ROBO ETFs: Q3 Market Brief

ROBO ETF Q3 Commentary

The ROBO Global Robotics and Automation ETF (ROBO) declined 14% in Q3 2023, underperforming the broader world index Morgan Stanley Capital International (MSCI) AC World Index (-4.86%).[1] However, ROBO remains up over 12% year-to-date. According to FactSet Data, revenue growth slowed from 9% in 2022 to a projected 6% in 2023 but is expected to reaccelerate to over 7% in 2024. EPS[3] growth is estimated to go from 12% in 2023 to 18% in 2024. Most recent Q2 earnings saw an average of 11.59% Earning Per Share (EPS)[3] positive surprise versus expectations.

Ongoing labor scarcities, fragile supply chains, and geopolitical shifts toward reshoring are catalyzing demand for robotic solutions. Geographically, we’re seeing increased investment diversifying away from China into the EU, North America and significantly India. Investment is diversifying geographically, notably drifting from China toward the EU, North America and rest of the Asia–Pacific Region (APAC). Cobots and Autonomous Mobile Robots (AMRs) are experiencing a growing, albeit nascent, market share, in one of the fastest growing robotics segments. Rockwell Automation's acquisition of Clearpath Robotics underscored this trend amid otherwise strong 1H results.

All 11 ROBO subsectors declined, with Manufacturing and Industrial Automation, the largest subsector by weight (17%), down -11.8% with mixed results. New build delays stretching into 2024-2025, mainly due to labor shortages and regulatory constraints, have temporarily stalled otherwise strong momentum. A recent National Association of Manufacturers (NAM) poll highlighted workforce retention as a primary hurdle for manufacturers (72% of respondents). Robotics pioneer Fanuc celebrated a milestone with its millionth robot delivery.

In our view, the disruptive potential of generative AI has yet to significantly impact investor sentiment around robotics. Many incumbents stand to gain from adopting AI to improve operational efficiencies and enhance capabilities. This, combined with easing inventory levels and the long runway for energy transition spending could reinvigorate lagging subsectors such as Sensing (-21.7% Q3 performance) and Actuation (-18.1% Q3 performance) to rebound as addressable markets expand and demand reverts, especially to companies like IPG Photonics, Ambarella, and Harmonic Drive Systems. Additionally, the introduction of humanoid robots manufacturing at scale potentially heralds an untapped market.

THNQ ETF Q3 Commentary

The ROBO Global Artificial Intelligence ETF (THNQ) slightly underperformed (-5.3%) the broader world index Morgan Stanley Capital International (MSCI) World Index (-4.86%), with YTD performance of +30.7%[1]. Despite the relative ETF underperformance to the World Index (MSCI)[1], 90% and 85.5% of holdings beat Earnings per share (EPS)[3] and Sales targets for the Q2 earnings season with growth rates of 64% and 14% respectively.

In Q3 2023, 4 of the 11 sub-sectors registered positive returns, spearheaded by Network & Security (17% weighting), which saw Darktrace, Varonis and Crowdstrike leading. This was closely trailed by Consumer, Big Data / Analytics, and Cloud Providers subsectors (all nearly flat/slightly up). Offsetting this, we saw a decline in Factory Automation, Healthcare and Ecommerce and Semiconductor subsectors.

Big Data/Analytics (14% weighting) saw heightened M&A. For example, THNQ holding Splunk was acquired by Cisco at 7x sales, a 30% market premium to THNQ's 5.4x sales for $28B.[4] This comes after just months when former member New Relic was taken private by Francisco Partners and TPG for $6.5B. Now, a third Big Data member, Alteryx, is exploring a sale. As AI transitions beyond this initial testing to real-world, cross-functional deployment, this subsector's importance should outpace the broader market. Notably, the most recent addition is fast-growing cloud monitoring leader, Datadog.

A lot can change in a year - just last Q3 2022 we defended an embattled Nvidia as more than a gaming/PC play when it was down 56% YTD. Its valuation has since expanded to 20x sales and 105x earnings.[2] While the world is in a (NVIDIA) Graphics Processing Unit (GPU)state of mind, it’s important to realize we are still in early innings and that the exposure to a broader AI semi basket may offer better risk-reward amid current valuations, especially as competitors ramp up offerings and the broader expected demand comes into focus. Furthermore, while mega-tech companies boast formidable strengths - market leadership and massive user bases, regulatory threats loom large, such as EU initiatives around AI regulation and the Digital Markets Act (gatekeeper) target anti-competitive behavior. Alphabet faces anti-trust scrutiny over search dominance and unfair practices. We’re also seeing new entrants and user interface modalities potentially causing disruption to what has been the status quo of the internet.

THNQ’s AI-focused Semiconductor (18% weighting) subsector cooled -12%, with companies such as ASML down 20% (sole provider of Extreme ultraviolet lithography (UEV) equipment required for making AI chips) and AMD down 9.8% (which recently had Microsoft CTO give a nod towards their GPUs). Ultimately, we believe it’s clear that investment into AI infrastructure and enabling technologies is only just beginning to ramp up as we wrap up 2023 and enter 2024.

HTEC ETF Q3 Commentary

The ROBO Global Healthcare Technology & Innovation ETF (HTEC) underperformed the global markets (-16%) vs. (-4.8%) for MSCI AC World Index[1] in the most recent quarter, with year-over-year growth still facing tail-end of Covid comps. Q2 earnings season presented outperformance overall vs expectations, with +80% of companies beating Sales and Earnings per share (EPS)[3] expectations with targeted full-year growth of 4.2% sales and 18.8% (EPS)[3], which is projected to further see profitability with ~10% sales and 26% EPS3 growth, according to Factset Data on 09/29/2023. The ETF is trading at a 25% discount to pre-covid 5x sales average at ~4X.[2]

All nine HTEC subsectors saw a decline in the third quarter of 2023, with Precision Medicine (12% weighting) down just 4% with performance from Regeneron +14.5% and Biomarin +2% leading. The largest subsector, Medical instruments saw a decline of 24%, providing some of the biggest discounts on blue-chip healthcare leaders since March 2020.  Insulet (-45%) and Dexcom (-28%) have fallen in tandem with recent attention towards GLP-1 weight loss drugs (e.g. Wegovy and Mounjaro), which we believe is a temporary market overreaction. Boston Scientific, one of the most trusted names in cardiovascular, Rhythm and Neuro medical instruments, had multiple positive catalysts announced such as margin expansion and the acquisition of Relievant Medsystems for $850M, which has the only FDA-cleared product for a type of lower back pain.

The technologies that HTEC companies provide are critical to the healthcare ecosystem, care delivery, and quality of life improvements. Companies within the Process Automation subsector work in less consumer-facing operations specifically in clinical, manufacturing and R&D settings. The latest reports suggest a pickup in pharma activity and new pipelines after a subdued year. Ginkgo Bioworks, the leading synthetic biology and cell engineering firm, stands to benefit as it expands partnerships leveraging its robotics, AI and automation solutions. Recent highlights include several multi-hundred million contract wins with Merck, Pfizer, as well as a program with Google combining generative AI and synthetic biology.

The diagnosis and treatment of Cancer continues to see progress. Diagnostics member Exact Science (-22%), a pioneer in liquid biopsy and non-invasive testing for cancers, recently raised guidance (including margins) and had a top and bottom-line beat. Additionally, they are testing blood-based residual cancer detection technologies, which could further boost the healthcare ecosystem and increase their growth opportunities.

While innovative healthcare technology companies faced a challenging quarter, these companies provide pillars of modern healthcare, and we believe the long-term outlook remains positive.

SOURCES & DEFINITIONS:
1 MSCI AC World Index is MSCI’s flagship global equity index and is designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 24 emerging markets.
2 The price-to-earnings (P/E) ratio relates a company’s share price to its earnings per share.
3 Earnings per share (EPS) is a company’s net profit divided by the number of common shares it has outstanding.
4 The market premium in a merger or acquisition context refers to the amount by which the acquiring company is willing to pay above the current market value of the target company.

Fund holdings and standard performance can be found here: https://www.roboglobaletfs.com/robo, https://www.roboglobaletfs.com/thnq & https://www.roboglobaletfs.com/htec. The performance data quoted represents past performance and is no guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance data quoted. Holdings are subject to change. Indices are unmanaged and do not include the effect of fees. One cannot invest directly in an index.

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the fund or any security in particular. Please consult your financial advisor for further information.