There Are Lots of Ways to Invest in Artificial Intelligence (AI). Avoid This One.

The WisdomTree Artificial Intelligence and Innovation Fund (WTAI -5.14%) is yet another exchange-traded fund (ETF) product that Wall Street is looking to sell to investors. That’s not an idle statement because the sponsor is charging a fairly material 0.45% expense ratio for what amounts to a product tied to a hot investment theme.

Be careful if you are considering WisdomTree Artificial Intelligence and Innovation Fund; you’d probably be better off in an S&P 500 index ETF.

What does WisdomTree Artificial Intelligence and Innovation Fund do?

WisdomTree’s offering is an index-based ETF, so, technically, all that WisdomTree does is match the portfolio to that of the index. The real question, then, is what is the index that WisdomTree Artificial Intelligence and Innovation Fund follows? That would be the WisdomTree Artificial Intelligence & Innovation Index. To WisdomTree’s credit, it provides a link to the index right in the objective statement. Far too many ETFs make you search for this information on your own.

The WisdomTree Artificial Intelligence & Innovation Index is “designed to provide exposure to equity securities of exchange-listed companies globally, which are primarily involved in the investment theme of Artificial Intelligence and Innovation.” That’s what you would expect to read, but how, exactly, does it go about doing that? To find this out, you need to read the index methodology document. Once again, WisdomTree has helpfully made this document easily accessible.

In this document, you’ll find that WisdomTree Artificial Intelligence & Innovation Index buys stocks that operate in the software, semiconductor, and hardware sectors. As for the innovation piece of the puzzle, WisdomTree defines it as “companies that introduce a new, creative, or different (i.e., ‘innovative’) technologically enabled product or service in seeking to potentially change an industry landscape, as well as companies that service those Innovative technologies, particularly those related to artificial intelligence.”

WisdomTree Artificial Intelligence and Innovation Fund is a big question mark

So, you know what stocks are being considered for the index, more or less, but how does a stock actually get into the index? That’s a little more tricky. According to the methodology, the index is “overseen by the WisdomTree Artificial Intelligence Index Committee.” The key explanation around the actual selection process is: “Qualitative and quantitative characteristics of eligible companies are evaluated by the Committee. Companies that are representative of the aforementioned Artificial Intelligence Activities and Innovation are selected for inclusion in the Index by the Committee.”

That sounds great, but step back and reread the two statements. They don’t actually tell you anything meaningful about the final selection process. The committee analyzes stocks. Stocks that are related to AI get into the index. Are the stocks expected to be good investments? Does the analysis being done actually change anything about the selection process? There is a lot of room for assumptions to be made in a situation where a clearer description could easily be created.

Then there’s the weighting methodology, which is described as “a hierarchical, multi-category, modified equal-weighted index.” What does that mean? The description continues, “The Committee makes strategic decisions regarding the weight allocated to each of the Artificial Intelligence Activities and Innovation themes based upon market forecasts, equal weighting the constituent stocks which are selected for inclusion based upon quantitative and qualitative criteria.”

WTAI data by YCharts

That sounds like the committee is strategically weighting the portfolio among the software, semiconductor, and hardware sectors, overweighting the sectors it likes the most. And then it equal-weights the stocks. So, it’s kind of an index fund and kind of not, which brings the story down to performance. As the chart above highlights, WisdomTree Artificial Intelligence and Innovation Fund has woefully underperformed the S&P 500 index and the broader technology sector since its inception. And that has occurred despite the popularity of many AI stocks over that time. It seems like WisdomTree’s ETF has gone to a lot of effort to be easily outperformed by much simpler ETFs.

What are you paying for all of this?

Perhaps the best part of the story is that WisdomTree Artificial Intelligence and Innovation Fund comes along with a 0.45% expense ratio. That’s kind of high for an ETF. But that’s what you get to pay to own an ETF that is hard to understand, invests in a niche that might be a fad, and underperforms broader offerings with materially lower expenses. This is one ETF that’s probably best avoided by most investors.