Ark's Cathie Wood: Disruptor Meets Disruption

Features March 22, 2021 at 05:03 PM

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Scroll through financial-focused tweets most days, and you'll find market watchers sounding off on everything from Federal Reserve Chairman Jerome Powell and bond yields to Barstool Sports' Dave Portnoy and the price of Bitcoin — as well as Ark Investment Management and its founder, CEO and Chief Investment Officer Cathie Wood.

Nate Geraci, president of RIA The ETF Store and a host of the ETF Prime podcast, said in a tweet March 4 about the Ark Innovation ETF (ARKK): "From inception thru Feb 28, $ARKK was +36% annualized." Just 64 of 8,637 U.S.-domiciled stock mutual funds in Morningstar's U.S. funds database have risen as much over a similar timeframe, he added.

From Feb. 16 through March 3, however, ARKK weakened about 19% while Berkshire Hathaway improved 3%, according to Geraci's analysis. "Wild," he tweeted in a conversation that evolved into a debate over Buffett vs. Wood. (That said, Wood's key fund was at $125.15 on March 22, slightly higher than where it began for the year.)

But while there are plenty of books to read about Buffett and his investing views, there aren't any out yet on Wood — though her trades are posted daily. How did Wood develop Ark's "disruptive" investing style, which has been taking Wall Street and Main Street by storm in recent years, and what lies ahead for the ETF shop?

Early Years

Early in her career when Wood worked at Jennison Associates, she was given the opportunity to be an analyst. She had to find her own stocks, or what she now calls "fall-through-the-crack stocks."

At that time, in the 1980s, neither the technology nor publishing analysts on the team wanted to invest in the stock of Reuters — then a database publishing company — but she did.

"Of course no one wanted it because they didn't understand this new thing that was happening … . It was called the internet and was in its very, very early stages," she told Benzinga CEO Jason Raznick in a recent video interview on the financial website.

"So I learned early on, if you have a good reason to expect something to happen that nobody else expects, the odds are high that you will do very well if you're right," she said.

Many times since then, not only has Wood been right on seeing big ideas early — and buying the disruptive companies that bring them to life — she's impressed individual investors and Wall Street professionals to the point that they aren't sure how to define her.

"The firm's recent growth is unprecedented among the upper ranks of the asset management industry," wrote Morningstar's Ben Johnson, director of global ETF research, and Bobby Blue, a manager research analyst, in a recent online report.

Ark's track record demonstrates her style, talent and (naturally) her investing moxie. For example, while at AllianceBernstein in 2002, she invested in Amazon when it had a $5 billion market capitalization.

"Every Monday morning I had to announce my trades," she told Raznick. "I announced Amazon, and you could have heard a pin drop. It was right after the tech bomb went off, and Amazon was down 85% from its peak. No portfolio manager wanted to admit having held or recommended an internet stock.

"But we were convinced. At the time, I had three little kids and had no time to shop. Did [Amazon have issues, yes] but I was delighted because I didn't have to go to the store. And I just knew online was going to become a big deal," Wood explained.

Today, 19 years later, Amazon has a market cap of $1.5 trillion.

Building the Ark

The firm Wood now leads — Ark Investment Management — has five actively managed ETFs and two index ETFs. The flagship Ark Innovation ETF (ARKK), with some $23 billion in assets as of late March, was launched on Oct. 31, 2014. The firm had about $50 billion of total assets under management in late March, according to ETF.com.

The Innovation ETF's yearly returns have averaged about 38% since inception, Ark says. In 2020, though, it soared 152%, according to Yahoo Finance. Ark ETFs had $3 billion in assets in early 2020 and $50 billion a year later.

At Ark, Wood employs a multi-layered investing strategy. She initially takes a top-down approach and focuses on big tech-oriented ideas. Next, she works from the bottom up, selecting the strongest (usually small- to mid-cap growth) stocks in each of the sectors Ark covers. She also emphasizes a long-term horizon (of five to 10 years), which is both different and volatile.

This year began well for Ark. However, when the market got volatile starting in late February, so did its returns. The Innovation ETF hit a low of $110.26 on March 8, down 30% from its peak of $156.58 of Feb. 12.

That downward path turned around on March 9, though, when the tech-laden Nasdaq rose 3.7%. ARKK ended up 10% for the day at $121.75, which put it down 2% year to date. Such is the life of Ark.

"You definitely have to give Cathie Wood credit for the amazing performance run she's had with the fund," Morningstar portfolio strategist Amy Arnott told Investment Advisor prior to the drop in early March.

"But it's also worth being aware of the risk inherent in having this full-throttle growth style and investing in stocks with very high valuation," Arnott explained. She added presciently: "If anything goes wrong, either in the market overall or the stock specifically, [the fund] can fall really rapidly and show a lot of volatility."

There's the rub. Although the Ark team sees many downturns as opportunities to buy stocks it is committed to, such as Tesla — which makes up roughly 10% of the Innovation ETF portfolio — and to adjusting other holdings accordingly, its style may not be a good fit for the fainthearted. (In late March, CNBC stated that Wood was projecting Tesla shares to quadruple by 2025).

How closely linked to Tesla is ARKK? From March 1 to March 8, Tesla stock dropped 21%, and ARKK fell almost 20%.

"The approach is one with conviction, concentrated positions in favorite stocks, which … is distinct in the ETF world though relatively common in the active management world," said Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA Research. "But the approach can underperform for periods of time in the same way it can significantly outperform for periods of time."

Her fans don't seem to mind. In late February when the fund took a hit, ARKK's outflows remained muted at $665 million, according to ETF.com. Then in early March, it experienced inflows of $510 million. Apparently, like Wood, her investors like to buy the dip.

Flows don't concern her, Wood told Benzinga in early March. "We are being opportunistic during a volatile market, and we trade around volatility. We are liquidity providers. When investors and speculators are selling our stocks, creaming them, we will be buying our highest conviction stocks," she said.

Asked on a March 9 conference call how she stays calm in the face of such volatility, Wood stated that "our conviction [is] that innovation solves problems and is probably going to be accelerated in a risk-off period … . [Falling markets] are usually really good buying opportunities. We know that our long-term returns are galvanized during these risk-off periods."

As Bloomberg Intelligence senior ETF analyst Eric Balchunas said March 4 on Twitter, while tech stocks were falling: "ARK selling the relatively safe mega caps and buying the banged up smaller stuff. Nerves of steel, altho that's what got her here."

How Ark Picks Stocks

Wood approaches the market by thinking big and zooming in on disruptive technologies. As she explains in Ark's recent "Big Ideas 2021" report, the team identifies "large-scale investment opportunities by focusing on who we believe to be the leaders, enablers and beneficiaries of disruptive innovation."

This largely means technology. Ark highlights electric vehicles and digital wallets as technology ideas that will continue to disrupt the status quo. But Ark has tech-oriented health care advancements included in the investment mix as well.

From there, its analysts work from the bottom up to find the top stocks they believe are and will continue to be successful and grow for the next five to 10 years. This includes firms like Square, a provider of digital wallets and payments, which represents about 5% of its Innovation ETF portfolio.

"It all starts with sizing [up] these opportunities at the technology level," said Ark Client Portfolio Manager Renato Leggi in an interview. "As we're sizing [up] these opportunities, we develop a forecast or thesis around the total adjustable market for each of these technologies, based on our expectations of what they will look like in five or maybe 10 years out."

From here, the team starts the bottom-up process and identifies the winners in each of these industry segments. But it doesn't take a "scattershot" approach.

Using a scoring system with six metrics, Ark determines its conviction for each of the top stocks in these segments. It's very committed to firms like Tesla, which "is disrupting the internal-combustion [engine] traditional auto," adds Leggi, who joined Ark in 2018.

The Ark Method

The staff of 29 works closely with Wood on a day-to-day basis, Leggi says. Every morning, members of the investment team — including Research Director Brett Winton, leader of Ark's nine analysts — meet to discuss business, as well as their research findings and stock updates.

Based on the information collected at these gatherings, Wood — who worked in the bullpen with the analysts and traders before the pandemic shutdowns — makes trading decisions as the traders listen in.

Friday "is when it all comes together in what we call our brainstorming session," Leggi explained. The meeting is led by Winton and features each analyst's research breakthroughs for the week.

The event includes about 80 invited guests, such as academics, early-stage venture capitalists and entrepreneurs (some of whom are building the types of technology that Ark invests in). Everyone contributes to the discussion.

"It is very helpful in the ideation process, and [guests] provide different vantage points [vs.] what we're looking at from a research perspective," Leggi said. "Those are valuable insights our analysts can [use]."

Wood's Roots

The daughter of Irish immigrants, Wood graduated from the University of Southern California in 1981 with a degree in finance and economics. She was a mentee of famed economist Arthur Laffer at the school.

She went on to Wall Street, where she spent 18 years with Jennison Associates in various roles: chief economist, analyst, portfolio manager and director. When she moved to AllianceBernstein, she became CIO of global thematic strategies. She started Ark in 2014 with the Innovation ETF.

"We wanted to dedicate a portfolio to innovation that didn't exist in the marketplace," she told Benzinga. "Again, innovation was out of favor. It was too volatile. In fact, when we started the firm in 2014, it took a lot to get people's attention, because they thought we were too risky, too crazy. And I see now it's coming full circle, because I hear that again."

Arnott says this approach allows Wood to "really [be] able to tap into market trends and be at the right place at the right time. There's definitely a momentum element in her strategy, but she's not just buying the same stocks as everyone else."

Ark's long-term view also sets it apart, Wood explained to Raznick: "If you talk to most analysts and managers, they're really focused on the next year or 18 months in terms of guiding their buy-and-sell decisions. We are not. In fact, we want our companies to sacrifice short-term profits to be in the pole position to win [long term]."

This long-term horizon means its Innovation ETF has been able to hold onto its holdings since the fund launched. "Even though you wouldn't normally associate patience with this kind of high-growth investment style, I think that has also contributed to the fund's success," according to Arnott.

It also makes for consistency, points out David Nadig, chief investment officer and director of research for ETF Trends and ETF Database. Wood and team "are doing what they said they were going to do since they started the firm — running an aggressive high conviction innovation next generation economically styled portfolio," he said in late February.

This Ark process is demonstrated by moves like its purchase of Tesla stock when the EV maker's price falls, for instance. "This is not only normal, it's literally exactly what she told you she was going to do," Nadig explained. "It's hard not to admire somebody who calls their shot and then lands it."

Talking Her (Open) Book

Many industry experts say that what makes Ark different from rivals is its transparency. Wood is vocal and open during interviews. She even provides investors with a blueprint of what the firm is doing through Ark's yearly "Big Ideas" report.

"In fact, there is a website and an app (Ark Tracker) that monitor the firm's trades daily. Investors can also sign up for intraday trade alerts on the company's website," according to Johnson and Blue. (Daily trading data is required of all asset managers running actively managed ETFs.)

Wood is "the best financial communicator on the Street," Nadig said. There's nothing wrong with her openness, he adds: "Talking your book is not a crime."

Wood is well aware that the firm gets lots of attention — and not only from its performance. "The fact we are willing to share our research and be vulnerable out there" gets attention, she told Benzinga.

And Ark shares more than its trading moves. A year ago, it put its Tesla valuation model on GitHub, a community software building site, and had blowback because of its errors.

"Guess what, there are errors in every buyside model — I guarantee it," Wood said. "But we are going to have fewer errors because all the 'kind' people out there gave us that constructive criticism … so our models probably are more robust."

With its transparency and high-profile status, the Innovation ETF has been a target for short sellers. "There are a lot of hedge funds who are trying to either front run their trades or kind of ride on coattails," according to Arnott.

Wood isn't worried. On a market call March 9, she said Ark wants to push its research out while it's evolving: "We want to engage with the innovation communities." Sharing ideas is a "win-win," she added. "If you don't give, you don't get."

Ark ETF Risks

Although Wood recently told Benzinga that the main criticism Ark gets is about the short-term valuations of its holdings (which she maintains Ark is invested in for the long term), many analysts say the portfolio's concentrated positions — like the Innovation ETF's 10% weighting in Tesla — are among its most significant downside risks.

The Innovation ETF holds about 48 stocks, with roughly half of its assets concentrated in the top 10 holdings, Arnott says.

Further, there is a liquidity risk in which "trading volumes can quickly dry up when valuations collapse or market darlings fall out of favor. If the fund experiences large redemptions, it could be difficult to liquidate some of the holdings where it has concentrated ownership," she explained.

Another concern, raised by John Rekenthaler, Morningstar's vice president of research, is that the cash flows of Ark's relatively small number of holdings may have boosted the stock prices of these holdings, which in turn boosts inflows. "Until Ark came along, I shrugged off claims that cash flows into funds influenced their returns. Now, I pay attention," he said.

But Ark has "a much different view than the broader market," argues Leggi. Plus, "there's still a lot of short interest out there, so there's always somebody that will take the other side of that trade. And if you believe in the efficient market, it should balance out over time."

He also points to the firm's patience when it comes to waiting for opportunities to build a position. "If we get a stock that runs up significantly, we're pretty quick to take some profits and redeploy it to other names … ," Leggi explained. "We're very active."

In addition, he notes, Ark "stocks are actually idiosyncratic to one another on the technology level. There is low correlation between them. For instance, what's happening in a DNA sequencing stock doesn't necessarily impact what's going on in a robotic stock. These stocks move in different ways, and we can trade around the volatility."

On their own, these stocks may be perceived to be risky. But "if you just look at a standard deviation kind of metric" they are diversified, Leggi said. "Look at our top 10 [holdings]. They are touching multiple technologies — fintech to digital streaming to gene editing to DNA sequencing — and they move in different directions. So it's a very diversified portfolio."

Beyond risks with the portfolio, Morningstar's Johnson and Blue see issues for Ark tied "to the fact that the majority of its assets are invested in fully transparent actively managed ETFs [which] make it unique."

The ETF wrapper Ark uses "has many investor-friendly characteristics," but it also "might be investors' enemy," they explained. "The risk facing investors is that the same degree of reflexivity that has seemingly benefited them on the way up is likely to work against them on the way down."

What's Next

Wall Street loves a winner — and watching a winner fail.

"On the one hand, Cathie and her team are the smartest analysts, and over the course of the last five years have had enormous success generating alpha for clients," said Nadig. But on the other hand, the press is piling on as part of the "entertainmentizing" of the financial media, he says. Plus, some industry participants and watchers are engaging in Schadenfreude.

But Wood's been through rough trading patches before and holds tight to her convictions, despite volatility. As Arnott points out, the AllianceBernstein fund she led was up 56% in 2009 and down 24% in 2011, "so I wouldn't be surprised if we saw similar performance swings here."

Even so, Wood's aura and style and Ark's emphasis on innovative and disruptive industries have captured investor interest. On top of last year's growth (from $3 billion to $50 billion in assets), the ETF shop recently has been outpacing both Vanguard and BlackRock iShares in net asset flows.

If investors keep piling in, Ark's biggest problem might be losing the ability to invest in smaller stocks.

"Mathematically, you can't run a microcap [fund] with a trillion dollars. With $100 billion, they're not going to take meaningful positions in $50 billion companies," Nadig said. "You can't run an enormous microcap fund. That's an oxymoron."

Ark Invest's ETF Lineup

The current list of its exchange traded funds (including their assets under management and expense ratio) is as follows:

Ark Innovation (ARKK) ($23 billion, 0.75%)
Ark Genomic Revolution (ARKG) ($9.07 billion; 0.75%)
Ark Next Generation Internet (ARKW) ($6.93 billion; 0.79%)
Ark Fintech Innovation (ARKF) ($4.0 billion; 0.75%)
Ark Autonomous Technology & Robotics (ARKQ) ($3.2 billion; 0.75%)
3D Printing (PRNT) ($527 million; 0.66%)
Ark Israel Innovative Technology (IZRL) ($347 million; 0.49%)

Source: ETFDatabase.com/Factset Research Systems (as of 3/9/21)

Ginger Szala is managing editor of Investment Advisor Group. She can be reached at [email protected]. Bernice Napach is senior writer and can be reached at [email protected].

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(Photos courtesy of ARK Invest)

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