hard to be confident in tech rising that much further, so in the end we'd pass.
For further details see:
Opposing Forces But AI Scale-Free Dynamics Support TECB