Morningstar go studs up on ARK Invest’s flagship ETF

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Ever turned away briefly from watching a football match only to a hear a fellow spectator loudly exclaim “ooooft”?

In such an instance, you’ll probably guess that someone has been poleaxed on the field, likely from a challenge that used to be referred to as a “reducer”. That was before, you know, injuring someone stopped being a point of pride in the sport sometime in the mid-2000s.

On Wednesday one corner of the second floor at Bracken House was treated to such a noise from this FT Alphavillain. This time, however, it wasn’t from witnessing a horror challenge, but after reading a piece published by fund research shop Morningstar explaining why it downgraded Cathie Wood’s flagship ARK Innovation ETF.

Move over Roy Keane, there’s a new enforcer in town, and his name is Robby Greengold, CFA.

Here’s an excerpt:

Since its meteoric rise in 2020, the strategy’s exchange-traded fund has been one of the worst-performing US-sold funds, as the aggressive-growth stocks it held fell back to earth. Its wretched 45.5% loss over the trailing 12 months through February 2022 significantly lagged the 7.9% decline of the average fund in the technology Morningstar Category and the Russell Midcap Growth Index’s 4.3% loss. (The strategy behaves more like a tech fund than its own mid-growth category.)

OK but I’m sure she’s learned a lot from such a humbling right?

Manager Cathie Wood has since doubled down on her perilous approach in hopes of a repeat of 2020, when highly volatile growth stocks were in favour. She has saddled the portfolio with greater risk by slashing its number of stocks to 35 from 60 less than a year ago — thereby amplifying stock-specific risk — and growing its aggregate exposure to companies in which ARK Investment Management is a large shareholder. The strategy has effectively become less liquid and more vulnerable to severe losses. Wood runs a variety of exchange traded funds that often make shared bets on stocks and can’t close to new investors — an option open-end mutual fund rivals can use to preserve their liquidity and investment opportunity set.

Oh. Well, I’m sure there’s an experienced team of risk managers there that keep an eye on things. What’s that Robby?

The firm has no risk-management personnel.

Wait what?

Wood’s reliance on her instincts to construct the portfolio is a liability. This is a high-risk, benchmark-agnostic portfolio that invests across technology platforms the team thinks will revolutionise how sectors across the globe operate. The firm favours companies that are often unprofitable and whose stock prices are highly correlated. Rather than gauge the portfolio’s aggregate risk exposures and simulate their effects during a variety of market conditions, the firm uses its past as a guide to the future and views risk almost exclusively through the lens of its bottom-up research into individual companies.

OK OK but the rest of the Ark team has plenty of experience, so maybe the cavalier attitude to risk management is fine.

ARK has in place a poor succession plan for the 66-year-old Wood, who is essential as the firm’s majority owner and lone portfolio manager. Director of research Brett Winton would succeed her if needed, but his 15 years of industry experience include none as a manager. Exacerbating that key-person risk is the firm’s inability to develop and retain talent: Many of its analysts have come and gone, and most of the nine remaining lack deep industry experience.

OK Robby, what do you REALLY think?

Wood has suggested that risk management lies not with her but with those who invest in ARK’s funds. It’s tough to see why that should be so. ARK could do more to avert severe drawdowns of wealth, and its carelessness on the topic has hurt many investors of late. It could hurt more in the future.

It did make us wonder, what has Cathie’s flagship fund been trading over the past few days?

Turns out, not much. Here’s its trade record during Monday’s shitco rally:

And the trade record during Tuesday’s shitco sell-off:

All seems quiet. A little too quiet.

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