As Nvidia drives a chip rally in 2024, why are some AI stocks getting left behind?

By Isabel Wang

The underperformance of AI ETFs suggests the ripple effects of Nvidia's success haven't yet reverberated throughout the industry

This was supposed to be a year for the entire semiconductor industry to shine amid booming artificial-intelligence demand. Yet Nvidia Corp. has once again taken center stage in the first half of 2024 - propelling the stock-market rally but leaving some AI names trailing in its wake.

Nvidia (NVDA) is now the undisputed leader of the AI frenzy, having earlier this week become the world's most valuable public company (before swiftly giving back that title). But the recent underperformance of some AI-related exchange-traded funds suggests the ripple effects of Nvidia's success haven't yet reverberated throughout the rest of the AI industry, according to market analysts.

The Global X Robotics & Artificial Intelligence ETF BOTZ, which has $3 billion in assets under management, has fallen by 4.7% over the past three months, while the VanEck Semiconductor ETF SMH - the largest fund in the chip industry, with nearly $24 billion assets under management - has advanced 19.7% in the same period.

For the year, BOTZ is up 7.9%, compared with a 51.5% advance for SMH and a 18.7% gain for the Technology Select Sector SPDR Fund XLK, which tracks a broader range of tech stocks, according to FactSet data.

"Nvidia's astronomical returns in the first half of 2024 are a catalyst for all of the funds, but [for] the AI-themed ETFs, it's happening to a lesser degree," said Todd Rosenbluth, head of research at VettaFi.

To be sure, most of the AI-related thematic and tech-sector ETFs count Nvidia's stock, which has jumped 155% so far in 2024, as their largest holding. Nvidia makes up more than one-quarter of SMH's assets and is followed by other chip performers such as Broadcom Inc. (AVGO), Qualcomm Inc. (QCOM) and Micron Technology Inc. (MU) Shares of those names are up 49%, 47% and 63% this year, respectively, according to FactSet data.

BOTZ has a Nvidia weighting of more than 13%, but the performance of its other components - primarily robotic and industrial-automation companies traded on foreign stock exchanges - has been sluggish this year to date.

The Global X Artificial Intelligence & Technology ETF AIQ, which is down 4.6% over the past three months, has a 5.8% weighting in Nvidia. Its top 10 holdings include nonchip tech companies such as Tencent Holdings Ltd. (HK:700), Netflix Inc. (NFLX) and Meta Platforms Inc. (META), according to FactSet data.

See: Nvidia is one of the 'three horsemen of AI.' Here are the others.

Rosenbluth noted that individual components of an ETF can significantly drive a fund's ultimate performance, which explains why investors could benefit more from a fund's increased exposure to Nvidia compared to companies that are "not riding the same tailwinds."

He added that those robotic-themed ETFs usually have more exposure to industrial companies, which are "more tied to the overall health of the U.S. economy" and could weigh down a fund's performance.

ETFs like BOTZ and AIQ are thematic funds targeting companies that are believed to benefit from an emerging trend, such as artificial intelligence, while sector-related ETFs such as SMH track firms in "a better-classified group" regardless of their connectivity to a theme, Rosenbluth said. "But you often get exposure to the strongest theme within a sector and [it] tends to drive the performance," he added.

Dan Faggella, founder and head of research at Emerj Artificial Intelligence Research, said that Nvidia's focus on AI beyond traditional tech sectors suggests a broadening landscape for AI applications - but that doesn't necessarily mean "other semiconductor and tech players are growing automatically."

"Stock prices are based on opinions and dollars moving in the physical world, but money flows are overwhelmingly centered around Nvidia, despite all the other startups that have tried to come up," Faggella told MarketWatch. "There's really nobody standing in its [Nvidia's] way right now."

There's also "scale production" and "reliability" problems that have made it almost impossible for other smaller-sized AI players to actually deliver a return on investment, Faggella added.

"These newer innovators, even if they can come up with hardware that's better than Nvidia, they can't produce it at scale for big buyers," he said, adding that investors also don't want to risk their money on startups who might go out of business in a few years. "They just want to go with Nvidia because it is not going to go away."

See: Not all semiconductor ETFs are the same. What investors need to know before betting on Nvidia and other chip stocks.

Still, if investors are concerned about how much exposure they have to Nvidia, the thematic and sector ETFs that are now lagging behind might be "more appropriate choices" than those having a 20% weighting in one stock, Rosenbluth said.

"If Nvidia stops leading the tech, and other companies perform relatively well going forward, that will be a drag on a market-cap weighted approach, and will be a benefit to something that's more equally weighted by its nature," he said.

U.S. stocks finished mostly lower on Friday as Nvidia stock pulled back for a second day. On a weekly basis, the Nasdaq Composite COMP ended nearly flat, while the S&P 500 SPX edged up 0.6% and the Dow Jones Industrial Average DJIA advanced 1.5%, according to FactSet data.

-Isabel Wang

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06-22-24 0730ET

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