AI’s Impact on Active Investing
Only a scant number of actively managed funds managed to beat the market over time. This trend becomes even more pronounced with the lengthening of the investment horizon. According to SPIVA (S&P Indices versus Active) research, only around 20% of funds outperformed the S&P 500 over a 5-year timeframe, and less than 15% did so over a 10-year period, respectively.
In light of this consistent underperformance, let’s explore how active funds using Artificial Intelligence (AI) as the primary driver for stock selection could be a key for breaking this trend.
Clarifying the Concept The term "AI ETFs" is often narrowly interpreted as ETFs that invest solely in AI sector companies. However, this perception, provides only a partial view of their scope. AI technology transcends its role from merely being a thematic exposure to driving the active decision-making processes within a fund. This approach dynamically identifies investment patterns, aiming for improved investment performance, showcasing the broader application of AI in the investment world. At Qraft Technologies, all our NYSE-listed ETFs, QRFT, AMOM, and LQAI, this innovative use of AI underscores our commitment to leveraging technology to enhance fund performance and adaptability.
How AI Differs from Quantitative Investing
Alternatively, ETFs utilizing AI technology also differ from traditional quantitative strategies that have been around for decades. Utilizing computers to develop and implement investment strategies is not a novel concept; it forms the basis of what is known as quantitative investing. However, AI extends well beyond the capabilities of traditional quantitative methods by simulating complex human decision-making processes. It continually learns and adapts from new data, evolving and refining its strategies over time.
Quantitative investing typically starts with a predefined hypothesis or investment thesis, which is then tested through back-testing before being applied to actual investments. AI investing, on the other hand, begins with the raw data itself, learning from the ground up without predefined biases or hypotheses. This fundamentally different approach allows AI to explore and exploit investment opportunities that may lie beyond the reach of traditional data analysis and quantitative models.
Significance
What are the significant potential merits of AI-driven investment strategies? There are two key advantages to consider.
The first potential advantage is the elimination of emotional biases. Human traders are often influenced by a range of psychological biases—such as fear, greed, and overconfidence—that can adversely affect their decision-making. These emotions can cloud judgment, leading to irrational trading decisions and, consequently, suboptimal investment outcomes. Behavioral economics has long studied how such biases impact economic decisions, underscoring the significant role that emotions can play in trading. AI, in contrast, operates devoid of these biases, potentially minimizing a significant source of error in investment decisions.
The second notable advantage of AI for investment decision making is its exceptional capacity for handling large volumes of data in a timely manner. Today’s global economy continuously generates massive amounts of data, growing exponentially each year. AI potentially provides the ability to process and respond to market data with unprecedented speed. This capability allows AI to identify optimal investment factors and construct portfolios that are well-tuned to current market conditions, potentially enhancing the risk-adjusted returns of investments. Through the use of sophisticated deep neural networks, Qraft's AI systems are capable of modeling complex, nonlinear relationships within financial data, thus accelerating the discovery of profitable investment patterns more efficiently and effectively, potentially transforming the landscape of investment strategy development.
Performance
Qraft Technologies launched two active ETFs in May of 2019. The Qraft AI-Enhanced Large Cap ETF and the Qraft AI-Enhanced Momentum ETF. These two funds use artificial intelligence to choose the holdings in the portfolio. As these funds have a five-year track record, this give investors insights on the possibilities that AI could bring to active management.
The performance data quoted represents past performance. Past performance does not guarantee future results. Current performance may be lower or higher than the performance data quoted. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost. Returns less than one year are not annualized. Performance data current to the most recent month end may be obtained by visiting qraftaietf.com.
The Future
As the financial landscape evolves, the growing recognition among major financial institutions of AI's potential to enhance investment decisions signals a transformative shift. This shift is not merely procedural but strategic, addressing key challenges observed in traditionally managed funds. The underperformance of actively managed funds, as highlighted at the outset of our discussion, is often influenced by limitations in human decision-making, slower reaction times to market shifts, and inherent biases that can cloud judgment.
AI-powered ETFs are poised to play an important role the industry as well as providing investors with access to AI-powered strategies in a transparent and potentially tax efficient manner. To this end, Qraft remains committed to ongoing refinement of its AI algorithms and is actively expanding its product range to include a broader array of AI-powered financial solutions.
QRAFT AI-Enhanced US Large Cap ETF (QRFT)
Investment Objective: Capital Appreciation
Costs & Expenses: 0.75%
Liquidity: Because the Fund is an ETF, only a limited number of institutional investors (known as “Authorized Participants”) are authorized to purchase and redeem shares directly from the Fund. In addition, there may be a limited number of market makers and/or liquidity providers in the marketplace. To the extent either of the following events occur, shares of the Fund may trade at a material discount to their net asset value (“NAV”) per share and possibly face delisting: (i) Authorized Participants exit the business or otherwise become unable to process creation and/or redemption orders and no other Authorized Participants step forward to perform these services, or (ii) market makers and/or liquidity providers exit the business or significantly reduce their business activities and no other entities step forward to perform their functions.
Risk: Investing involves risk, including loss of principal. The Fund is subject to numerous risks including but not limited to: Equity Risk, Sector Risk, Large Cap Risk, Management Risk, and Trading Risk. The Fund relies heavily on a proprietary artificial intelligence selection model as well as data and information supplied by third parties that are utilized by such model. To the extent the model does not perform as designed or as intended, the Fund’s strategy may not be successfully implemented and the Fund may lose value. Additionally, the fund is non-diversified, which means that it may invest more of its assets in the securities of a single issuer or a smaller number of issuers than if it were a diversified fund. As a result, each Fund may be more exposed to the risks associated with and developments affecting an individual issuer or a smaller number of issuers than a fund that invests more widely. A new or smaller fund’s performance may not represent how the fund is expected to or may perform in the long term if and when it becomes larger and has fully implemented its investment strategies. Read the prospectus for additional details regarding risks.
Fluctuation of Principal or Return: As with all funds, a shareholder is subject to the risk that his or her investment could lose money.
Tax Features: Distributions from ETFs are subject to taxation.
SPDR S&P 500 ETF Trust (SPY)
Investment Objective: The Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the “Index”).
Costs & Expenses: 0.09%
Liquidity: As with all exchange-traded funds, Fund Shares may be bought and sold in the secondary market at market prices. The trading prices of Fund Shares in the secondary market may differ from the Fund’s daily net asset value per share and there may be times when the market price of the shares is more than the net asset value per share (premium) or less than the net asset value per share (discount). This risk is heightened in times of market volatility or periods of steep market declines
Risks: Investing involves risk, including loss of principal. The Fund is subject to numerous risks including but not limited to: Equity Risk, Sector Risk, Large Cap Risk, Management Risk, and Trading Risk. The Fund relies heavily on a proprietary artificial intelligence selection model as well as data and information supplied by third parties that are utilized by such model. To the extent the model does not perform as designed or as intended, the Fund’s strategy may not be successfully implemented and the Fund may lose value. Additionally, the fund is non-diversified, which means that it may invest more of its assets in the securities of a single issuer or a smaller number of issuers than if it were a diversified fund. As a result, each Fund may be more exposed to the risks associated with and developments affecting an individual issuer or a smaller number of issuers than a fund that invests more widely. A new or smaller fund’s performance may not represent how the fund is expected to or may perform in the long term if and when it becomes larger and has fully implemented its investment strategies. Read the prospectus for additional details regarding risks.
Fluctuation of Principal or Return: As with all investments, there are certain risks of investing in the Trust, and you could lose money on an investment in the Trust.
Tax Features: The Trust will make distributions that are expected to be taxable currently to you as ordinary income and/or capital gains, unless you are investing through a tax-deferred arrangement, such as a 401(k) plan or individual retirement account.
QRAFT AI-Enhanced US Large Cap Momentum ETF (AMOM)
Investment Objective: Capital Appreciation
Costs & Expenses: 0.75%
Liquidity: Because the Fund is an ETF, only a limited number of institutional investors (known as “Authorized Participants”) are authorized to purchase and redeem shares directly from the Fund. In addition, there may be a limited number of market makers and/or liquidity providers in the marketplace. To the extent either of the following events occur, shares of the Fund may trade at a material discount to their net asset value (“NAV”) per share and possibly face delisting: (i) Authorized Participants exit the business or otherwise become unable to process creation and/or redemption orders and no other Authorized Participants step forward to perform these services, or (ii) market makers and/or liquidity providers exit the business or significantly reduce their business activities and no other entities step forward to perform their functions.
Risks: Investing involves risk, including loss of principal. The Fund is subject to numerous risks including but not limited to: Equity Risk, Sector Risk, Large Cap Risk, Management Risk, and Trading Risk. The Fund relies heavily on a proprietary artificial intelligence selection model as well as data and information supplied by third parties that are utilized by such model. To the extent the model does not perform as designed or as intended, the Fund’s strategy may not be successfully implemented and the Fund may lose value. Additionally, the fund is non-diversified, which means that it may invest more of its assets in the securities of a single issuer or a smaller number of issuers than if it were a diversified fund. As a result, each Fund may be more exposed to the risks associated with and developments affecting an individual issuer or a smaller number of issuers than a fund that invests more widely. A new or smaller fund’s performance may not represent how the fund is expected to or may perform in the long term if and when it becomes larger and has fully implemented its investment strategies. Read the prospectus for additional details regarding risks.
Fluctuation of Principal or Return: As with all funds, a shareholder is subject to the risk that his or her investment could lose money.
Tax Features: Distributions from ETFs are subject to taxation.
Behavioral Bias: Behavioral biases are irrational beliefs or behaviors that can unconsciously influence our decision-making process. Emotional biases involve taking action based on our feelings rather than concrete facts, or letting our emotions affect our judgment. Cognitive biases are errors in our thinking that arise while processing or interpreting the information that is available to us.
iShares MSCI USA Momentum Factor ETF (MTUM)
Investment Objective: The iShares MSCI USA Momentum Factor ETF (the “Fund”) seeks to track the investment results of an index composed of U.S. large- and mid-capitalization stocks exhibiting relatively higher price momentum.
Costs & Expenses: 0.15%
Liquidity: Only authorized participants (“APs”) may engage in creation or redemption transactions directly with the Fund. The Fund has a limited number of institutions that may act as APs and such APs have no obligation to submit creation or redemption orders. Consequently, there is no assurance that APs will establish or maintain an active trading market for the Shares. This risk may be heightened to the extent that securities held by the Fund are traded outside a collateralized settlement system. In that case, Aps may be required to post collateral on certain trades on an agency basis (i.e., on behalf of other market participants), which only a limited number of APs may be able to do. In addition, to the extent that Aps exit the business or are unable to proceed with creation and/ or redemption orders with respect to the Fund and no other AP is able to step forward to create or redeem Creation Units, this may result in a significantly diminished trading market for Shares, and Shares may be more likely to trade at a premium or discount to the Fund’s net asset value (“NAV”) and to face trading halts and/or delisting. Investments in non-U.S. securities, which may have lower trading volumes, may increase this risk. The Fund faces numerous market trading risks, including the potential lack of an active market for the Shares, losses from trading in secondary markets, and disruption in the creation/redemption process of the Fund. Any of these factors may lead to the Shares trading at a premium or discount to the Fund’s NAV.
Risk: Investing involves risk, including loss of principal. The Fund is subject to numerous risks including but not limited to: Equity Risk, Sector Risk, Large Cap Risk, Management Risk, and Trading Risk. The Fund relies heavily on a proprietary artificial intelligence selection model as well as data and information supplied by third parties that are utilized by such model. To the extent the model does not perform as designed or as intended, the Fund’s strategy may not be successfully implemented and the Fund may lose value. Additionally, the fund is non-diversified, which means that it may invest more of its assets in the securities of a single issuer or a smaller number of issuers than if it were a diversified fund. As a result, each Fund may be more exposed to the risks associated with and developments affecting an individual issuer or a smaller number of issuers than a fund that invests more widely. A new or smaller fund’s performance may not represent how the fund is expected to or may perform in the long term if and when it becomes larger and has fully implemented its investment strategies. Read the prospectus for additional details regarding risks.
Fluctuation of Principal or Return: As with all funds, a shareholder is subject to the risk that his or her investment could lose money.
Tax Features: The Fund’s distributions generally are taxed as ordinary income, capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a 401(k) plan or an individual retirement account; in which case your distributions may be taxed as ordinary income when withdrawn from such account.
Artificial Intelligence (AI) does not guarantee a gain or protect against a loss.