Oscar-winning actress Reese Witherspoon may have irked the internet when she said the artificial intelligence revolution has begun, but ETF investors are certainly hoping she’s right.

Overall assets for thematic AI funds have skyrocketed in the past year, according to a recent report from J.P. Morgan Asset Management. While assets were at $10.3 billion a year ago, they hit $64.9 billion as of the end of June, according to data shared with ETF Upside. Artificial intelligence is now the top theme by AUM, followed by infrastructure, defense, cybersecurity and natural resources. The funds are a convenient vehicle for institutional money to trade broad exposure quickly with plenty of liquidity, said Erik Kratz, chief investment officer at Arena Private Wealth. But they also let passive-leaning investors feel active by targeting a theme without the concentration risk of a single stock.

“We view these thematic ETFs as sentiment-driven vehicles rather than an ETF that will be found in future retirees’ portfolios in 30 years,” Kratz said. “Real wealth is still built by owning great businesses directly within a secular theme like AI, and holding them through the volatility, not by rotating through a basket.”

Legally Bullish

Long-term plays or not, it’s no wonder that investors are excited to get exposure to the AI craze without having to commit to individual stocks, many of which have been volatile as investors weigh massive capital expenditures against potential returns. NVIDIA’s stock, for instance, sank to about $165 per share in April before soaring to above $230 in May. But AI has also helped accelerate a surge for thematic ETFs in general. Unlike previously popular niche funds like those focused on cannabis, these span many sectors including robotics, electric vehicles and data infrastructure:

• “What qualifies as ‘thematic’ continues to evolve as yesterday’s niche becomes today’s mainstream allocation (e.g., space and memory),” J.P. Morgan Asset Management Chief ETF Strategist Jon Maier and ETF Strategist Shannon Oliver recently wrote in a blog. In an interview with CNBC, Maier added that infrastructure, energy and materials are all “feeding into the AI story.”
• Overall AUM for thematic ETFs jumped by nearly 33% in the first half of the year to about $430 billion, J.P. Morgan found.

Sweet Home AI: Performance-wise, some of the most popular AI funds are doing their part to keep investors’ portfolios in the black. The iShares AI Innovation and Tech Active ETF (BAI) is up around 30% year to date, while the Global X Artificial Intelligence & Technology ETF (AIQ) is up around 15%.

Much like Fleetwood Mac, SpaceX … wants to be with you everywhere.

Since its explosive initial public offering in June, issuers and index providers have rushed to incorporate the aerospace and satellite communications company into their products. So far, it appears in 179 exchange-traded funds, according to a recent Morningstar analysis, including both your traditional broad market index funds and some thematics as well. But as more shares of the company become available, its weight could become oversized in some indexes and the products that track them, said Zachary Evens, a passive strategies analyst at Morningstar.

“That will be an important story going forward over this next year, as more shares get unlocked, as SpaceX crosses several milestones,” Evens said. “A: How many shares will become available; and B: What does that increase in float do to … its position in these benchmarks?”

Value Prop

One surprising finding from the Morningstar report is that SpaceX has already made its way into several value ETFs, specifically value index funds, he said. In other words, the company is being added to funds that hold stocks considered undervalued, despite the company’s sky-high market cap and reports of it even being overvalued. The reason behind its inclusion in these funds is that the products have rules in place to determine what is considered a value or a growth ETF. One metric some value funds take into account is price-to-earnings ratio, and because SpaceX’s PE ratio is currently negative, it can be considered a value company, he added.

“[SpaceX] found its way into SCHV, the Schwab ETF, which uses price-to-earnings as one of its criteria when deciding if a stock fits in the value or growth bucket,” Evens said. “The unusual cases test those rules, and that’s what happened here with SpaceX having a very negative price-to-earnings ratio.”

According to Morningstar data, some value funds that hold SpaceX include:

• The Schwab US Large-Cap Value ETF (SCHV), which has $15 billion in AUM, has a 0.27% allocation to the company.
• The iShares Russell 1000 Value ETF (IWD), which oversees $81 billion and allocates 0.02% to SpaceX.
• The Vanguard Russell 1000 Value ETF (VONV), which has an AUM of $21 billion and gives SpaceX a 0.02% weighting.

Space From the X? Should value fund investors be worried about SpaceX’s presence in value products? Probably not, Evens said, because right now, it claims a very small part in all of those strategies. But, it does highlight the need for investors to be aware of the rules that underpin these indexes because it can lead to different portfolio outcomes than expected, he added.

“Investors might think that the Russell 1000 index is pretty similar to the S&P 500 index, and that is generally true, but there are some important distinctions between those indexes, and unique cases, like SpaceX, test some of these index rules,” Evens said. “I think awareness of the underlying index rules is the most important takeaway for investors.”

Oh, the spoils of war.

The House of Representatives narrowly passed a record $1.15 trillion annual defense budget last week. It still needs Senate approval, but Washington’s appetite for military spending is clear, and the US isn’t alone. The EU, Japan and Middle Eastern nations have all been ramping up defense budgets, too, creating real sector opportunities for portfolios. Capturing them, however, takes more than pure defense-category investing: It requires knowing where the money actually flows.

“The defense ecosystem is actually much larger than most investors think,” said Chris Grisanti, chief market strategist at MAI Capital Management. “It can include industrial companies like autos — GM has a big defense business — and of course technology and communications companies.”

War All of the Time

Beyond active conflicts in Ukraine, Iran and Gaza, much of today’s defense spending is being driven by the global AI arms race, as nations rush to defend against cyberattacks and threats to financial systems. “The increase in defense spending is huge, and it will flow into many sectors,” Grisanti said. “My favorite way to play it would be broad industrial companies.”

Looking at some of the biggest sector ETFs that could benefit from increased defense spending, we’re already seeing strong performance and flows:

• The State Street Industrial Select Sector SPDR ETF (XLI) is up almost 16% this year, with $3.6 billion in net inflows, per ETF Database.
• The First Trust NASDAQ Cybersecurity ETF (CIBR) has surged 25% and taken in $470 million.
• The iShares US Telecommunications ETF (IYZ) has jumped 18% with roughly $470 million in flows of its own.

Pure-play defense ETFs, by comparison, are more mixed:

• iShares US Aerospace & Defense (ITA) and Invesco Aerospace & Defense (PPA) are both up about 8%, though ITA has shed $175 million in outflows.
• Global X Defense Tech (SHLD) is down 5% yet still pulled in $2.6 billion in new inflows.

A Game of Risk: Bigger budgets don’t immediately mean bigger revenue for contractors, either. “The spending still has to get through Congress and become actual contracts,” said Louis Kondratev, a trading associate at XFUNDS. “That backlog will be realized as revenue over multiple years, not immediately, but the stock can move sooner since investors would price in future growth.”

Defense investing also carries a narrow customer base. “You always have government risk: Money gets delayed, contractors get sued, there are claims of defects,” Grisanti said. “All that happens with a regular customer, too, but when you have only one client, and it’s the government, it’s a risk.”