Cathie Wood’s Sinking ARK

TLDR

• Cathie Wood’s ARK Invest controls some of the world’s largest actively-managed ETFs with focuses on technological innovations
• In 2022, ARK ETFs are bleeding badly from their investment operations while they are making handsome management fees.
• We investigated all ARK ETF performances since inception and found little deviation from market benchmarks up to the COVID-19 pandemic.
• Over the past 2 years of extreme market conditions, the ARK ETFs trended similarly to sector-matched ETFs on the market.
• We simulated the trading strategy by ARK ETFs and found recent trades failed to even beat random stock picking.
  
  

Background

In 2014, ARK Invest (Ark Investment Management LLC) was registered to provide investment management and advisory services with a focus on disruptive technologies. With her own money and some seed funding from fellow Wall Street friend Bill Hwang, ARK Invest launched its first 4 actively managed ETFs: the flagship ARK Innovation ETF (ARKK), the Genomic Revolution ETF (ARKG), the Next Generation Internet ETF (ARKW) and the Autonomous Technology & Robotics ETF (ARKQ). These were later followed by the ARKF (Fintech Innovation ETF) in 2019 and ARKX (Space Exploration & Innovation ETF) in 2021.

2020 was an eventful year wherein the stock market experienced extreme highs and lows due to the COVID-19 pandemic. Tech companies, among those dubbed “COVID-winners”, soared in market valuation and helped lift one particular “ARK” riding the waves. This ark contained investments in blockchain technologies, Web 3.0, genomic revolutions, electric vehicles - all exciting innovations for a brighter future. As the captain of this ship, Cathie Wood sailed into the media spotlight and the hearts of her retail followers. She was winning, big time.

Fast forward to 2022, the tides have turned. Ms. Wood is steering the ARK in a stormy sea of uncertainty with inflation, rising interest rates, and a possible recession. Criticism and doubts have flooded her social media after lackluster performance. However, this is not her first rodeo in investment fund crisis management. The question is, will this time be different from her Alliance Bernstein finale?

In this post, we will look at the performance of ARK ETFs to better understand Cathie Wood’s strategy in investing in innovation.

Red flag on the ARK

There are an abundance of social media posts detailing the recent losses of ARK funds, many focus solely on ARKK. This post will explore that topic for all 6 ARK ETFs. Similarly to SPY, ARK 2022 returns do not look good. An early conclusion from the chart below may be that cutting edge disruptive technologies do well in extreme bull markets, but have trouble in bear markets. The current economic conditions are tough for all, but it appears particularly brutal for cutting edge technologies that haven’t had time to prove their place in society.

ARK fund performance in 2022 is down bad. However, the red flags we should be paying attention to are buried in ARK Invest’s financial statements. In their semiannual report posted on January 31, 2022, they disclosed some concerning numbers. We’ve highlighted some in the chart below. The flagship ARKK fund made $560,193 investment income, while the net asset loss from operation was logged at just under $7.5B. For context, that’s about 57% of its total net assets. Meanwhile, investors paid $72,452,561 in management fees. Another example: ARKW made less than $2,000 in its investment operations but took in nearly $18 million in fees. Perhaps 2022 is not so bad for ARK management.

Devoted supporters can argue a bear market is not fair for ARK ETFs. However, for all investors out there we urge you to remember that markets can stay irrational longer than one can stay solvent. While the top brass of ARK Invest can still live comfortably on the fees collected, the ETFs are losing significant capital from operations compared to the net assets left (shown below). This raises the concern on just how much more water can the ARK take in? After all, ETF liquidation due to dwindling assets is a real risk (59 ETFs in the United States closed down in 2021).

ARK trading strategy and reality check

What is ARK’s trading strategy and why is it doing so badly?

ARK Invest declined to share their complete trading logs. So instead we derived their trades since 2020 from ARK Invest daily emails. Across all ARK funds, 2021 was definitely the busiest year for their management team based on the sheer volume of trades (almost two times more trades than 2020).

However, the market capitalization caught our attention. Recent volatility in ARK funds may be attributed to its bias towards trading small cap companies thus the ETF experienced very high beta.

A challenge with the trading log data was the lack of stock purchasing price. Using the second best estimator, the trading volume, we sorted out the top long and short companies in each of the ARK ETFs using their accumulated trading volume in the past 3 years below. The idea is to quickly filter out what companies were ARK Invest consistently hoarding and selling.

The trend is very consistent with the heatmap above that ARK funds were committed to take long positions in small cap, “hot” tickers. And we can see overlaps between ETFs with companies such as $DNA.

More interestingly, the companies being net sold by ARK were mega cap companies like GOOG, AMZN and SHOP.

Unfortunately for ARK and its investors, approximately 90% of ARK’s top accumulated long positions have suffered heavy losses.

ARK vs passively-managed sector ETFs

It may not be fair to judge the ARK team by looking at fund price fluctuations in extreme market conditions. So how do ARK funds compare to their sector-equivalent ETFs that are passively-managed?

To answer this question, let’s compare the following:

• ARKW with Invesco NASDAQ Internet ETF (PNQI)
• ARKG with Global X Genomics And Biotechnology ETF (GNOM)
• ARKQ with First Trust Nasdaq Artificial Intelligence & Robotics ETF (ROBT)
• ARKF with Global X FinTech ETF (FINX)
• ARKX with Procure Space ETF (UFO)
• And finally ARKK with SPY
  

We show the comparisons using their normalized monthly price movements over the last 3 years. In contrast to returns, this allows us to track the movements in pattern and magnitude at the same scale, at the same time it allows us to highlight the historical high and lows. Clearly, none of the actively-managed ARK funds beat any of their counterparts.

Did all that active management beat anything?

We had some doubts on ARK Invest’s trade selection and hence set out to check if ARK Invest’s active trades were sound. Some retail investors might be mimicking the trades made by ARK Invest so we want to know what would happen if you trade like ARK Invest.

To do this, we calculated returns on ARK daily trades and compared these trades by substituting ARK traded companies with sector and market cap matched companies at random to construct 4 synthetic ETFs. These 4 synthetic ETFs covered 3,943 distinct publicly-listed companies. Their performances were collected to synthesize the ETF performance by taking advantage of the recorded “trade percentage of ETF” as a scalar to assign weights.

The end results are shown below and quite shockingly we found by just comparing ARK fund trades to “random,” simulated ARK trade returns (in red) were no better than randomly traded stock returns. In fact, only ARKK, ARKW, ARKF had brief periods of outperformance compared to these synthetic ETF trades. More surprisingly, the red lines are almost always the most volatile, indicating ARK trades were potentially exposing investors to increased risk but with little return.

Final remark

Wood’s ARKK has been called the worst performing US equity in 2022 Q1, and her 2022 prediction on bitcoin has clearly been rejected by reality. We have shown that ARK Invest’s active management failed to beat market counterparts. Even by narrowing the scope down to their top picks, the majority of them were deeply in the red.

Admittedly, adoption of disruptive technologies happens over a longer period of time than what this analysis focuses on. Only time will tell if Cathie Wood’s faith in her (favorite) innovations will pay off.

Check out our blog for more interesting deep dives into the market, follow along at @unusual_whales or join our Discord.