My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

ARK Invest: Digging Deeper

ARK Invest (“ARK”, website here) is the investment company responsible for a stable of actively-managed ETFs focused on disruptive companies / industries. ARK was founded by Cathie Wood in 2014. She is currently the CEO and CIO of the firm and the “face” of the company to the market. I wrote an article about ARK Invest and Ms Wood on March 11th, which you can find on my website here.


ARK has a series of six actively managed funds, of which the sixth – the ARK Space Exploration & Innovation fund (ARKX) – went live on March 30th 2021. The largest and most widely followed of the ARK funds is ARK Disruptive Innovation Fund (ARKK). ARK has been under more scrutiny since the tech sell-off that began on February 12th. One of the major reasons has been that the ARK stable of funds, which generated outsized returns in 2020, has stumbled badly in 2021. However, there are other reasons, too, and I will mention some of them in this follow-up article.


Reduction in Assets under Management (“AuM”) and Poor Performance: The AuM of the five actively managed ETFs of ARK that were live at the end of 2020 reached nearly $58.1 billion on February 12th, an increase of $23.9 billion (+69.6%) in the first six weeks of 2021. February 12th is a relevant date because it was the peak price of most of the ARK ETFs and many of the shares of the companies held in the portfolios of the ARK ETFs. Since then, tech shares have been under intense pressure. Even with the addition of the space ETF (ARKX), collective AuM of the funds has fallen to $38.6 billion at May 14th, a decrease of 33.7%. Keep in mind that the fluctuation in AuM does not translate fully into redemptions, as with traditional (open ended) mutual funds, but rather reflects the significant decline in share prices of the funds’ underlying holdings. Here is the recent AuM history.


Similar to the dramatic decrease in AuM, the performance of the ARK funds has been similarly poor since mid-February, following a spectacular 2020 as you can see in the table below.


The five main funds returned between 107% and 180% in 2020, multiples of the return on the Nasdaq 100 over the same period (47.6%). However, four of the five funds have had losses (-6.6% to -17.9) YtD whilst the Nasdaq 100 has gained 3.9%. Since the tech sell off began on February 12th, the funds have lost between 22.3% (ARKQ) and 33.4% (ARKK), whilst the Nasdaq 100 is down only 3%. The harsh sell off of high flyer stocks like TSLA, SQ, TDOC, ROKU, SQ, ZM, SHOP and others has had the same turbo-charged effect on the funds’ performance on the way down as it did on the way up. Questions regarding the Ark Space Exploration & Innovation fund (ARKX): ARKX was launched on March 30th 2021. The fund has $624.9 million in AuM and is down 2.7% since its inception in late March. The underlying holdings of ARKX have investors scratching their heads for several reasons. First, the fund’s holdings generally are not what you might expect, as the portfolio includes companies like Amazon, Google, Netflix, Deere & Co and Alibaba, mixed in with its holdings that are clearly more related to navigation and “space” technologies. Secondly and perhaps even more controversial, ARKX’s second largest holding (6.7% of the portfolio) is actually one of the passive ARK ETFs, the 3D Printing ETF (PRNT). I believe Ms Wood has rationalised this holding by saying that 3D printing will play a role in the evolution of space technologies. Some investors have said it could be a placeholder until ARKX can acquire individual shares of 3D printers. Nonetheless, this cross-ownership looks unusual on the surface, and the effect in a downturn is unpredictable in that both funds are highly correlated because of this arrangement. The last issue with the fund is timing. Late March was not ideal for the launch of this much-anticipated ETF, and the road has been rocky since its launch. Ties to Archegos and its founder Bill Hwang: Another thing that has caught the attention of investors is the involvement of Bill Hwang as a seed investor in four ARK funds at their inception, which Cathie Wood revealed in an FT article on May 8th (see here, FT subscribers). Both Mr Hwang and Ms Wood share a bond in that both are devout Christians. According to the FT article, they met around 2013 when both were ministering to young Wall Street professionals. Whilst Mr Hwang might have been an investor in four ARK funds, I find it a stretch to splatter ARK with the Archegos saga, as he was nothing more than an investor. Nonetheless, critics of ARK and Ms Wood have been quick to try to draw a sinister connection, suggesting that some of the mechanics of the ARK funds might be equally suspect.

Have there been redemptions? The short answer to this question is yes perhaps, but not in a traditional sense. If investors want liquidity in the ARK ETFs – or any ETF for that matter – they can sell their ETF shares to a broker, just like any ordinary stock. It is important to remember that the ETF sponsor has no responsibility to provide cash to investors at the end of each day like an open-ended mutual fund. I wrote about the role of Authorised Parties (“AP”) in providing an orderly market for ETFs in an earlier article (“ETF and Passive Investing”, published on February 19th 2020). APs are important participants in the primary and secondary market for ETFs, responsible for closing arbitrage between the ETF price and the price of underlying shares (secondary market activity) and creating (fund growing) and destroying (fund shrinking) ETF units (primary activity) based on investor flows. When units are destroyed, the ETF sponsor delivers the basket of shares – not cash – to the AP in exchange for ETF units. Also keep in mind that changes in assets under management probably comes more from fluctuations in underlying share prices of the portfolio than from the creation or destruction of ETF shares. Still, the combination of falling underlying share prices and investors selling their ETF shares can be a double-whammy on the downside. Of course, when things head in the other direction – like they did in 2020 – this same combination of circumstances can turbo-charge performance in the other direction, like it did for the ARK funds in 2020.


Before leaving this topic, let me mention one other related concern. When an AP delivers ETF units to the sponsor in exchange for the underlying shares of an actively managed fund, the ETF sponsor can deliver whatever shares it wishes to satisfy ETF share redemptions. This means that the ETF sponsor can deliver the most liquid shares, potentially leaving the most illiquid holdings (that are more difficult to price) to satisfy future redemptions. ARK Invest has been clear that this is not what occurs. Instead, shares are sold across the portfolio such that the basic portfolio’s composition is largely left intact. The COO of Ark Invest, Tom Staudt, covered this topic in some detail in a March 1st article in the FT that you should be able to access here. The article also points out quite rightly though that APs (and brokers trading the ARK ETF shares) can and do use a variety of derivatives to hedge their positions, which are not necessarily known but can cause higher variability in certain ETF fund prices, and also in the shares of underlying portfolio companies.


Holdings: The table below shows the holdings of technology shares (not biotech or other types) of ARK Invest across the six actively managed ETFs, along with the price migration for the shares of the largest holdings for the period i) 2021YtD, and ii) since the tech sell-off began on February 12th. For those of you that follow the high flyers, most of these companies should sound familiar.

To say most of the shares held by ARK Invest, regardless of the fund, have been hammered is an understatement, especially since February 12th when the tech market peaked. With the exception of Sea Limited YtD and Coinbase since its IPO, all of the shares are negative YtD, some significantly. Since the February 12th peak, all of these shares are off 22% to 52%, a harsh turnaround over the exceptional share performance of many of these companies in 2020, when some saw their prices double, triple or appreciate even more post-pandemic.


I thought it would be interesting, too, to look at how ARK Invest has changed the holdings of its major positions. The table below compares ARK Invest’s holdings of the largest technology names

between March 9th , 2020 (which I used in the original article), and May 14th. As you can see, ARK has lightened its positions in TSLA, SQ, ROKU and SPOT, and has added to its positions in TDOC, ZM and TWLO, and bought into COIN since it went public. One thing MS Wood is not shy about doing is “buying the dip”, but how much this has helped is difficult to tell because the entire portfolio has performed very poorly.



Aren’t the underlying stocks still expensive? I would be remiss not to mention valuations in this article, although I am not going to dwell on it. ARK’s strategy is to buy the companies of the future, which means most defy traditional valuation metrics. This makes many of the companies look extremely expensive when valued against earnings (many of which have none) or revenues. There is a very good website called cathiesark.com, which provides a lot of granular information on the ARK ETFs and their holdings. The website, not affiliated with ARK Invest, provides for each fund: holdings, trades, weight rankings, trends and performance. In addition to things like daily flows in each fund, one particularly interesting graphic concerning valuation is provided at the bottom of the “holdings” section. For example, the website reports that of the ARKK (flagship) portfolio of 58 holdings (as of May 10th), the average price-to-revenue is 44.9x (gulp!), 37 of the companies loss money, and three of the portfolio companies have no revenues at all. As frightening as this might sound, it is worth pointing out that most of the companies had revenue and earnings beats in 1Q21. The sell-off is more about excessive and frothy valuations for many of these companies, and therefore for the ARK funds, than it is about performance. Valuations remain ahead of earnings, and this will continue to make these companies vulnerable to rapid sentiment swings. So what’s the message? It’s this – if you invest in ARK ETFs, make sure you understand exactly what you are buying.


Conclusion: The performance of ARK Invest is certainly under the microscope at the moment for some of the reasons I highlighted in this paper. Even so, the ARK ETFs are different from the majority of ETFs that are passive index funds rather than actively managed. I believe that Ms Wood has stated the mission of ARK very clearly, which is to focus on and invest in disruptive companies ­– or high flyers – one or more of which might turn out to be the next Amazon, Apple, Google or Facebook. As far as I am concerned, Cathie Wood has done no wrong so long as you buy into her philosophy. She clearly has passion for her views and her mission, although investors must recognise that the ETFs are high risk because of the nature of the companies in each ETF, limited portfolio diversification and high correlation risk. The ARK ETFs have performed poorly since the tech sell-off began in mid-February, not surprising given the construction of the portfolios. These companies will remain under intense pressure going forward due to valuations, a concern that is magnified as inflationary expectations rachet up. If you don’t like the ARK ETFs on the long side, they serve another purpose as they (especially ARKK) can be used to hedge a portfolio of individual high flyers you might hold albeit not perfectly. Or if you are just negative, play ARKK or one of its brethren from the short side.

 

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