3 ETFs for Diversifying Beyond AI

Key Concepts

• Artificial Intelligence (AI)
• Exchange Traded Funds (ETFs)
• Fundamental Investing
• Market Capitalization
• Price-to-Fundamentals Ratio
• Growth Expectations
• Value Investing
• Midcap and Small Cap Stocks
• International Equities
• Quantitative Active Investing
• Morningstar Global Markets Index
• Nvidia
• Tesla
• Schwab Fundamental US Large Company ETF (FNDX)
• Dimensional US Targeted Value ETF (DFAT)
• JP Morgan International Research Enhanced Equity ETF (JIRE)
• MSCI EAFE Index

AI's Dominance in Business and Investment

The transcript highlights Artificial Intelligence (AI) as a leading business topic, acknowledging that this might be a biased observation due to the source (ChatGPT). Nevertheless, AI's profound impact on the global economy and investment portfolios is undeniable. The profit potential of AI companies is described as "astronomical," but this is mirrored by the high valuations these companies command.

Market Concentration and Investor Risk in AI

• Morningstar Global Markets Index: This index, comprising 7,500 global companies, shows Nvidia, a key player in AI chip manufacturing, holding over 4% of the total global portfolio.
• Top 10 Companies: A significant portion (over 22%) of the value of global public companies is concentrated within just 10 entities. These companies are primarily engaged in the race for superior AI models, advanced AI chips, or effective AI technology distribution.
• Investor Overexposure: The transcript suggests that investors may be placing "too much" reliance on AI, indicating a potential risk of overexposure.

ETFs for Balancing AI Exposure

To mitigate the risk of over-reliance on AI, the speaker proposes three ETFs designed to reduce AI exposure without completely abandoning the sector.

1. Schwab Fundamental US Large Company ETF (FNDX)

• Methodology: FNDX employs a fundamental approach, grounding portfolio holdings and their weights in financial metrics rather than solely market prices.
• Targeting: It focuses on large and midcap US stocks.
• Weighting Criteria: Holdings are weighted based on sales, cash flows, dividends, and buybacks.
• Rebalancing Strategy: The fund sells exposure to companies whose prices have outpaced their fundamentals and buys companies that have become relatively cheaper based on these metrics. This is described as a "contrarian approach."
• Impact on High Growth Expectations: This strategy limits exposure to companies with very high growth expectations.
• Specific Holdings: Nvidia and Tesla each represent less than 0.5% of FNDX's portfolio.
• Performance: Over the past 10 years, FNDX has achieved an annualized return of 13%, placing it in the top 5% of funds in the "large value boring star" category.

2. Dimensional US Targeted Value ETF (DFAT)

• Objective: DFAT is recommended for investors seeking to augment their core US stock exposure with a different investment strategy.
• Focus: It concentrates on the "cheaper half" of US mid and small-cap stocks in a cost-effective manner.
• Exclusions: Nvidia and Tesla are not included in this portfolio.
• Diversification: The ETF invests in approximately 1,400 companies, with its top 10 holdings accounting for only 6% of the portfolio.
• Profitability Filter: It excludes the least profitable companies.
• Weighting: Companies that meet the profitability criteria are weighted by market capitalization.
• Approach: This is characterized as a "cost-conscious approach" that avoids overpaying for speculative growth prospects.
• Track Record: DFAT's mutual fund sibling has outperformed the Russell 2000 Value Index by 2 percentage points annualized over the decade ending December 2024.

3. JP Morgan International Research Enhanced Equity ETF (JIRE)

• Objective: This ETF aims to diversify investment outside the US and employs a bottom-up fundamental research process to identify companies trading at attractive prices.
• Type: It is an actively managed ETF.
• Strategy: JIRE combines elements of index and quantitative active investing to enhance returns relative to its benchmark.
• Holdings: It invests in MSCI EAFE (Europe, Australasia, and Far East) stocks.
• Stock Selection: The fund tilts towards companies favored by JP Morgan analysts and steers away from those they do not recommend. Stock picking is identified as a primary driver of relative returns.
• Benchmark Tracking: The ETF is designed to closely track the MSCI EAFE index, suggesting similar return profiles.
• Performance: Since its inception in 2022, JIRE has outperformed its index-tracking peers by a few percentage points in total returns.

Further Resources

Investors are encouraged to visit Morningstar's ETF research page at morningstar.com/topics/etfs for more information and ETF picks.

Conclusion

The transcript emphasizes the significant influence of AI on the investment landscape, leading to high valuations and potential investor overexposure. To manage this risk, the speaker recommends three ETFs – FNDX, DFAT, and JIRE – each employing distinct strategies (fundamental weighting, value focus on smaller caps, and international active research) to provide a more balanced portfolio without completely divesting from AI-related opportunities. These ETFs are presented as tools to ground portfolios in fundamentals, diversify holdings, and potentially achieve long-term outperformance.