Sinking Ark: What a star US investor’s predicament tells us about this market
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Last year Cathie Wood was the hottest fund manager in the globe as the value of her flagship exchange-traded fund soared more than 150 per cent. This year, however, the Ark Innovation fund has lost money.
Within that remarkable disparity in performance lie a number of strands to wider debates, most notably the future course of inflation and interest rates but also about the types of technologies and companies that will shape the future, as well as more technical discussions about portfolio construction and accounting for risk.
The outbreak of the pandemic had profound impacts on bond and equity markets. Central bankers slashed interest rates and flooded markets with liquidity. There were enormous economic dislocations, with some sectors – airlines, tourism and travel-related activity, restaurants and physical retail – savaged.
Others, however, benefited dramatically. Online businesses gained from the lockdowns, fear and the floods of government relief money while technology companies generally soared because the benchmark rates used to discount their expected future cash flows were slashed close to zero.
It was those macro settings, particularly the ultra-low rates, that powered Ark’s performance last year.
In 2020 the Nasdaq index rose 43 per cent. The NYFANG+ index of the tech heavyweights like Facebook, Apple, Amazon and Google nearly doubled.
Senior business columnist
Wood’s Ark Innovation’s 152 per cent growth, however, massively outperformed the broader tech stock markets, earned her an equally massive and extremely devoted fan base and gave her the ability to move markets in the stocks she targeted.
This year, with Nasdaq up about 15 per cent and the FANGs up 13 per cent, the $US22 billion Ark Innovation ETF is now down more than three per cent from its starting point and about 23 per cent from its year-high in February.
Such has been Wood’s fall from grace – albeit not in the eyes of her loyal followers – that Ark Innovation is now heavily shorted and recently another ETF manager launched a fund that tracks the inverse performance of Ark Innovation. It’s a vehicle for retail investors to short the fund.
How is it that Ark was able to so materially outperform the market last year but lag it so badly this year?
The explanation lies in the nature of Wood’s strategy, the Ark portfolio and its interaction with the external settings.
Wood launched Ark Innovation and a range of tech-focused funds (Ark Innovation bundles the themes of the other funds, which have more specific strategies) after more than 30 years as a fund manager. Before launching the Ark funds she spent more than a decade at Allied Bernstein, pursuing similar strategies to those she now employs but with lacklustre results.
She’s not an index-hugger, running highly concentrated portfolios and making big bets on companies with little regard to their size.
Across the range of Ark funds some of the bets are also doubled up, either through holdings in the same companies or from cross-holdings between the funds.
At the moment the biggest bet in the Ark Innovation portfolio is Tesla, where more than 10 per cent of the fund is invested, with other big positions in stocks like Teladoc Health, Roku, Coinbase and Zoom.
The critical issue for ARK investors – Wood has more than a million followers on Twitter – is whether her aggressive approach to investing is a sustainable one.
Ark’s buying of Robinhood shares recently abruptly turned . The shares initially fell heavily before ending its first week up 56 per cent in wild trading after Wood – ubiquitous on traditional and social media – disclosed her buying. It’s still up more than a third on its market debut.
It is that concentration of its portfolio that provides leverage to the movements in the tech stocks and which drove Ark Innovation’s performance last year. It’s also, however, what’s sunk the fund’s performance this year. , which caused Wood to sell out of her exposures, hasn’t helped.
The critical issue for Ark investors – Wood has more than a million followers on Twitter – is whether her aggressive approach to investing is a sustainable one.
Whether or not it is or isn’t doesn’t just depend on whether the companies her portfolios have invested in – many of them loss-making and cash-burning – deliver on the markets’ expectations but on the macro environment.
As we saw for a while earlier this year, a sustained recovery in the US economy lifts the stocks that were most affected by the pandemic in a broad rotation from growth stocks to value stocks.
The Delta variant of the coronavirus and the outbreaks in some US states might threaten the economic recovery but the unprecedented spending plans of the Biden administration – the $US1 trillion infrastructure bill that passed the Senate this week and the $US3.5 trillion budget in prospect – ought to underwrite solid growth, at least.
That spending might also add to the inflationary pressures that have built this year and the pressure on the US Federal Reserve Board to start reducing its bond and mortgaged purchases and to lift interest rates earlier than anticipated.
This week’s US inflation numbers didn’t help resolve the debate about whether inflation is becoming entrenched at high levels or is merely transitory, as the Fed continues to believe.
While the headline rate of 0.5 per cent was in line with expectations and lower than June’s 0.9 per cent the annual rate is still 5.4 per cent, well above the Fed’s two per cent or so target.
If the Fed does start to wind back the extraordinary measures it took last year earlier than expected the most vulnerable sector will be the tech stocks, with their inflated valuations. Higher interest rates mean lower net present values for their future cash flows.
The volatility in Ark Innovation’s securities – they’ve ranged from $US156.60 in February to $US99.48 in May to $US121 today – underscores how sensitive and leveraged the fund and Wood’s strategy are to the ebbs and flows of the economic data and debates.
Senior business columnist
The element of a “meme” stock that retail investors have brought to Wood’s flagship fund adds another layer of volatility and uncertainty as to how the fund might fare in a tech stock meltdown – retail investors have shown during the pandemic that they are prepared to buy when institutions are selling – but Ark Innovation may well be something of a bellwether for the wider market.
There’s been a lot of discussion about whether tech stocks, particularly the larger ones, are in “bubble” territory and destined for big falls as rates eventually rise.
The Ark funds are either a big bet on the answer being “no,” or, for those shorting the stock or investing in the Short Ark ETF (SArk), a leveraged bet on the answer being “yes”.