Growth investors who have flocked to Cathie Wood’s ARK Innovation ETF (ARKK) in years past have certainly done well for themselves. This aggressive hyper-growth fund has been a key beneficiary of some impressive valuation expansion through the pandemic.
As interest rates remained near zero, this fund vastly outperformed most of its benchmark funds, including the Invesco QQQ (QQQ), since its inception in 2014.
However, of late, ARKK has lagged its benchmarks by a wide margin, as investors choose to de-risk their portfolios. Valuation compression is hurting this ultra-aggressive growth fund, leading to capital outflows, which are furthering selling pressure among investors.
For some, this recent bearish activity may signal a buying opportunity for ARKK. After all, this ETF is now almost back to pre-pandemic levels. At some point, this grouping of hyper-growth stocks will pick up steam again, right?
Well, I remain bearish on the medium-term outlook for ARKK. I think this actively-managed ETF is one that’s too risky to hold right now for a number of reasons. Let’s dive into what investors should watch with this fund right now.
Selling Pressure Forces ARKK to Adjust Its Mix
When times get tough for ETFs, a certain amount of selling is required to meet the capital outflows these funds see. In some cases, as in the case of ARKK of late, some of the higher-quality growth stocks held within this fund have been sold at the expense of chasing higher-growth, more speculative companies with higher valuations.
Case in point has been ARK’s recent selling of Twitter (TWTR). Despite being one of the growth stocks many think is worthy of a long-term hold regardless of this sell-off, the ARK Innovation ETF sold 3,663,744 shares of Twitter last week, days before its earnings report, while the Ark Next Generation Internet ETF (ARKW) shed 280,974 shares.
These funds (more than $140 million as of last week) were used to purchase various small to mid-cap growth stocks with much less proven business models and a higher-risk profile.
Thus, Cathie Wood is taking an interesting strategy here. Her actively-managed ETF appears to be moving up the risk spectrum. For more aggressive investors, perhaps this is the preferred strategy. However, for most conservative long-term investors, the ARK group of ETFs may be becoming too risky to think about right now.
‘Innovation Is on Sale’
The sell-off in unprofitable tech organizations has certainly hit Ark Invest’s performance. Now, there are two ways fund managers actively managing an ETF could look at this. Either, the market is right, and de-risking is something that should be embraced. Or, sticking with one’s guns and doubling down is the best move.
In Ms. Wood’s perspective, the latter strategy is what is being imposed. Cathie Wood recently stated that she believes “innovation is on sale,” and her conviction remains higher than ever. Accordingly, she urged investors to look beyond this market volatility to the future prospects of the companies in this ETF.
Now, volatility is often linked to risk, and the ARKK fund, along with the other Ark Invest ETFs, isn’t short of risk, at least from a valuation standpoint. Should this market continue to take a risk-off view of equities, it’s likely that selling pressure will continue. For how long is the main question many investors have.
Yes, ARKK and Cathie Wood’s other funds have a five-year time horizon. Looking at this fund over the past years, its performance is still decent. However, ARKK is losing ground as a ‘proven’ outperformer compared to larger index funds. For Wood and her team, this view that innovation is on sale is one that the market may not share, suggesting this fund could be in for a rough ride in the quarters to come.
Ark Looking Forward to Launch New Fund
In addition to doubling down on her core funds, investors will reportedly have another fund to watch in the Ark Invest family of ETFs. This ETF will focus on venture companies or early-stage companies that are even less liquid than many of the growth stocks currently held in Ark ETFs.
Similar to ARKK, this fund will focus on disruptive secular tech themes that the Ark Invest team thinks are worthy of being invested in over the long term. Whether this lack of liquidity is a good thing is being debated. On the one hand, illiquidity means it’s harder to pull one’s capital out without seeing a big haircut. This will entice many investors to stay the course. On the other hand, should the market continue to turn lower, such a fund could see amplified liquidations.
For many, the risk held within the ARKK ETF is already more than enough. Indeed, Cathie Wood is one of the most aggressive active managers of ETFs out there. Her stance is a bold one, whether it’s ultimately proved to be right or wrong.
Bottom Line
There’s a significant amount of debate ongoing with ARKK right now. Indeed, much of this debate appears to relate to the average risk tolerance level of the market, which is deteriorating.
Should valuations continue to come down as interest rates rise, this ETF will likely continue to vastly underperform the market. Accordingly, investors looking at this fund need to have a very long-term investing time horizon or think about dollar-cost averaging into it.
The market prices its winners and losers by decades, not years, and this fund isn’t even a decade old yet. Thus, there are some investors who may not yet be sold on ARKK, and that view is likely prudent right now.
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