ROBT: Unique Exposure To AI + Robotics, Market Yet To Digest Value

Investment outlook

Artificial intelligence (“AI”) and robotics have the potential to vastly change the way we work, eat, sleep – you name it. Whether the AI impulse will have such far-reaching impacts remains to be seen. Nonetheless, the commercialization of machine learning and artificial intelligence platforms in the last 12 months has opened the floodgate for those in our capitalist system to vote with their dollars on what the most beneficial companies will be (i.e., the biggest ‘problem solvers’).

Investors can participate in the good fortunes of AI and robotics companies, too. Multiple investment vehicles have been created to provide liquidity and equity ownership in a basket of relevant securities in addition to individual securities.

For investors seeking exposure to this space via a diversified portfolio of companies, The First Trust Nasdaq Artificial Intelligence and Robotics ETF (NASDAQ:ROBT) steps to the front of the stage, ready for analysis.

Facts pattern underlining the fund’s economic value:

1. Exposure + benchmark
   • The fund invests in companies that operate within the software artificial intelligence and robotics segments. It tracks the Nasdaq CTA Artificial Intelligence and Robotics Index, a benchmark designed to track the performance of companies in AI and robotics operating in the technology, industrial, medical and other economic sectors. Constituents are categorized as 1) enablers, 2) engagers or 3) enhancers.
2. Holdings + assets under management
   • ROBT’s holdings are concentrated in the technology sector at 60% weighting. Industrial and consumer cyclical weights are at 21.8% and 8.95% respectively. The top 10 holdings comprise 21% of the portfolio, of which they are 118 holdings. The bulk of holdings are domiciled in the US.
   • It has $423mm in AUM and charges an expense fee of 65 basis points on this amount. This is considered to be on the higher side, around 35% above the median of all ETFs. The fund was inaugurated in 2018, and its share price has increased from loads of $25 to around $41, where it currently sits at the time of publication.
3. Additional factors
   • ROBT has a three-year tracking error to its benchmark of 16.3%, more than double that of the ETF universe median. Turnover is reasonably high as well, at 36%.
   • The fund does not pay a dividend. If adding this fund to the long account, investors are buying it for capital appreciation.
   • It has lagged the broad market’s return over the last 1-3 years.

Based on factors raised in this report, I rate ROBT a hold across all investment horizons.

Figure 1. ROBT Fund Performance, December 2021-November ’23. Just nudged above 50DMA after bouncing from 200DMA.

Talking points

Growth + adoption of AI cannot be ignored, and nearly every sector is seeking ways to integrate. Global investment in AI is set to have an impact on GDP. Goldman Sachs research says $200Bn of investment in “physical, digital, and human capital to acquire and implement new technologies and reshape business processes” would change the economic landscape with AI as the catalyst. It could lift global labour productivity by up to 10 percentage points over a decade, the firm says. The firm also sees value in the disruptive power of AI using its PEARLs framework. The long-term growth cycle may be to the benefit of the long-term investor.

Figure 2.

A central point in the AI productivity debate is labour displacement. Will humans be “replaced” by automation? Goldman illustrates in a separate note:

• Over history, jobs replaced by automation have been offset by the new jobs created,
• New occupations – after impactful innovations – have generated the “vast majority of long run employment growth”,
• Statistically speaking, >85% of growth in employment since 1943 has a causal link with new jobs created by technology.

These facts provide useful context in the AI debate. The point is, that any new industries created could prove to be immensely beneficial to the betterment of our economy + society, and unlock risk capital.

Figure 3.

• The place for AI in an actively managed portfolio

Already AI has made its inroads into finance + investment management. We have faster transaction speeds, for one. Analytics, programming and the like will also benefit.

For the non-quant side, there are investment opportunities:

1. A report by Man Group (OTCPK:MNGPF) on the critical themes of AI + finance noted that diversification was the value proposition for ML investment strategies.
2. Those at Bridgewater believe AI will be a “productivity enhancer” with peak benefits not for another ten years.
3. With those 2 points in mind, the likely value factors investors will realize will be efficiencies (decision making + speed) and the sales + earnings profile of public securities. This could create a wave of new investment opportunities.

RBOT’s top 10 holdings account for 21% of the portfolio, as mentioned earlier. The major positions are in names such as AeroVironment (AVAV), Splunk (SPLK) and Synopsys (SNPS). This is a relatively concentrated fund playing a substrata of the highly valued US tech sector.

Figure 4.

The problem is returns have been underwhelming to date. This is somewhat related to investment selection. ROBT builds the portfolio via a full replication technique of the Nasdaq CTA Artificial Intelligence and Robotics Index, as mentioned earlier. The index’s performance has been flat this year, mirroring the U.S. benchmarks in directional bias.

Will the good fortunes change moving forward? I would consider that (1) turnover in the index is high, leading to high turnover for ROBT, and (2) ROBT’s tracking error to its benchmark is equally as high, at 16% in the last 12 months. My judgement is that catalysts in the space will be concentrated as new ideas are quickly adopted by the AI majors. These factors are not constructive to a buy in my estimation.

Figure 5.

• Fundamentals are off point

In the current market, starting valuations make a world of difference to the next 12 months’ returns. ROBT trades at 27.5x earnings, surpassing the 12.7x category average and FactSet’s segment average of 11.7x. I find it difficult to see ROBT re-rating beyond this multiple in a rational world. Plus, the extent to which it can realistically compound is capped at the starting multiple of 27.5x. There are also no dividends to provide a cushion or investment income, thus balancing the valuation debate. Finally, 27x earnings are well above the zone of comfortable price I’d want to pay for any equity selection.

Technicals for consideration

Technicals are improving for ROBT and provide detailed analysis to price visibility into the coming weeks and months.

Observations from daily cloud chart (looking to coming weeks)

1. Clear breakout from downtrend. Price line crossed into cloud, lagging line yet to arrive.
2. Both turning line + conversion line upward = momentum.
3. Massive buying volume this week, above last 3 months’ average.
4. 2x gaps higher to take out previous highs. $42 is the next level on the upside, $38s on the downside.

Figure 6.

Observations + key levels

1. Breakout above cloud on price line. The lagging line yet to give the full signal. Look to volume spikes if/when the lagging line is about to cross.
2. Currently testing cloud top. This is a critical juncture. A lift from the $41.50s would be remarkable.
3. Expect pullbacks to the cloud base at ~$40 into December/January. These may be effective entry points and part of the trend.

Figure 7.

As a balancing factor, we have downside targets from the point and figure studies below, extending to $32.75 then $29.25. These would be sharp levels to pull back to. However, we can’t ignore the objective view of the directional bias on the market. ROBT’s equity line is not yet firmly in bullish territory. More evidence must still be gathered. So a whip back to $32 may not be out of the question.

Figure 8.

Discussion summary

AI + robotics are emerging as an exciting growth corner of the market. AI’s presence, in particular, cannot be ignored. Yet the question of investment returns has yet to be answered fully. The predictability of cash flows is not yet certain and many new ventures are still in the “prove it” stage. This makes the distribution of potential outcomes vastly greater than many intelligent investors will tolerate. There is no denying AI’s role in the future, but there’s no certainty on its investment value either. Further time is likely needed for the market to digest all of the moving parts and for more established capital roots to be sowed into the fields of our economy. This is a time where ROBT will mature. Net-net, I rate ROBT a hold.