How ARK Innovation’s Poor Execution Undermines Its Aspirations

Key Morningstar Metrics for ARK Innovation ETF ARKK

• Morningstar Medalist Rating: Negative
• Process Pillar: Below Average
• People Pillar: Below Average
• Parent Pillar: Below Average

ARK Innovation ETF steers through challenging territory with a loose grip on the wheel.

With its focus on five technology platforms that manager Cathie Wood believes will reshape global economic sectors—artificial intelligence, blockchain, DNA sequencing, energy storage, and robotics—this strategy stands out for its bold bets. These platforms’ potential is compelling, but the firm’s ability to spot winners and manage their myriad risks is less so.

Diverging starkly from broad market or growth indexes, which are chock-full of profitable companies with lengthy histories as public entities, this fund mostly sails the rough seas of early-stage firms. They often promise rapid top-line growth, but also scant earnings and uncertain futures; results range from tremendous to horrendous. Successfully traversing such terrain demands forecasting talent, which ARK Investment Management lacks.

The firm has also struggled to develop and retain its investment personnel. Many have come and gone over the years, including two of its longest-tenured members in 2023. Wood remains the firm’s key person.

Wood’s reliance on her instincts to construct the portfolio is a liability. The highly correlated stock prices of its holdings belie its apparent diversification across many sectors (per conventional classifications). In practice, the portfolio’s exposures strongly resemble those of a technology-oriented fund.

But while the average tech fund rose 15% annualized since this strategy’s 2014 inception—coincidentally the minimum rate of return Wood expects from all this portfolio’s holdings—this fund gained 11.6% annualized through February 2024. Its total returns lagged nearly all surviving technology funds, and its standard deviation (a measure of volatility) topped all but one. It also underperformed the S&P 500.

ARK’s pursuit of disruptive innovators has merit, and its quest for big rewards may appeal to aggressive investors. But it has not proved it is worth the risks it takes.

ARK Innovation: Performance Highlights

The strategy has posted middling total returns and poor risk-adjusted results from its October 2014 inception through February 2024.

The exchange-traded fund’s 11.6% annualized gain was a solid absolute return but puny relative to technology-focused funds—its closest peers—which averaged around 15% gains over the same span. The stylistically relevant Russell Midcap Pure Growth Index gained 13.5% annualized, while its S&P 500 prospectus benchmark gained 12.4%.

Extreme volatility is the strategy’s hallmark. It soared in the wake of 2020′s pandemic-induced bear market, notching a gain exceeding 150% for the year. But the following year it dipped 23% as its bogies climbed by double-digit percentages. In 2022, it lost two thirds of its value as inflation and interest rates soared and high-growth stocks fared especially poorly.

The strategy’s style often explains its results when markets rise or fall. It typically underperforms during market drawdowns or when value stocks are in favor—as they were in 2022. It has instead excelled during market rallies when taking risks on companies with high price multiples or highly uncertain futures was handsomely rewarded, as was generally the case in 2023. That year, the ETF climbed by 68%.