ARKK Capsizes

If presidents are made by the times then fund managers are made by the markets.

Cathie Wood became a household name as shares of stocks from Tesla (TSLA) to Zoom (ZM) more than doubled coming out of the pandemic.

As reality set in, Cathie’s high-flying ETFs were shot out of the sky.

Her flagship innovation fund, ARKK, is down nearly 25% year to date and more than 50% over the past year.

A deeper look into Cathie’s thesis and outlook highlight flawed assumptions most investors take for granted.

We wanted to make sure you understood them.

Concentrated Risk

Over the past year and a half, the S&P 500 (SPY) and Nasdaq 100 (QQQ) rose on the backs of a few large-cap tech names, creating concentrated risk.

To alleviate this problem, investors may choose ETFs like the S&P 500 equal weight index (RSP), which gives each company 0.2% weight.

ARKK holds 44 stocks, of which, the top 10 make up nearly 55% of the holdings.

The average investor could consider ARKK as a ‘tech growth’ ETF like the Nasdaq 100. Yet, it focuses more on disruptive technologies.

And therein lies the rub.

Disruptive technologies take time and competitive advantage to achieve greatness.

Take Tesla for example. It’s built a supply chain fortress that no one dare touch save other automakers.

Zoom, on the other hand, makes one product that you can get from other companies such as Microsoft (MSFT) and Google (GOOGL), 

These same technologies also lead to bubbles like we saw in the early 2000’s when the dotcom craze ended.

That didn’t mean the internet was dead. Just that it had gotten ahead of itself.

Deflation Isn’t on the Table

We also have the Fed set to raise rates, which makes growth more expensive.

And why are they raising rates? Because inflation is at a 39-year high.

Everyone accepts this…except for Cathie.

Ms. Wood believes the U.S. is facing long-term deflationary pressures caused by innovation.

Her idea is right. Her timing is not.

In the last decade before Covid, inflation barely budged as supply chains became more efficient driven by technology. It’s quite likely these dynamics will continue and probably are.

Yet, they exist underneath a stronger inflationary demand that’s more akin to the oil bubble in the last ’70s.

To give you a sense of timing, it’s the equivalent of investing in the dotcom bubble as it was crashing. Yes, those stocks came back. It just took another decade.

Net Flows Change

ETFs create both virtuous and vicious cycles.

As money flows into an ETF, the fund deploys that capital to buy more  stock, sending shares of that ETF higher. In turn, that attracts more capital.

On the flip side, when money flows out, it forces the fund to sell stock to raise capital, creating the opposite effect.

ARKK went from a net buyer to a net seller of stocks. Assets under management have fallen by $2.11 billion in the last 6 months.

Source: ETFDB.com

In fact, the returns for ARKK are so bad that when you compare them to the QQQ, they underperform in nearly every timeframe save when ARKK was in its infancy.

Our Opinion – 3/10

ARKK is volatile and in our opinion dead money over the next five years.

Sure, it will have fits and starts with eye popping rallies along the way.

But over the long-run, we’d prefer the passive Nasdaq 100 index.