'Disrupters Get Disrupted': Smart Beta Pioneer Has a Warning for AI Investors

Research Affiliates, with assets under management of more than $153 billion, is winner of a 2024 ThinkAdvisor Luminaries award for thought leadership and education.

A pioneer in creating unconventional portfolio strategies, Arnott is co-portfolio manager of the PIMCO All Asset and All Asset Authority funds and PIMCO RAE funds.

“Stimulus Does Not Stimulate,” his recently released paper, argues that “beyond a certain sweet spot, higher government spending and debt levels actually systematically undermine economic productivity and prosperity.”

In the interview, Arnott discusses some of Research Affiliates’ unconventional investment products distributed by its partners, including Schwab, PIMCO and Invesco. He also names “the dangerous place to invest on a 10-year basis” and cites “stupid questions” that Wall Street is asking about President Donald Trump’s tariffs.

Here are highlights of our conversation:

THINKADVISOR: Of all the technological disrupters that business has experienced over the past several years, artificial intelligence is certainly the biggest disrupter. What’s your take? 

ROB ARNOTT: AI is the real deal, but that doesn’t mean it’s not a bubble. The internet was the real deal, but it was a bubble. AI is a bubble, and it will probably burst.

The internet and the dot-com bubble changed everything. But disrupters get disrupted. You also find that change happens slower than expected.

AI is going to change everything. But, as I say, disrupters get disrupted. OpenAI was suddenly disrupted about three months ago by DeepSeek [a Chinese AI company], coming out of nowhere.

Nobody was aware it was coming. It’s an AI just as powerful as ChatGPT 4.0 and almost as powerful as 4.5.

What other disrupter is being disrupted?

Google has been the utterly dominant player in search engines for upwards of a quarter of a century. Now, ChatGPT and Perplexity.AI are starting to threaten Google’s model. AI works better as a search engine than Google does.

So, yes, disrupters get disrupted. And the technology happens slower than advocates of technological innovation tend to expect. That’s where the narrative can go wrong.

Tell me about Perplexity.AI.

I’ve been using it as my search engine, and I love it. No pop-up ads! It’s a cool tool. It came out of nowhere.

People at Google didn’t anticipate AI chipping away at their business model. They thought they were going to have their own AI tools as the natural way for Google to answer questions.

When somebody comes along and says, “You don’t need ads,” how will Google make money?

So, is Google’s model getting disrupted? Sure.

Blackberry was disrupted by Apple’s iPhone. Disruption is normal.

It’s not that the narrative is wrong. It’s that the narrative gets the pace of change wrong.

People are so excited about AI. Should they be more skeptical?

They’re very excited about it and have great expectations for it, but they’re too optimistic about how fast it will happen and how well protected the big players are for basically facing no competition in the years ahead.

Competition comes out of nowhere when you least expect it.

When Research Affiliates comes up with an innovation, does it start with brainstorming or a kernel of an idea that’s then extrapolated?

It can start from any of a number of sources. It can come from reading others’ research and thinking, “What about this angle?” — and then coming up with variance on those ideas.

Some [innovations] come from pure research, like the paper I have coming out tomorrow, “Stimulus Does Not Stimulate” [debt-financed stimulus creates long-term headwinds],

I have no idea if that’s going to lead to a product. We spend millions doing research, and, once in a while, we come up with a new product. We don’t always know where it’s going to come from.

Where’s the best place to invest right now?

I would say the dangerous place to invest on a 10-year basis is U.S. growth stocks. They’re very expensive. I [recommend] investing in broadly diversified multi-asset strategies in stocks all over the world, non-U.S. stocks in particular.

Those are the areas that are attractively priced, and the patient investor who has a five- or 10-year horizon will likely be very, very happy with the results if they’re willing to go outside the mainstream.

What are your thoughts about President Donald Trump’s tariffs?

I’ve been amused that Wall Street keeps asking questions about what tariffs mean for future GDP or inflation or interest rates.

Those are stupid questions. First of all, the model for forecasting anything based on tariffs is a lousy model.

Tariffs change every day. But what you can do is model the impact of Trumpian uncertainty on market volatility.

Where do your unconventional investing strategies come in amid the volatility and uncertainty in today’s stock market?

There are lots of ways people can invest with us. Many of them are products we offer indirectly through our affiliates, our distribution partners.

We have multi-asset solutions in the form of actively managed PIMCO funds, and [our partners] Schwab and Invesco have ETFs and mutual funds.

We have a strategy called NIXT ETF-RAFI Indices. This [focuses on] companies that have been blocked from major indexes. Stocks that are dropped from an index usually have performed horribly, been battered down to really cheap valuations but usually turn out to do just fine and outperform over the next five years. We launched that strategy last summer.

Any other unconventional strategy that you’d like to note?

We’re challenging investing thinking with Research Affiliates Cap-Weighted Index series (RACWI), which I think is going to rock the index fund world, but not fast.

It will rock it over the next 20 years. All you have to do is introduce a little bit of patience in deciding on the stocks, and you wind up with a little less risk, a little more return and a little less turnover.

The index world is very staid, very rooted in a particular set of ideas. I think [this product] will revolutionize indexing, but it will happen slowly.

Twenty years from now, people will look back on it as a truly pioneering innovation.