Cathie Wood, chief executive officer and chief investment officer of ARK Investment Management LLC
Alex Flynn/Bloomberg
It’s been another bad week for investors in ARK exchange-traded funds. The flagship and largest of the seven—the $21 billion ARK Innovation (ARKK)—is down 25% from its peak on Feb. 12. It dropped 20% in just 12 trading days, faster than the 13 days it took to fall more than 20% in March 2020 as pandemic fears hit stocks. This pullback, however, was very different, and it indicates much about where the market is headed, as well as how actively managed ETFs might handle it.
Unlike last March, when ARK funds fell along with the broader market but suffered less than value funds, this time they’ve trailed the market significantly. ARK funds fell the hardest in the past two weeks, while the S&P 500 declined just 1.7%. Growth stocks lead the way down; the Invesco S&P 500 Pure Value ETF (RPV), made of the 100 cheapest stocks within the S&P 500, actually gained 6.1%. This signals a likely shift in market momentum toward value from growth, as interest rates creep higher and inflation concerns set in, discounting the future value of the high-flying stocks and favoring those that could benefit from near-term economic recovery.
ARK ETFs’ pullback is mostly due to the sharp price drops of its highly volatile holdings, tech stocks like Tesla (TSLA), Roku (ROKU), and Square (SQ). ARK investors should always be prepared for some volatility, especially after the unbeatable returns it saw last year. “ARK funds are bull-market stories,” says Morningstar vice president of research John Rekenthaler. “These are highly aggressive, high-beta stocks.”
There’s a bit more to it. ARK funds are, in some ways, a test case for active management in the ETF structure. For starters, ETFs are easy—and in many cases free—to trade. Investors can too easily heed the call of their worst instincts, buying as an ETF is shooting up and selling as it’s falling. This was what Vanguard founder Jack Bogle worried about when he decried the rise of ETFs. This can cause money to rush in and out, when the market is volatile, making it even more difficult for the manager to invest amid an already difficult market.
Investors have whipped money in and out of ARK funds over the past few weeks. They yanked nearly $700 million out of ARK Innovation in the few days between Feb. 24 to March 1, then bought back enough shares that the ETF was almost back to even for two days, before selling once again.
This can make it difficult for managers, who, even in actively managed ETFs, still need to sell stock to give investors their money back. That can be frustrating for managers like Cathie Wood, the founder of ARK Investment Management, who take a long view and expect to ride out some rough patches.
It’s especially problematic with regard to thinly-traded small-company stocks like the ones in ARK portfolios. ARK Innovation famously has nearly 10% of its assets in Tesla, but that is still just $2 billion, a drop in the bucket to Tesla’s $574 billion market value. ARK owns a larger stake in smaller companies, where a lot of buying or selling can have a more material impact on a company’s market value. “It’s going to have the most meaningful impact in those stocks where they have the most concentrated ownership,” says Ben Johnson, director of global ETF research for Morningstar.
Even investors who take a longer view still often overestimate their comfort with risk. “Regardless how aggressive you are, or how much you say you are willing to be in something over the long term, when you lose 70% of your money—not over three weeks, but two years—people got out,” says Rekenthaler, referring to the Nasdaq’s fall from 2000 to 2002. “It’s just too long, month after month of loss.” The Nasdaq took five years from its March 2000 high to get back to that level, and in that time, many tech funds shut down. That is another risk: Even if you have the grit and/or vision to hang through the tough times, if enough other investors don’t, a fund could be forced to liquidate due to large outflows. ARK’s lineup of ETFs is still $47 billion strong, so that outcome is not likely, though it’s worth keeping an eye on smaller competitors that will undoubtedly continue to launch.
What’s more, ARK’s ETFs are fully transparent. For years, asset managers have refused to put their active strategies into ETFs, waiting instead until regulators approved five new ETF structures that allow for less frequent reporting. Most firms feared front-running—that other investors would see what they were doing and copy those trades, driving prices up or down in the process. “If we are making a move into a certain security, that may need multiple days of trading,” says Tim Coyne, head of ETFs at T. Rowe Price. “If that information goes out to the public, it could lead to predatory trading strategies that would increase our costs.”
Wood values transparency, but her recent stardom means her trades may be even more under the microscope, and her focus on “disruptive innovation” companies are the kind of stocks that may be more susceptible to the increasing influence of retail investor excitement. Social media and trading apps, like Robinhood in particular, have created a sense of community among investors, says Rekenthaler.
“We know there are stocks out there buzzed up by public conversation, which ends up driving the price of the stocks,” says Rekenthaler. “The discussion around the portfolios of ARK funds have had a similar effect.” He notes the danger to the market when investors move together: “Historically, when you have large investors talking to each other about buying stocks at the same time, that’s market manipulation, and it leads to dangerous and unnatural stock behaviors.”
Write to Evie Liu at [email protected]
