- ARK Invest’s actively-managed ETFs saw remarkable outperformance in 2020.
- So far in 2021, their performance has been lackluster.
- According to some experts, the funds won’t be able to match their 2020 returns going forward.
Cathie Wood’s ARK Invest was one of the biggest stories in the financial world last year.
Five of Ark’s actively managed exchange-traded funds were up more than 100% in 2020, with the ARK Genomic Revolution ETF (ARKG) outperforming them all, returning 185%.
But 2021 is a different story so far. Though Wood said herself in a December interview with Bloomberg that she expects yearly returns in the low 20s in percentage terms over the next half-decade, four out of the firm’s largest funds by managed assets are negative since January 1, with the ARK Fintech Innovation ETF (ARKF) being the only exception.
Is the underperformance just a break in the action after such a remarkable run-up? Or is it the start of a longer dry-spell for the acclaimed investment firm?
According to some experts, the list of reasons why their relative underperformance will continue is piling up.
Ark Invest did not respond to a request for comment for this story.
9 reasons why Ark's relative underperformance is likely to continue
Morningstar strategist Robby Greengold laid out in a Wednesday note why he doesn't think Ark's main fund, ARKK, will continue to beat, on a risk-adjusted basis, the Russell Mid-Cap Growth Index, its benchmark for performance comparison.
Greengold argued that one reason is what he essentially labels a lack of qualifications on Ark's team.
He said that Wood's number-two in line, Ark's Director of Research Brett Winton, has no experience as a portfolio manager. He also said that Ark's analysts don't have the resumes that peers at other firms have.
"The firm's analyst bench is distinct from traditional asset managers, but not in a good way," Greengold said. "The typical equity research analyst in the asset management industry has a predictable set of credentials: an undergraduate degree from a name-brand institution, some entry-level work experience, an MBA, an analytical internship, and at least some progress toward investment-related credentials, such as becoming a CFA charterholder."
"Almost none of Ark's analysts have progress beyond earning bachelor's degrees," he added.
Greengold also said that some analysts cover specific sectors, like genome editing, have little relative experience in these areas compared to those at other firms.
Wood appears to see this lack of traditional experience as a competitive advantage, however, and cites it as a big reason for their success. She told Bloomberg as much last year.
Second, Greengold also pointed to the high turnover of analysts at Ark, and said that "many of the analysts supporting the funds' research have come and gone."
Third, the firm relies in part on crowdsourcing for its technical knowledge, Greengold said, by consulting social media users and others whose opinions the firm deems valuable. This is in contrast to their peers, who tend to rely on paid experts.
Greengold also highlighted that Ark has no risk-management team, and said they instead rely on their scoring system for individual stocks, and on instinct.
Then there is the threat of a negative feedback loop because of their positioning, especially in the smaller stocks that they own. As of the beginning of last month, they owned at least 10% of 26 different firms across their five actively-managed funds, according to Morningstar.
Since Ark has grown so big and owns so much of many of the firms they invest in, if they go to cut their position in a firm, it would likely create downward pressure in its share price, therefore hurting Ark's performance as well, Greengold said.
"As an ETF, the strategy must disclose its portfolios to the market each day - and traders can respond either by buying up a stock's known supply (putting upward pressure on its price) or selling it (downward pressure) before Ark has offloaded its own position," Greengold said.
Greengold's Morningstar colleagues Ben Johnson and Bobby Blue said the same in a March 3 note.
Fewer 'best ideas'
This reality has also made them step into larger names that are less volatile and therefore less likely to drive such extreme performance, according to Nate Geraci, president of The ETF Store.
Though Geraci thinks one can make a case to own the funds as a smaller piece of a broader portfolio - and applauds Wood's outperformance of passive funds and says they could still beat their benchmark - he doubts that Ark will be able to repeat its 2020 dominance.
One reason is because it will be difficult for Ark and Wood to keep coming up with the type of "best ideas" that drove their level of success last year, he said.
"There's only so many truly wonderful investment opportunities available. Ark calls those their best ideas," Geraci told Insider on Wednesday. "But as your fund grows, there aren't enough best ideas to invest in, so you have to move to your next best ideas, and then your next best ideas. And I think that will be the case with Ark.
"It doesn't mean that they can't generate outperformance," he continued. "I'm just not sure I would expect the astronomical returns that they've generated over the past few years."
Geraci also said that the rotation out of growth stocks and into value stocks as the economy recovers has hurt their performance. Many on Wall Street see this rotation as likely to continue.
Lastly there's precedent. According to research from S&P Dow Jones Indices that Geraci highlighted in a January post, a top-quartile fund in terms of performance has a 98.4% chance of dropping out of that quartile over the next four-year period. In other words, outperformance rarely lasts.
It could be said that many of the criticisms aimed at Ark Invest are exactly why they've done so well recently. But as their funds balloon thanks to their staggering performance, the case for not buying into them also appears to grow.