Investing in AI, Robotics Through ETFs

Jeremie Capron, director of research and managing partner with ROBO Global, sits down with etf.com Senior Analyst Sumit Roy to discuss the rally in Nvidia and the broader investment opportunity in artificial intelligence, robotics and healthcare technology. 

Podcast Transcription:

Sumit Roy: Hi, this is etf.com’s Exchange Traded Fridays podcast, a weekly podcast covering developments in the ETF industry. My name is Sumit Roy, and I'm senior ETF analyst for etf.com.

This week I'm talking with Jeremie Capron, director of research and managing partner with ROBO Global Insights, an index and research company focused on helping investors capture opportunities in robotics, artificial intelligence and healthcare technology companies around the world. Jeremie, welcome to the show.

Jeremie Capron: Good to be here.

Roy: It's really great to have you on the show, especially given how hot the topic of AI has been this year. As I understand it, you have a background in equity research. So I have to ask you, what do you think about this massive rally we've seen in the hottest stock on the market today, Nvidia. Is it sustainable?

Capron: Yes, certainly. A stunning move last week in particular. I mean, Nvidia stock was up more than 35% in the month of May, single-day pop of more than 25% last week that added $180,000 billion in market cap.

So to put things in perspective, this is more than the total market value of the top semiconductor companies around the world like Intel or Texas Instruments or Qualcomm, which are all top global players with market caps between $100 billion and $150,000 billion each. So, big move indeed.

And the catalyst for this last week was the news that investors had dramatically underestimated the acceleration in demand for GPUs, which is, called that a proxy for the boom in AI and especially the extremely rapid adoption of generative AI tools in recent months.

So since the launch of OpenAI's Chat GPT-3, that was about six, nine months ago, we've all become more familiar with the large language models, and this newfound ability for machines to generate and understand text as well as images.

And we're quickly moving to video now and everyone is experimenting with these new tools. So in the case of Nvidia, which is the de facto leader in GPUs, that are the most powerful compute tool for machine learning in data centers, we learned last week that demand was running around 50% above analyst expectations. This are big numbers.

Nvidia is just printing money now, despite the broader downturn that we've seen in the semiconductor market that we've been in for about a year now. Nvidia stock now is very expensive. It's trading on more than 200 times trailing earnings and over 30 times trailing revenue.

So those are pretty long payback periods if one assumes that Nvidia is going to continue to generate the same level of profitability. And certainly we think Nvidia will continue to grow in the years to come and continue to ride that AI wave.

But you have to be careful. If you are taking the shortcut of investing in a single stock to invest in AI, I think that's probably a bad move. There are many other beneficiaries of the AI revolution and that's what we do here at ROBO Global, researching and investing in the entire ecosystem.

Roy: Absolutely. That's a great point you made. As hot as Nvidia is, as fast as it's growing, it's always risky to invest in one stock. And that's where ETFs come in, right?

Nvidia is, of course, a holding in the ROBO Global Artificial intelligence ETF (THNQ). Like you mentioned, everyone's seen the extremely impressive things that AI can do, including Chat, GPT, Midjourney, and more recently, Adobe's Generative Fill feature in Photoshop that's been taken Twitter by storm.

Can you talk about the investment opportunity in AI, and why this ETF in particular is one investors should consider?

Capron: So look at ROBO Global. We recognized the robotics automation and AI revolution was coming early on and we launched ROBO, the ROBO Global Robotics and Automation Index ETF (ROBO) in 2013, almost 10 years ago today.

We did that to capitalize on what we regard as a technological revolution that is comparable to prior technology revolutions like that of the internet and mobile in the past 20 years, or the advent of electricity and the gas engine [at the] beginning of the 20^th century technology revolution.

This is a set of general purpose technologies that can be applied to every market, every industry, and it's happening now. And in researching the universe of enablers of automation over the years, over those past 10 years, we recognized the inflection that was occurring around machine intelligence.

And that's why we created the artificial intelligence index. We call it THNQ. That was the first research index dedicated to broad exposure to the global leaders of AI. That was in 2018.

So we have about five years of a track record at this point. The U.S. ETF that tracks it is a little more recent, but there's also one in Europe that was started in 2018. And so the artificial intelligence index is composed of the companies that are leading the AI industry from data and compute to some of the most promising applications in many different industries.

And the idea is to look at not only the companies that provide AI solutions for particular problems, but also the whole set of enablers. The infrastructure and the core technologies that make AI possible. So Nvidia, for example, would fall in the compute and semiconductor category, which is row compute power that enables the processing of vast amounts of data.

And so in terms of infrastructure, we're going to be looking at the cloud providers, we're going to be looking at the data collection and processing providers, and we're going to look at the networking, we're going to look at the cybersecurity aspects, etc. When it comes to applications, we're going to be looking at the most attractive vertical markets where those technologies are being deployed, so business process automation and healthcare and manufacturing and transportations, etc.

Now, the important thing to understand is that these index portfolios are composed of best-in-class companies from all around the world, and they're small, mid and large caps. These are companies that we research and we score on various metrics to determine if they are to be included in the index and at what weighting. And then we rebalance every quarter.

So the result is you have portfolios that are broad and at the same time, they're very unique in a sense that they have a low overlap with broad equity indices like the S&P 500 or the Nasdaq or the global equity indices. I think it's become increasingly clear that the AI revolution is ongoing.

And when you think about the problems that businesses are facing today, the supply chain disruptions, the labor shortages and inflation and rising costs across the board, the one clear response from business leaders is automation. And business leaders and corporations are making it a top priority.

In fact, today, demand for robots, automation and AI tools is at record highs and has exceeded what providers can actually supply, as Nvidia demonstrated last week.

Roy: That's great. And just for context, THNQ is up 29% this year. It's having a great year, but it did fall 40% in 2022. I assume last year's decline had to do with the whole bursting of the COVID bubble and issues related to valuation and growth stocks, is that right?

Capon: Well, I think there's two parts to that.

Last year we saw a major decline that I think was highly driven by the sudden powerful rise in interest rates and the impact on long duration stocks.

And a lot of those AI plays are typically in growth mode, and they're scaling very rapidly and they generate lower amounts of profits.

So a lot of the profits are relatively far into the future, and when they're discounted at a higher rate, the present value falls. And so rising interest rate was a factor in the decline last year for sure.

The second part to that decline last year, I think, is clearly the hangover after the COVID boom that we saw in digital technologies.

And as the pandemic rolled out in 2020, we saw dramatic acceleration in terms of our adoption of digital technologies in general. Many of these businesses had a huge year in 2020.

In many cases, the equity market probably got a little bit ahead of itself and probably built those stocks to unsustainable valuation.

So we had the hangover stocks corrected a lot last year, and now it looks like we've started a new uptrend.

Now, if you step back and you look at the longer-term picture, which I think is critical when you invest in technologies, and in particular in robotics and in AI, you have to look at performance through the cycle.

We've been running the THNG index for almost five years now, during which the index has delivered returns at about 13% compounded average growth rate. That's about 6 percentage points more than global equities that have been trending around 7% during that five-year period.

Returns have been, I would say, pretty satisfactory so far.

Roy: That's great. And looking through the cycle makes a lot of sense. Now I want to turn to one other, one of your ETFs, the one you mentioned the ROBO Global Robotics and Automation Index ETF (ROBO). This has been a very popular ETF; it has $1.4 billion invested in it. How is this different than THNQ? Is one more software and the other is hardware? How should investors think about it?

Capron: Yes, that's a great question. ROBO is where we started 10 years ago. And the view at the time was that robotics automation was on the cusp of a massive adoption. And robotics has been around for a long time.

It started in the 1960s, but for decades it was confined to a small set of applications, primarily in manufacturing, in the automotive industry in particular. In fact, the first robot was deployed in an auto factory in Detroit in the 1960s.

But over the past 15 years or so, we've seen the performance capabilities expand dramatically, and at the same time, the cost of these technologies has been on the decline.

So we hit an inflection point where automation is now being deployed not only in manufacturing, but in every sector of the economy.

So the ROBO index and the ETFs that track it are designed to capture this wave and this technology transition as it happens across the various sectors of the economy and across various regions of the world.

So it's a global index of best-in-class robotics and automation companies from around the world; Small, mid, large caps and they're all focused on that business in particular.

The philosophy behind the portfolio construction is really one of, number one, diversification; so this is not a concentrated bet on a handful of stocks. To the contrary, it's diversified across more than 80 holdings. And what they all have in common is that they are technology and market leaders in one or several of the 10 subsectors that we track.

About half of these subsectors are about enablers technology, the companies that make the technologies that make a robot or an autonomous system possible.

So you think about the sensing, you think about the computing and the actuation and how those systems interact with the physical world, and the position size is typically between 1% and 2%.

We rebalance every three months, which means that we use the benefits of index investing in terms of managing risk.

We have an embedded process that, every three months, the rebalancing will naturally buy the holdings that have come down and sell those that have gone up during that period.

So you have, as a result, kind of a smoother ride, and you're able to provide this exposure to the industry and the top players in the industry without taking undue risk or limiting the risk by diversifying.

There is some overlap between ROBO and THNQ because AI is an important component of the automation industry, and the overlap is about 10%.

So you'll find companies like Nvidia belong to both ROBO and THNQ, and there's a few others like that, particularly in the compute and AI segment. But ROBO is a lot more diverse than THNQ. THNQ has a high exposure to the semiconductor and software and tech industries in general, whereas ROBO is more, diverse because you're going to find industrial companies in there; for example, the makers of factory robots or the core components that are critical to robotics.

You're going to find some healthcare exposure as well in ROBO with the healthcare automation businesses. And it goes from surgical robotics to pharmacy automation and other hospital workflow automations and lab automation, the manipulation of samples and things like that.

So you've got two portfolios that are quite different in the end, in terms of their sector exposure and also in terms of their exposure to small and midcaps.

And ROBO is a pretty pronounced tilt towards small and midcaps that account for more than 60% of the portfolio.

Roy: That's great to know. Only 10% overlap between the two ETFs. So these are pretty distinct funds. Interesting. And before I let you go, Jeremie, I want to ask you about the ROBO Global Healthcare Technology and Innovation ETF (HTEC). When people think about tech and innovation, healthcare usually isn't the first thing that pops into their mind. But there are a lot of cutting-edge advancements taking place in that sector. Can you tell us about that?

Capon: Sure. So our research work around automation led us to realize, around 2018, that there were really two areas of extremely strong growth where we saw an inflection.

The first one is artificial intelligence and we just touched on that at length. The other one is really healthcare.

What we noticed is that in the last few years, the convergence of robotics, AI and life sciences has enabled some breakthrough advances which we believe will transform the healthcare industry.

If you think about it, we now have more than 7,000 robots around the world.hospitals assisting surgeons perform prostate and gynecology procedures.

We have AI that can help physicians increase the accuracy of their diagnosis when reading medical imaging and biopsy results. We have 3D-printed implants for organ transplants. We have miniature medical devices like heart pumps the size of a fingernail.

And of course, and perhaps most important, we have affordable gene sequencing technology which has opened the door to entirely new medical approaches when it comes to detecting diseases at a very early stage and to develop custom treatments that are tailored to each individual.

And the first gene therapies have been approved by the FDA in the last few years, and of course, the COVID vaccines that are genetic technology.

So realizing this, I think it’s pretty clear that the next big economic sector that’s going to be profoundly transformed by these technologies is healthcare.

The penetration today is relatively low, and that’s why we designed the ROBO Global Healthcare Technology and Innovation ETF (HTEC), to help individuals get exposure to that megatrend.

Sumit Roy: Wow, great stuff. We’re going to have to leave it there. Jeremie, thanks so much for coming on the show and sharing your insights with us.

Listeners, I hope you enjoyed this episode. You can find this, and all other Exchange Traded Fridays podcasts, on etf.com or on any major podcast platform. See you next week.