Thematic-investing specialist ARK Investment Management has been in tune with the market’s unfolding narrative in recent years, but its lone portfolio manager, inexperienced team, and lax risk controls make it ill-prepared to grapple with a major plot twist, according to Robby Greengold, Morningstar’s Chicago-based strategist on US equity strategies.
Morningstar initiated its analyst rating coverage of actively-managed ETF ARK Innovation last week with a Neutral rating, which indicates that the fund research firm’s analysts have neither a strong positive nor negative conviction about the fund over the next five years.
Greengold highlighted the importance of the ETF’s experienced portfolio manager Cathie Wood, who founded ARK Investment Management in 2014 and has overseen its rapid asset growth during the past year.
“As ARK’s primary investment decision-maker, Wood is essential to the firm’s continued success,” he wrote.
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, according to Greengold.
The danger is that the fund lacks a robust investment process, which might leave the fund exposed in Wood’s absence.
Greengold described a “go-with-your-gut” approach to the portfolio’s risk management, with Wood relying on her instinct rather than data or rules.
But, Wood’s reliance on her instincts to construct the portfolio is “a liability”, he noted.
Yet, the $23.48bn New York-listed ETF has generated stellar returns through its hefty exposure to technology firms, ranging from giants such as Tesla, to smaller names such as predictive drug company Compugen and cancer genomics firm Personalis.
From its October 2014 inception through to February 2021, the ETF’s 36.4% annualised total return was the best performance of any actively managed fund in the mid-growth equity category. It also beat the Russell Midcap Growth Index’s 15.5% gain and the 19.5% gain of the NASDAQ Composite index, to which it is most highly correlated, according to Morningstar.
Although it also posted higher volatility than virtually any other fund, its risk-adjusted results were nonetheless “top-ranked”.
INFORMAL RISK MANAGEMENT
However, ARK’s untested analysts, “go-with-your-gut” risk management approach, and bloated asset base raise doubts about whether this fund’s outstanding historical results can continue, noted Greengold.
ARK, which has no risk management personnel and vaguely defined risk controls, views the subject almost exclusively through the lens of its bottom-up stock research, according to Greengold, who warned that this provides little visibility into the portfolio’s aggregate risk exposures, which can make or break a fund’s returns during one market environment or another.
The firm’s Innovation ETF has 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, highly volatile, and could plunge all together, wrote Greengold
But, 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.
Moreover, as its asset base has swelled to $23bn, the fund has become less liquid and more vulnerable to severe losses; as an ETF, it can’t close to investors.
“The firm is poorly positioned to prepare and react,” wrote Greengold.
ARK Innovation ETF: Top 10 holdings
| Stock | portfolio weight % |
| Tesla | 10.06 |
| Roku | 5.78 |
| Square | 5.49 |
| Teladoc Health | 5.00 |
| Baidu | 3.72 |
| Spotify Technology | 3.64 |
| Zillow Group | 3.43 |
| CRISPR Therapeutics | 3.12 |
| Shopify | 2.89 |
| Invitae | 2.87 |
