AI skeptics like Timothy Casaletto are having a tough stretch.
The artificial-intelligence frenzy that fueled a record run for stocks has left the biggest fund he manages starkly underperforming the S&P 500. The Vanguard Dividend Growth Fund is up 55% over the past four years, compared with a return of 126% for the S&P 500, through Friday.
"The last four years have not been fun," says Casaletto, a portfolio manager at Wellington Management who started co-managing the fund in July and was previously an analyst on the team.
Now, the AI trade is starting to show signs of entering a new stage. Companies with weaker balance sheets and higher sensitivity to rising borrowing costs are receiving greater scrutiny from investors. CoreWeave's shares slid about 25% last week, then slipped again Monday, while the tech-heavy Nasdaq rebounded 1.1%.
For stock pickers like Casaletto, the cracks in the trade raise the possibility that vindication might finally be near. His fund rose 1.9% last week when AI stocks swooned. The S&P 500 fell by around that much.
"I have high conviction that the AI trade will roll over -- and roll over hard -- at some time," Casaletto says.
As of June 30, his Vanguard Dividend Growth Fund didn't hold any shares of Nvidia -- the chip maker that has surged more than 1,300% since the end of 2022. The fund has had minimal exposure to Meta and Alphabet, which have more than tripled.
Some AI skeptics don't think it is possible the technology can ever deliver on the profits to justify soaring shares. Others say the market has rewarded AI stocks indiscriminately, even though some of them -- especially memory-chip makers and cloud companies -- are more speculative.
"Will we actually be able to build data centers in as great a scale as the market thinks? If we cannot, that will be enough to take down this AI trade," he says.
Despite the recent stumbles in the AI trade, it has been a bleak year for fund managers who aren't all-in on it. Avoiding some of the biggest names in the S&P 500 has left money managers lagging behind the benchmark.
Active managers in the large-blend category -- Morningstar's largest category tracking funds investing in large-cap stocks -- began the year underweight AI stocks compared with the S&P 500 by more than 8 percentage points, with a 28.4% holding compared with the index's 36.5%, according to an analysis of funds overseeing nearly $11 trillion in assets prepared for The Wall Street Journal by Morningstar.
That is a big reason 70% of active stock mutual-fund and ETF managers underperformed their benchmarks this year through Oct. 8, according to Bryan Armour, director of ETF and passive strategies research in North America for Morningstar.
Casaletto's skepticism is based on the rising borrowing costs that so-called neocloud companies like CoreWeave face, and the possibility that the data-center build-out won't be as fast as investors expect.
Manish Gupta, a portfolio manager at First Eagle Investments, owns shares of tech highfliers such as Alphabet, Meta and Microsoft. But he's cautious about corners of the market that appear more speculative.
Two of the funds he manages, the First Eagle U.S. Fund and Global Fund, have lagged behind their stated benchmarks so far this year, returning 8.9% and 9.9%, respectively, through Friday. Another, the First Eagle Rising Dividend Fund, has outperformed, rising 15.8%.
Gupta says he doesn't regret his AI wariness, and doesn't care to follow the herd.
"We are better safe than sorry," Gupta said. "We've been cautious for quite some time, and I think those concerns are now showing up in the market."
The poor performance of stock pickers this year is something of a surprise. For years, active investors blamed their underperformance on the unusually high correlation among stocks, which can make it hard to sort winners from losers.
This year, dispersion among stock returns is near record levels, based on various measures, setting the stage for what should be a stock picker's paradise.
Yet finding the right winners, and sizing them appropriately, in a trade that seems increasingly crowded, has been vexing for even seasoned investment managers.
Some of those who are underperforming lately because of limited exposure to artificial intelligence say they aren't AI skeptics -- they just see more attractive opportunities elsewhere.
"We're not anti-AI," says Mike Nicolas, co-portfolio manager of the Oakmark Investor Fund. Instead, he says, he's betting on companies selling at attractive prices that "have been left behind" as AI stocks steal the show.
The Oakmark Investor Fund, which is up 8% so far this year through Friday, owns no shares in AI and semiconductor companies, including Nvidia, AMD and Snowflake.
The fund's largest holding at the end of the third quarter was Salesforce, the software company that is down about 8.5% this year owing to worries it will be threatened by AI.
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