Active Research Knowledge (ARK) ETF | White Coat Investor

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ARK (Active Research Knowledge) Funds is a primarily actively managed ETF company founded by Cathie Woods in 2014. It has achieved phenomenal success over that time period, enough that one of the ETFs (ARKK- The ARK Innovation Fund) became the largest actively managed ETF in the world in late 2020 and Cathie was named the “Best Stock Picker of 2020” by Bloomberg News.

 

How Many Funds Does ARK Have?

ARK operates seven funds in total which include:

• ARKK – ARK Innovation ETF
• ARKQ – Autonomous Technology & Robotics ETF
• ARKW – Next Generation Internet ETF
• ARKG – Genomic Revolution ETF
• ARKF – Fintech Innovation ETF
• PRNT – The 3D Printing ETF
• IZRL – Israel Innovative Technology ETF
• A new “Space Exploration ETF” coming out in 2021

In a period of time when very few people are moving money into actively managed mutual funds, investors seem to be flocking toward ARK Funds. YCharts tracks fund flows, and this is what they showed for the 4th quarter of 2020.

It is super-impressive to see any reversal of this long-term trend, even if for just a quarter. If you’re not familiar with the trend, these two charts demonstrate it well.

In this chart representing annual flows to U.S. Mutual funds and ETFs, you can see that annual flows into funds have been going more and more into Vanguard and iShares—primarily into their low-cost index funds—and flows into the rest of the mutual fund industry have been gradually getting lower and lower, even going negative some years.

In this chart representing annual net flows for active funds by fee, you can see a dramatic flow from the most expensive 80% of mutual funds (primarily actively managed) to the least expensive 20% of mutual funds (primarily index funds). So while that trend persisted in 2020 ($154B out of active funds and $437B into index funds), the trend actually reversed for quarter 4. One big reason is the popularity of ARK Funds. However, a closer analysis of the data shows what is really happening (not that it is news to any long-term observer of markets). Look at the largest outflows from passive funds. What you see is money flowing out of international stocks (VXUS), gold (GLD), and treasury bonds (IEF) and into ARK funds. Why in the world would you see investors as a whole moving money from one asset class to another? I’ll give you a hint.

2020 3rd Quarter Returns

• VXUS: 6.84%
• GLD: 6.98%
• IEF: 0.24%
• ARKK: 29.18%
• ARKG: 22.19%
• ARKW: 27.99%

In case it isn’t obvious, investors chase performance. They routinely move money from underperforming assets into recently overperforming assets. It’s the classic buy high, sell low behavior and a major reason why investor returns trail investment returns.

 

ARK Funds Performance Review

Let’s talk about performance for a while, shall we? Let’s start with the first, largest, and best known ARK Innovation ETF, ARKK. As of February 10, 2021, Morningstar reports the following performance:

Morningstar classifies it as a mid-cap growth fund, which seems appropriate:

But among mid-cap growth funds, ARKK is the very best one over the prior 3 months, prior 1 year, prior 3 years, and prior 5 years. Congratulations to Cathie Wood! No wonder she won the best stock picker award. Let’s see what she’s been picking.

ARKK Top 10 Holdings

How about that! Tesla! Everybody’s favorite stock. Obviously a good pick recently, and it’s pretty clear Cathie likes it a lot. In fact, she reportedly talked Elon Musk out of taking it private after this famous (and possibly illegal) tweet:

She reportedly sent Tesla a letter explaining she was certain it would go to $4,000 within 5 years. Guess what? She was right, and it only took three years, not five. When you account for the 5:1 split in 2020, Tesla is (as of the date I’m writing this) trading at over $4,000 a share.

Cathie REALLY likes Tesla. A lot. Don’t believe me? Take a look at the holdings in some of the other ARK Funds.

ARKQ ETF Holdings (Technology and Robotics)

ARKW Holdings List (Next Generation Internet)

12% and 10% respectively. Now I suppose I can see how Tesla would be a robotics company, but I didn’t realize they were an internet company. At any rate, the prospectus says Cathie only has to put 80% of the fund’s money into internet companies so I guess she can put 10% into Tesla if she wants. Certainly, the investors aren’t going to complain about her doing that in 2020!

“Companies within the ARK Next Generation Internet ETF* (ARKW) are focused on and expected to benefit from shifting the bases of technology infrastructure to the cloud, enabling mobile, new and local services, such as companies that rely on or benefit from the increased use of shared technology, infrastructure and services, internet-based products and services, new payment methods, big data, the internet of things, and social distribution and media. These companies may develop, produce or enable:

• Cloud Computing & Cyber Security
• E-Commerce
• Big Data & Artificial Intelligence (AI)
• Mobile Technology and Internet of Things
• Social Platforms
• Blockchain & P2P

ARKW is an actively managed ETF that seeks long-term growth of capital by investing under normal circumstances primarily (at least 80% of its assets) in domestic and U.S. exchange traded foreign equity securities of companies that are relevant to the Fund’s investment theme of next generation internet.”

 

Should You Invest in ARK Funds? Does Cathie Wood Have a Crystal Ball?

So now that we have clearly established that ARK funds have had a heck of a run the last few years as the best fund(s) in the best corner of the market, we are left with the question of whether you should invest in ARK funds or not. This question really comes down to whether or not Cathie and her team are likely to beat the market going forward. I don’t profess to know the answer to this question. But I do think it might be interesting to go back a few years and see who the “ARKK of 2015” was and see if their performance persisted.

The Best Mutual Funds of the 2000s

In 2015, Morningstar had an article about the “Best 9 Funds of the 2000s“. Here are the top 5 returning funds from 2000-2015:

1. Prudential Jennison Health Sciences Fund (PHSZX)
2. Rydex Basic Biotechnology Fund (RYBOX)
3. Profunds Biotechnology UltraSector Fund (BIPIX)
4. Fidelity Select Biotechnology (FBIOX)
5. Rydex Dynamic NASDAQ-100 2X Strategy (RYVLX)

It seems that health care and biotechnology were the Tesla and Apple of the first 15 years of this millennium. So, how would a strategy of investing in these funds starting 5 years ago (after reading this article) have worked out for you? Let’s take a look at their five year annualized returns as of Feb 2021:

1. PHSZX: 20.53%
2. RYBOX: 16.72%
3. BIPIX: 16.00%
4. FBIOX: 21.91%
5. RYVLX: 53.73%

Would you have done just fine the last 5 years with a performance chasing approach? Absolutely. Market returns for this time period were 19.27%. Three of the five funds outperformed the market (one substantially) and none of them had what anyone would describe as poor returns. But what if we look at other time periods? Well, here’s a study from Morningstar that did so, called “Performance Persistence Among Mutual Funds“.

Here’s what they did:

“For our study, we looked at fund performance relative to Morningstar Category peers, assigning all actively managed funds in each category to quintiles based on their performance over the past one-, two-, three-, four-, five-, and 10-year periods. Each of these sorting periods represents a separate analysis. We track the average returns of the funds in each quintile over the same period after the sorting date. For example, for the three-year performance sorting period, funds are ranked according to their total returns over the past three years through the sorting date (for example, December 1996). This is the lookback period. Funds representing the best-performing 20% of each category over that period are assigned to the top quintile (Q1), the next-best-performing 20% go into the second quintile (Q2), and so on. The study then tracks the performance of each quintile over the subsequent three years (for example, January 1997 through December 1999).”

And here’s what they found:

 

In case it’s not obvious what is being shown, those numbers are the difference in return in the new time period between the 20% highest-performing funds in the previous time period and the return of the 20% lowest-performing funds in the previous time period. If past performance were a good predictor of future performance, those numbers should all be positive and should all be statistically significant. As you can see, at the one-year mark the numbers are all positive and 5/14 are even statistically significant. At the five-year mark (i.e. the track record we have for ARK Funds), 7/14 numbers are negative and nothing is statistically significant. 14 asset classes and past five-year performance doesn’t predict future five-year performance in any of them. The data at 10 years looks slightly better, except in one asset class, which just happens to be the one the ARK funds are in.

Dimensional published a similar study in 2018.

 

As you can see, over 20-year time periods nearly 60% of mutual funds just disappear. And they’re not the successful ones that go away. Even more concerning, over longer periods of time 10-20 years, less than 1/4 of funds manage to outperform their respective index. And those that do typically do not do it by very much. Here’s another great chart from their study:

 

As you can see of the outperforming funds in any given 5-year period, only 1/6-1/3 of them outperformed in the next 5-year period. Those are not very good odds. So the question you need to ask yourself is:

 

 

The history of mutual funds is replete with fund managers who outperformed for years, and then didn’t. Statistically speaking, just from sheer luck alone, there should be a lot more outperformers than there are.

Maybe Cathie Woods is the next Warren Buffett. But consider the alternative hypothesis. Maybe she just got lucky. Maybe she happens to invest in what happened to be the best performing part of the market. Maybe she made a good call or two. Will she be able to continue to do it? How much of your serious money are you willing to bet on her ability to do so?

Do you know anyone who still invests in Janus funds?

What Happened to Janus Funds?

You would do well to learn their history prior to investing substantial money in ARK Funds. They were basically the ARK of the late 1990s. Let me recap a bit:

“Throughout the bull market of the 1990s, Janus funds were marked by their aggressive growth style; fund managers made outsized bets on fast-growing technology companies with little regard to price. By 1997 when KCSI announced its intention to separate its financial services division (consisting of DST, Janus, Berger, and IDEX) from its transportation operations, Janus was generating 85 percent of its parent company’s operating profit. It ranked in the nation’s top mutual fund families, had $166 billion under management, and four million client accounts. From late 1999 to late 2000 shareholder accounts increased 62 percent from 3.7 million to 6 million, and Janus more than doubled its workforce. It was the year’s top-selling mutual fund group for both 1999 and 2000.”

Sound familiar? Let’s get to the rest of the story.

“By early December 2000 Stilwell’s shares had fallen 28 percent, more than double the S&P 500’s overall drop. Throughout October and November it had shed more than $1 billion a day in assets as sliding stock prices cut into the value of its holdings. For its part, Janus suffered a pounding as the technology bubble burst; it posted a dismal performance in 2000 with 14 of its 16 equity funds suffering a decline. Still, the company retained its title as the nation’s best-selling mutual fund family in 2000, topping its 1999 investment inflows.

Yet from the start of 2000 through 2001, Janus became the emblem of the ‘tech wreck’. It fared worse than many of its peers because its assets were not widely diversified and invested largely in growth equities. Further compounding its decline were its large stakes in Enron and Tyco. In 2001 Janus was forced to cut its staff in half; it laid off 15 percent more of its workforce in early 2002. The fund, which lost its four-star rating from mutual fund research firm Morningstar for the first time since 1985, also began to shift its focus from technology to the pharmaceutical, media, and financial services sectors. Janus unloaded some of its tech shares in favor of stocks such as Boeing while adding more “value” funds to its roster along with blue chips such as Citigroup, Exxon, and Pfizer. Through it all, Janus investors remained remarkably loyal.

Janus assets fell $90 billion in 2001, with most of the decline due to plunging stock prices and investors pulling their fund shares. Even founder Thomas Bailey appeared to be jumping ship; in late 2001 he arranged to sell his remaining 6.2 percent stake in the company to Stilwell.”

Now I’m not saying that ARK is necessarily going to follow the same pathway as Janus nor that Tesla will follow the same pathway as Enron. But it could. It sure feels like I’ve seen this movie before and I know how it ends.

Now it’s a lot better to invest in actively managed mutual funds than to pick your own stocks. Mutual funds provide the following benefits:

• Diversification
• Professional management
• Economies of scale
• Easy liquidity

But at the end of the day, the data is pretty clear that betting on mutual fund managers for long-term performance is a loser’s game. Like with amateur tennis, the winning strategy is not to play to win. It’s to play not to lose. Just return the ball back over the net until your opponent screws up. It won’t take long. The way you avoid choosing a losing active manager is not to choose one at all. Sure, you’ll never “win”, but you will also never lose. And eventually, that means you win.

What do you think? Do you invest in ARK Funds? Why or why not? How will you decide when to stop investing in them, if ever? Comment below!