I've been very critical of ARK. Up until now, I've focused my thinking on why ARK's fund won't work. However, over the past few days, I've spent time trying to understand what Cathie and her team are attempting to accomplish.
It's easy to zoom in on ARK's year-to-date performance. Their flagship, ARK Innovation, is down about 35% from its highs in February and down double digits this year. A stark contrast to the S&P 500 and Nasdaq. But what about 2020? ARKK returned 250%, leaving other funds in the dust.
If the stars were aligned for them in 2020, can we expect them to continue outperforming moving forward? As investors, we need to recognize that others may be playing different games . This post is about me, a devout ARK bear, trying to learn the game ARK is playing.
It might just work. After years of criticizing ARK, I want to admit that ARK's strategy, heavy concentration in a handful of high-conviction growth stocks, might work. Something happened in 2020 that made ARK more viable than previous years, and I'm not talking about Tesla.
My arguments against ARK thus far are:
- investing in disruptive innovation doesn't result in disruptive returns
- active management risk
- investors are irrational and aren't patient enough for ARK's long term vision
- likely won't survive a prolonged bear market
2020 was a turning point in how the stock market works or how it's supposed to. The U.S. government has witnessed the power of the bazooka. U.S. citizens have witnessed the power of stimulus checks. During the next recession, people will expect the government to send out stimulus checks, and the stock market will expect the Fed to step in. There is no going back.
You think 2020's crash was short, but what happens when the market crashes and algorithms price in rate cuts before they're announced? The post-2020 market could lead to:
- more frequent, but subdued, crashes
- faster recoveries
- higher overall volatility
The market thrives on expectations. Right now, the expectation is that the Fed will step in when things get rough. All of this is great news for ARK's strategy.
The Fed's intervention will likely consist of lowering interest rates. It doesn't take much to notice that every recession leads to a new low for interest rates. Low interest rates benefit stocks that choose to delay profitability and instead focus on rapid growth. They also encourage more risk-taking, a perfect environment for ARK's concentrated portfolios.
Active managers underperform passive ETFs but tend to do better during times of high volatility. ARK can step in and provide some active value in uncertain times if we see more frequent crashes and faster recoveries.
Finally, if bear markets are now cut short, ARK may not have to worry about outflows thanks to fiscal and monetary policy. When investors put all their trust in the Fed, they are less likely to continue selling when things get rough. Thanks to the Fed, ARK may never have to experience a prolonged bear market.
Sometimes Cathie Wood goes on T.V. Sometimes she forecasts twenty to twenty-five percent annual returns for her funds over the next five years. She recently forecasted $500,000 for Bitcoin. These numbers seem aggressive, but they aren't out of reach if current conditions hold.
There's no doubt that ARK is very optimistic; you have to be when investing in unproven companies that have the potential to change the economy. In theory, ARK is well-positioned to capitalize on the shift the market & economy experienced in 2020. However, when you zoom out, you realize that the "new" market isn't all good news.
The type of market ARK is designed to thrive in encourages immense amounts of speculation and risk-taking. Those market conditions are exactly what led to the internet bubble. Swap "dot com domains" for "vehicle reservations," and you get the current state of the EV SPAC bubble: no revenues, no product, just reservations, and a CEO wearing a hard hat on CNBC.
Things go wrong when investors unanimously believe they can take more risk. ARK's success will spawn similar thematic funds, all trying to do the same thing. The next few years could reward those investors handsomely. But high prices only lead to higher returns in the short term,
Cathie Wood often brags about not hiring analysts from a traditional background.
“They are our secret weapon. Those analysts have their education and feet in the new world. They are coming to us from college with domain expertise in a way most [Wall Steet] analysts are not.”
She boasts about their ability to actually do the work and understand technology far better than traditional finance analysts. I agree with her, but I don't think it gives them an edge in picking stocks.
Making money is not as straightforward as finding disruptive companies to invest in. Though uncertainty might keep their valuations temporarily high, disruptive companies often see their valuations fall as the technology gets adopted and integrated into the new economy.
Due to turnovers, ARK investors "buying and holding" for the future may very well end up with a portfolio unlike what they initially bought. They are investing in Cathie Wood's daily trades and decision-making process as much as they are investing in the underlying portfolio companies, maybe even more so.
I was late to the ARK hype train. To catch up, the first thing I did was listen to Cathie Wood's appearances on podcasts and shows. She's always been excited and proud of her holdings. But being a latecomer, I noticed that ARK had dumped some of their "high-conviction" positions despite claiming to be investing in them for the future.
Take Illumina (ILMN), for example. In ARK's own words : "Illumina [ILMN] is the cornerstone of our Genomic Revolution theme, and one of our highest conviction stocks." Illumina used to be their second-largest holding second only to Tesla. Today, they own ZERO shares.
And what about Workhorse (WKHS)?
I understand the need to act when circumstances change, but ARK's decisions seem focused on the short term. Earlier this year, they added many large-cap names to their ETFs in preparation for a market correction. They were right. A correction came (at least for their funds), and the liquidity of the large-cap companies allowed them to purchase more of the less liquid but high conviction names they really want while they were down.
They were right. This time, they were right. This event raises the question of what might have happened if they didn't buy those liquid large-caps in time.
The Fed may be the ultimate liquidity engine for Ark, but that is becoming less so. The Fed's backstop doesn't apply to crypto - an asset that, up until the recent crash, was becoming a larger portion of Ark's portfolio.
Ark is exposed to Bitcoin via Greyscale, Coinbase, Tesla, and other portfolio companies that buy into the cryptocurrency. When the stock market crashes, the Fed steps in. Who steps in during crypto crashes? Technoking Musk?
I continue to come back to ARK because many readers of this blog are in tech. Most have experienced first-hand how startups grow and scale rapidly. Most are investors, and I know some invest in ARK ETFs. If you take anything away from this, let it be that: Technical know-how doesn't automatically transfer to the investing world, and investing in disruptive innovation isn't a guaranteed source of outsized returns.