Bob’s Journal for 1/18

Can Artificial Intelligence Improve Investment Returns?

Artificial intelligence, or AI, became mainstream in 2023.

Businesses increased their use of it, and investors sought ways to invest in AI. But can using AI as part of the investment process improve your investment returns?

A number of investment firms, including some exchange-traded funds (ETFs), have been developing AI models and using them to manage at least part of their portfolios for several years, and the results aren’t good yet.

The first ETF to rely fully on AI, and that’s still operating, is AI Powered Equity (AIEQ).

The ETF uses IBM’s Watson program to select its portfolio. The ETF sponsor says Watson is the equivalent of 1,000 investment professionals working around the clock.

AIEQ’s been operating since late 2017. It consistently has been in the bottom half and usually the bottom quarter of large growth stock ETFs in Morningstar’s rankings.

For example, it lost 31.90% in 2022 and gained 26.47% in 2023.

In the one-, three-, and five-year rankings, its best finish is the 93% percentile.

Coincidentally, AIEQ has been on a positive run lately. It is in the top 1% for the last four weeks and top 3% over three months. But it is in the bottom 97% for the year to date.

Other ETFs I’ve been able to find that invest in the broad equity market and use primarily AI are BTD Capital (DIP) and WisdomTree International AI Enhance Value (AIVI).

DIP hasn’t been around long and doesn’t have a distinguished performance in that time.

AIVI apparently only shifted to an AI strategy in January 2022, using a model developed by Voya Investment Management, so its extensive record before that isn’t relevant. It is not clear whether the fund relies entirely on the AI model or AI is a tool used by the management team.

AIVI’s relative performance has improved since the change, rising from the bottom half to the lower part of the top half in its Morningstar category.

There are a few other ETFs that say they use AI in whole or in part, but they haven’t been around long and don’t have enough assets under management to qualify for inclusion in the major databases.

The investment markets are one of the toughest tests for AI. There are numerous factors that influence investment prices. And machine learning needs much more historic data than currently is available for most investments and markets.

The large hedge fund firm, Bridgewater Associates, said it recently turned a small portion of its portfolio over to an AI tool it has been developing for years.

A few other successful hedge funds say quantitative tools have been keys to their investment returns. But it isn’t clear to outsiders if the tools are sophisticated enough to qualify as AI. The extent to which the technology dictates portfolio positions also isn’t clear.

Investment firms that do use software successfully say they constantly are updating their systems.

The bottom line is it will be at least a few more years before there is a widely available AI model that will do better than an index fund.

Why Airlines and Other Businesses Push Credit Card Offers

Airlines, hotels, and other major businesses spend a lot of resources asking you first to sign up for credit cards affiliated with them (known as affinity cards) and then use the cards for a lot of your spending.

The arrangement is very profitable for everyone concerned, and some recent reports reveal how profitable the cards can be.

Of course, the card users receive benefits. Each dollar spent on the card usually earns a point, and points can be redeemed or spent in many ways in most programs.

Points can be converted to cash or gift cards or applied against the monthly bill. Or the points can be redeemed in the business’s customer loyalty program, resulting in free flights or hotel rooms, upgrades, and more.

The businesses who sponsor the cards also do quite well.

Consider the Delta Airlines affinity card from American Express.

The total spending on the cards recently was nearly 1% of the U.S. gross domestic product, according to The Wall Street Journal. Delta will receive almost $7 billion from American Express in 2024 as its share of purchases charged to the cards. Delta received almost that much revenue from its main business of flying passengers in 2022. Delta’s goal is to increase its annual take from the cards to $10 billion within a few years.

The affinity credit card is such a good deal for Delta that it recently rewrote the rules for its frequent-flier rewards program. The number of flights or miles flown no longer count. The only metric that counts toward rewards now is spending. Spending on the cards earns points, even spending that’s unrelated to Delta.

You can see why many businesses, nonprofits, and others offer affinity credit cards and spend a lot of time promoting their use.

Of course, the financial services companies make a lot of money managing the cards.

The only people who don’t do well under the affinity card programs are the unrelated businesses who accept the cards as payment and pay processing fees to the card companies.

Most of us can increase our standard of living, at least a few thousand dollars a year, by selecting a payment card that earns rewards points for spending, and then using that card for as many payments as possible.

An ETF Recap for 2023

There’s a lot of activity in exchange-traded funds (ETFs) every year, and 2023 was no different.

There were about 520 new ETFs in 2023, according to a summary from Morningstar. But 244 ETFs were shuttered during the year, leaving about 3,500 ETFs vying for a place in your portfolio.

The ETFs took in about $598 billion in new money in 2023.

Commodity ETFs took a big hit because Barclays decided to close most of the iPath series of exchange-traded note (ETN) funds that focused on commodities and had been around for a while. (ETNs technically aren’t ETFs, but are similar enough to be included as ETFs in industry summaries.)

Barclays closed 23 of the commodity ETNs. Actions from other firms brought the total of closed commodity ETFs to 30. On average, the closed commodity ETFs were 8.5 years old but had only $25 million of assets.

Another 34 funds focused on large company stocks folded in 2023. This is the most crowded segment of the ETF market and a tough sector for a new fund to gain traction.

Leveraged funds that try to earn multiples of an index’s return saw 12 of their number closed. There was a surge in launches of these types of funds in 2021 and 2022, and their sponsors decided in 2023 some of the funds weren’t going to attract enough investors to be viable.

There were no real surprises in 2023. ETF providers have a history of issuing a lot of new funds and hoping some of them attract enough investor dollars to be viable.

Often, the new ETFs are in niche areas because the major investment categories already are dominated by the top three ETF providers. As in past years, many of the sponsors of niche and esoteric ETFs decided a bunch of the funds hadn’t attracted enough investors and it was time to liquidate them.

The Data

Retail sales rose 0.6% in December, which follows a 0.3% increase in November. Over 12 months, retail sales climbed 5.6% through December after gaining 4% through November.

Excluding autos and gasoline, retail sales were 0.6% higher in both December and November and jumped 5.8% over 12 months through December.

Industrial production increased 0.1% in December after being unchanged in November. Over 12 months, production is 1% higher through December after being down 0.6% through November.

Manufacturing production increased 0.1% in December, which is down from a 0.2% rise in November.

Over 12 months, manufacturing production was 1.2% higher through December after slipping 1.0% through November.

In January, the Empire State Manufacturing Index fell to its lowest level since May 2020, negative 43.7. It was negative 14.5 in December.

Home builders were a little more optimistic in January. The Housing Market Index from the National Association of Home Builders (NAHB) rose to 44 from 37 in December.

The index had declined in each of the four previous months. But any reading below 50 generally indicates the market is contracting. The index last was above 50 in July 2023.

The Consumer Price Index (CPI) increased 0.3% in December, following a 0.1% gain in November. Over 12 months, the CPI rose 3.4% through December after being up 3.1% through November.

The core CPI, which excludes food and energy prices, rose 0.3% in both December and November. Over 12 months, the core CPI was up 3.9% through December and 4.0% through November.

The Producer Price Index (PPI) declined 0.1% in both December and November. Over 12 months, the PPI was up 1.0% through December and 0.8% through November.

The core PPI was unchanged in both December and November. Over 12 months, the core PPI rose 1.8% through December and 2.0% through November.

New unemployment claims declined by 1,000 to 202,000 in the latest week.

Continuing claims, which lag a week behind new claims, decreased to 1.834 million from 1.868 million.

The Markets

The S&P 500 rose 0.22% for the week ended with Tuesday’s close. The Dow Jones Industrial Average lost 0.41%. The Russell 2000 fell 2.12%. The All-Country World Index (excluding U.S. stocks) declined 0.96%. Emerging market equities retreated 1.90%.

Long-term treasuries lost 1.86% for the week. Investment-grade bonds declined 0.33%. Treasury Inflation-Protected Securities (TIPS) gained 0.37%. High-yield bonds rose 0.03%.

On the currency front, the U.S. dollar gained 0.87%.

Energy-based commodities fell 0.20%. Broader-based commodities lost 1.10%. Gold rose 0.03%.

Bob’s News & Updates

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