Cathie Wood’s ARK Finds Gains and Pain in Money-Losing Companies

Despite this week’s rebound in tech stocks, all five of ARK’s ETFs remain down at least 14% from their mid-February highs, trailing the Nasdaq Composite, which is off 5% from its Feb. 12 record.

Performance of the holdings of ARK’s five actively managed ETFs

Past month

Average

performance

Unprofitable

companies

Profitable

companies

Unprofitable

companies

Profitable

companies

The pain has been most acute among shares of the unprofitable companies in ARK’s funds. Those stocks have fallen on average 18% over the past month, according to a DJMD analysis of ARK’s holdings and FactSet data, while the profitable holdings are down 8% over the same period.

“These stocks are inherently more risky than the broader market,” said Ben Johnson, director of global ETF research at Morningstar.

A spokeswoman for ARK declined to comment. Ms. Wood, though, has taken to television and YouTube to put her investors at ease, stressing the firm remains committed to its strategy.

“We’re as excited as ever about everything we’re doing. The last few weeks hasn’t done anything except increase the returns we expect from each of our stocks to the extent they’ve come down,” Ms. Wood said in a video posted to YouTube last week that has racked up more than 700,000 views.

Among ARK’s high-profile positions are streaming company Roku Inc., home-sales website Zillow Group Inc. and music service Spotify Technology SA, none of which posted a profit in their most recent annual reports. Shares of those and many other unprofitable companies span multiple ARK funds. Teladoc Health Inc., for example, is included in four of the five ETFs, a combined position worth $2.3 billion. The virtual medical services provider has reported losses every year since it went public in 2015, including a $485 million loss last year.

Of the 56 stocks in the flagship innovation fund, 36 generated no earnings during their latest fiscal years, according to an analysis of the firm’s holdings. ARK’s genomics fund, the only ETF of the firm that is still in the red this year, has even more exposure to unprofitable companies, with 43 of its 57 holdings reporting losses last year. In ARK’s three other funds, at least roughly a quarter of the companies represented posted no earnings last year.

Investors have long relied on valuation metrics like price-to-earnings ratios to gauge the prospects of a stock. But such metrics are irrelevant for companies that generate no profits. ARK instead relies on a mix of imagination and discounted cash-flow models premised on near-zero interest rates to justify the lofty valuations of stocks that have a big potential to grow and conquer their respective industries, like Alphabet Inc.’s search domination and Facebook Inc.’s moat around social media.

Many of ARK’s “disruptive” stocks went gangbusters in 2020 during the Covid-19 pandemic. The innovation ETF jumped more than 150% last year alone, helping it triple from its 2014 debut. A flood of inflows from investors followed, allowing ARK to make even bigger bets on the next wave of revolutionary companies.

Another potential concern among ARK investors is the funds’ heavy concentration. The firm, for example, owns a 15% stake across two of its funds, worth $156 million, in biomedical products company Cerus Corp. The company hasn’t been profitable in more than a decade, most recently reporting a nearly $60 million annual loss.

The more an investor owns of a particular stock, the harder it is to add or sell shares without moving prices. Morningstar crunched the numbers and found that if ARK opted to sell its Cerus shares, it would take more than 52 trading days to completely exit the position to avoid materially shifting the stock price to the detriment of its own investors.

Shares of Cerus have fallen 13% over the past month. Redemptions appear to have led ARK’s funds to shed more than two million shares between Feb. 22 and Wednesday, according to Cathiesark.com, a website that tracks ARK’s trading activities, potentially exacerbating Cerus’s slide.

“That’s the No. 1 concern in portfolio management,” said Saumen Chattopadhyay, chief investment officer at wealth-management firm Carson Group, referring to concentration. “When the bubble bursts, funds like that can get caught up.”

ARK isn’t changing its approach. Executives, including Ms. Wood, have said the volatility hitting the market and their funds will be short lived. Over the past several weeks, the firm has sold more-liquid stocks to buy shares of companies in which it says it has a higher conviction, including smaller, harder-to-trade and, in several cases, unprofitable stocks. Those buys include Roku and 908 Devices Inc., a chemical analysis company worth $1.4 billion.

Ms. Wood, in her video last week, said the funds haven’t experienced any trading or liquidity issues.

“We are not in a bubble,” she added.

—Ken Jimenez contributed to this article.

Write to Michael Wursthorn at [email protected]