When discussing progress made in AI technology so far, a common phrase stated one way or another is, “We’re in the early innings." Baseball references aside, it is largely thought that the buildup of AI infrastructure is part of the first stage of this new technology. In 2022, ChatGPT showed how useful large language models (LLMs) can be. This sparked big investments over the following years. Four hyperscaler firms will invest over $300 billion in AI infrastructure in 2025.
However, AI infrastructure won’t have a fully revolutionary impact on society in a vacuum. To do this, the world will need revolutionary AI applications, particularly software. Many see this as the next phase of AI. This brings up an interesting fund, the iShares Expanded Tech-Software Sector ETF (NYSE:IGV). It holds many software companies that are developing AI products. So, does this ETF offer a strong way to play the next phase of AI while reducing company-specific risk?
IGV: Holdings Deep Dive and AI Exposure Analysis
Looking at IGV’s holdings reveals it has a large stake in companies deeply involved in using software to further AI. It has an 8.7% weight in Microsoft (NASDAQ: NASDAQ:MSFT), essentially tied for its largest holding with Oracle Corporation (NYSE:ORCL) as of Mar. 10. Microsoft plays in both the AI infrastructure and software space. Its Azure platform provides a computing infrastructure that AI software can run on in the cloud.
Additionally, the firm has made a significant investment in OpenAI, the maker of ChatGPT. According to the Wall Street Journal, the company is effectively entitled to 49% of the earnings in OpenAI’s for-profit arm, up to a certain limit. At this point, OpenAI is the preeminent name in AI applications.
Meanwhile, Oracle (NYSE:ORCL) also plays a significant role in AI infrastructure and software. The company mentioned in its latest earnings call that its Autonomous Database product grew by 42%, an increase from last year’s 32% growth. The Autonomous Database uses AI to help develop applications, analyze data, and automate low-value-added tasks. Oracle’s place as an enterprise resource planning stalwart gives it a strong link with many large businesses, which can help Oracle expand its AI software relationships over time.
IGV also allocates significantly to some of the more high-flying and pure-play software names committed to AI. This includes stocks like Salesforce Inc (NYSE:CRM) and Palantir Technologies Inc (NASDAQ:PLTR). These companies have been largely building their businesses around AI applications or shifting their focus significantly toward them.
Overall, many of the over 100 software companies within IGV are building or have already built software tools focused on AI. However, this focus varies significantly from holding to holding. For some, everything revolves around AI, while for others, it is far from the main area of importance.
IGV: Software Focus Has Advantages Over Other Funds
One interesting aspect of IGV compared to other funds with AI in their names is that it doesn’t include firms centered on robotics. For example, the Global X Robotics & Artificial Intelligence ETF (NASDAQ:BOTZ) has a large weighting toward robotics-centric stocks.
Its 33% weighting in the industrials sector exemplifies this. This is important to point out due to the difference in profitability for robotics firms versus software companies. High margins, scalability, and recurring revenue characterize software.
Meanwhile, robotics companies can have trouble achieving even positive gross margins. Their products also take a long time to build, and sales deals can have complicated revenue recognition structures. This can create significant revenue and earnings volatility, offering higher potential rewards for companies that navigate these challenges successfully but also increasing overall risk.
Thus, this risk and reward relationship bleeds down to the ETF. In comparison, software companies investing in AI can be thought to have a lower risk and lower reward profile.
IGV: Providing Diverse AI Software (ETR:SOWGn) Exposure in Tech, But Sector Risks Remain
Overall, IGV offers an interesting way to play what many see as the next phase of AI. It has notable advantages and downsides compared to other funds or individual stocks. Its 123 holdings help limit individual stock risk. However, that also reduces its effectiveness as a pure-play AI investment.
Additionally, it is still directly exposed to the volatile tech sector, which has gotten battered lately. These dynamics make considering IGV worthwhile, but understanding its pitfalls is essential.
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