While global techs are faltering, ARK Invest’s founder Cathie Wood says, in the flagship ARK Innovation ETF (ARKK), she has been loading up Chinese tech names, such as JD.com (JD), Tencent (700) and Baidu (BIDU), the most known rivals to Alibaba (BABA). Wood is betting on them taking a large market share from Jack Ma’s e-commerce empire.
It wouldn’t be surprising that these potential global leaders of tomorrow would draw interests from global growth or innovation-theme managers. But also because these names happen to be large in scale and continue growing, the decision in gaining such large-cap exposure is more than reflecting Wood’s investing convictions. Robby Greengold, a Chicago-based strategist of Morningstar, sees snares in ARKK’s portfolio risks and constraints.
“ARKK’s portfolio is global in nature. They would pursue these opportunities wherever they can. But, Wood’s call on mega Chinese names has shown signs of Ark’s inability to invest in the small and micro caps that it has heavily favored in the earlier years.”
The fund’s return profile most resembles the Russell Midcap Growth Index, according to Morningstar Direct. Falling into the mid-growth Morningstar Category, ARKK’s portfolio willingly remains concentrated, holding less than 60 stocks. Its skew toward particular themes, such as the healthcare sector, makes it less like its active and passive peers.
“It is not to say that by adding large-caps the strategies managed by ARK are anywhere close to looking like any other fund or index. It has got its own place that's carved out its own niche,” says Greengold, adding that this niche is though becoming eroded away by a bloated asset base.
Flows into the ARK family of six funds totaled over $35 billion over the past 12 months through April 2021. The ETF registered an organic assets growth of 660% from a year back. The momentum of asset growth has though slowed due to the recent slid in stocks of so-called new economy sectors. Specifically, in April, ARK Innovation saw its first net outflow in 1.5 years totalling US$ 77.7 million.
Plenty of risks
The rapid asset growth over the past months has pushed ARKK to take larger stakes in these smaller company holdings. “We've seen that happens with 13 companies or about one-third of the holdings that ARKK owns 10% or more of the outstanding shares.”
In an unlikely event of these companies get into trouble themselves at one time, ARK isn’t able to just hold them forever. The more of a company the firm owns, the more difficult it will be to add to or reduce its position without significantly moving their stock prices. “If the entire world wants to sell them because all of a sudden they're terrible investments, everybody knows it and ARK will probably know it, too. ARK won't be able to sell nearly as quickly as the market will. Or, if ARK did sell down shares of the companies it own a large ownership stake, it would really negatively impact the stock prices,” Greengold adds.
With a much larger assets under management, these large stakes raise concerns around capacity and liquidity management and Wood has to look outside of the mid-cap universe, like the Chinese tech names, for example.
This revolves back to the risk-taking mindset. “Although it’s not in Wood’s hands to close the ETFs to guard inflows, what she could do is refrain from selling the strategies as hard as she does. She gets out into the media, and she exudes confidence over her strategies and the opportunities she sees and whether it's it's her purpose or or not. One outcome of such attention-grabbing interviews is that it will solicit additional interest from investors, she doesn't have to do that. She can go more under the radar and you know manage assets that way and manage investor interest that way if she if she was concerned about the funds, the funds asset base so so that's what I would point to as one way she could mitigate the risks that we're talking about.”
In describing Wood’s portfolio management style, Greengold says the portfolio are run based on her instinct and not on formalized data or rules. “The firm doesn't seem to have visibility into the portfolios aggregate risk exposures.” He explains: “The aggregate risks of the portfolio she may intuitively have a sense for that, but it's very ill-defined. ARK has not put in place a structure that allows the team to manage risk to some predefined tolerance. The absense of defined risk tolerance is also the major contribution to the below average for process.” The ETF is awarded an overall Morningstar Analyst Rating of Neutral.
On performance, the fund’s track record tends to be boom or bust in relative terms. It boded well in some directional bull markets like 2017 and 2020, winning on its hefty exposure to the rising tech and rather overlooked micro-cap names. Since the start of 2021, ARKK dipped 17.3% as of May 19, 2021.
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