Should You Buy Into Queen Cathie’s Innovation ETF?

Should You Buy Into Queen Cathie’s Innovation ETF?
Stéphane Renevier, CFA

almost 2 years ago5 mins

  • ARK Innovation Fund is down 76% from its peak as higher rates and lower growth led to a sharp reversal in their valuations.

  • And while plenty of downside risks remain, now could be an interesting time to carefully add some exposure to innovation to your portfolio.

  • You could either buy the ARK Innovation Fund (ticker: ARKK) or invest directly in its top picks: Tesla, Zoom, Roku, Exact Sciences, or Block.

ARK Innovation Fund is down 76% from its peak as higher rates and lower growth led to a sharp reversal in their valuations.

And while plenty of downside risks remain, now could be an interesting time to carefully add some exposure to innovation to your portfolio.

You could either buy the ARK Innovation Fund (ticker: ARKK) or invest directly in its top picks: Tesla, Zoom, Roku, Exact Sciences, or Block.

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Ark Invest’s main fund – the ARKK Innovation ETF, which specializes in “innovation stocks” like Tesla, Coinbase, and Teladoc – is down 76% from its peak, with higher interest rates and slower economic growth playing havoc with its holdings. And now, investors are turning on the fund’s founder, Cathie Wood. So let’s take a look at whether you should listen to the haters, or if you should be buying into the fund while it’s in a slump.

Why should you buy into ARKK?

For one thing, the world is undergoing one of the largest technological transformations in history, with the companies disrupting their industries likely to be handsomely rewarded. And as Ark’s team argued in a recent paper, innovation stocks aren’t particularly heavily represented in traditional indexes like the S&P 500. That means it’s essentially underweighting future winners in favor of current ones. Keeping a spot for innovation in your portfolio, then, could help you reap attractive rewards over the long term.

For another, investors now seem to be pricing “stagflation” – that is, slow economic growth and high inflation – into the markets, and it’s been a key reason for the recent selloff in tech stocks. So any positive surprises to the contrary could lead to a significant reversal.

Let’s say the Federal Reserve (Fed) manages to slow rising prices down without causing a recession: investor sentiment could turn bullish again, and growth stocks could suddenly play catch up. And even if the economy were to slow down, the Fed would quickly go back to cutting interest rates. That could prove positive for growth stocks, pushing up the present-day value of their future cash flows. Consider too that investors looking for double-digit growth opportunities in a slowing economy could also bundle in, pushing their valuations higher again.

Why shouldn’t you buy into ARKK?

Even though the market has dropped recently, it’s hard to claim that valuations of the disruptive, high-growth companies that Ark invests in are dirt cheap. If anything, the correction has only brought their valuations back to more normal levels.

But here’s the thing: company valuations often don’t just stop at their fair values. In fact, they generally overshoot the mark and go a lot lower. That’s especially true right now, when an environment of languishing economic growth and high inflation is proving particularly challenging for growth stocks, and when investor sentiment could deteriorate a lot more still. If investors start to sell off more aggressively, growth stocks wouldn’t be spared just because they’ve already fallen. Nor would ARKK, which could fall even further than – well, take a look.

Source: Koyfin
Source: Koyfin

Remember too that any drawdown can have a bigger impact on your portfolio than you might realize. Let’s say a stock has corrected 80%, from $100 to $20. So you buy in, expecting your downside to be limited to 20%. But that’s not the case: if that turns into a 90% correction, your drawdown – from $20 to $10 – is another 50%. That means there’s room for significant percentage losses.

Another worry is that many innovation stocks tend to be owned by large funds like Ark Invest, meaning they’re a lot less liquid than other stocks. If selloffs force those funds to trim their positions, that could lead prices to dip sharply. And if market makers and algorithms anticipate that as a possibility, it could fall even faster. Put differently, prices could go a lot lower before they go higher, which means buying the dip is always a risky proposition.

So should you buy into ARKK?

I think that having at least some long-term exposure to the most disruptive businesses makes sense – especially when you can buy in at these levels. That said, their high-risk, high-return profile means you’ll have to be careful with your implementation: only risk an amount you’d be willing to lose entirely, and buy at different intervals to benefit from dollar-cost averaging. You could invest half now and half in 3 months, for example, with the option to buy earlier if prices fall further.

As to what to buy, you’ve got two options. The first, obviously, is to buy into the ARK Innovation ETF (ticker: ARKK, expense ratio: 0.75%), which invests in the firm’s top picks. Investing in ARK is a bit like investing in a VC fund: you should expect plenty of losers, but a few big winners that should more than compensate for them. That means judging the fund’s results over a much longer horizon than what you might be used to. Of course, you could try to do better, but if you don’t have the time or experience, investing in ARKK is arguably a good way to back disruptors.

You might also be hesitant to buy in given all the negative press around the fund. But you have to respect Cathie Wood: she’s democratized access to information by openly sharing her research – and even her actual trades – with investors. What’s more, she takes tough but smart decisions, like cutting the number of holdings in her funds, and increasing the concentration in the top ones when times are hard. That forces analysts to focus on Ark’s most committed convictions – a far cry from managers who just hug their benchmarks and follow the herd. And sure, Wood focuses a lot on the stories and narratives behind companies. But that’s the nature of the companies she invests in: they’re taking big, bold bets that will only pay off years from now, making current financial numbers less relevant than the prospect of where they’ll be in the future.

If you’re still not convinced, the second option is to cherrypick from the holdings within her funds. Crypto bulls might want to scoop up shares of crypto exchange Coinbase, which have slid to all-time lows in the wake of falling crypto markets and disappointing earnings. Ark also seems bullish on healthcare, with three companies in the top 10: ExactScience Corp (cancer screening), Teladoc (virtual healthcare services), and Crispr Therapeutics (gene editing). And more traditional tech – Zoom (video meetings), Roku (TV streaming), Block (payments), Twilio (cloud communications), and UIPath (robotic) – rounds out the top 10. Oh, and not forgetting Tesla – a long-time favorite and the fund’s biggest position …

ARK Invest top 10 holdings. Source: Tesla
ARK Invest top 10 holdings. Source: Tesla
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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