AI stock selection misses AI stocks, actively picking stocks underperforms the market in the long run

The buzz around AI this year has also sparked a wave of investment, but a WSJ article points out that AI funds have missed out on the boom of AI stocks. Tech stocks are driving the bull market, but AI-driven ETFs are lagging behind.

AI Stock Selection Missed the Hottest G7 Stocks of the Year

The WisdomTree U.S. AI Enhanced Value Fund AIVL, established since 2006, introduced by WisdomTree, selects companies with value characteristics based on a proprietary quantitative AI model developed by Voya Investment Management to seek income and capital appreciation. The fund has assets of $385 million. As of August 21st, the total return of the closing price is 0.65%, while the benchmark it tracks, the Russell 1000 Value ETF, has risen by 4.5%.

According to WSJ analysis, the main reason for AIVL's underperformance is that AI refused to buy stocks of Meta, the parent company of Facebook. Meta's stock price has surged from $122 at the beginning of the year to $289.9 yesterday, even reaching a high of $325 in between, with a whopping 137% increase year to date.

Looking at the major holdings of AIVL, the top three holdings are Comcast Corp in the communication industry, Abbott Laboratories in pharmaceuticals, and Medtronic Plc in medical technology. It doesn't even hold the hottest G7 stocks of the year.

Note: The G7 refers to the seven major U.S. tech giants, including Microsoft, Meta, Apple, Amazon, Google, Tesla, and Nvidia, which have been driving the surge in the U.S. stock market this year, with Nvidia leading the astonishing AI wave.

AI Currently Limited to Mimicking History

Funds driven by artificial intelligence aim to avoid the costs of human behavior and bring hedge fund-like techniques to the public. Research by Eric Ghysels, professor of economics and finance at the University of North Carolina at Chapel Hill, shows that in some cases, AI can more accurately time stock trades than individual investors. However, AI cannot quickly adapt to unforeseen events such as 9/11 or Russia's invasion of Ukraine, making it unreliable over time to surpass professional fund managers.

Perhaps one day it will happen, but for now, AI is limited to mimicking history.

Another AI Powered Equity ETF, AIEQ, is an actively managed ETF created using EquBot's proprietary algorithm, utilizing IBM Watson's cognitive and big data processing capabilities to analyze investment opportunities in the U.S. It aims for long-term capital appreciation. It outperformed major indices in its initial years but suffered significant losses in 2022 due to a sharp stock market decline triggered by the Federal Reserve's substantial interest rate hikes. AIEQ has a total return of about 44% since its inception, while the SPY ETF tracking the S&P 500 index has a total return of 93% during the same period. This is also attributed to the fact that AI's historical data did not include such violent interest rate hikes.

Warren Buffett's Ten-Year Bet, No One Can Beat the Market

In 2007, Warren Buffett initiated a century-long bet, believing that no fund could consistently outperform the market, and only one person, Ted Seides, a partner at Protégé Partners, stepped up to bet against him.

Ultimately, Buffett specified that the ETF tracking the S&P 500 had a return of 125.8%, far surpassing Ted Seides' 36.3% return from his selected five hedge funds.

Buffett has repeatedly stated in shareholder letters: For the average non-professional investor, the best investment option is low-cost index funds. It appears that even AI stock selection has not been able to break this rule.