Cathie Wood has become a nearly household name among investors over the past two years, with some even hailing her as the next Warren Buffett.
Wood’s ARK Invest funds, however, have taken punishing losses this year amid broad stock selling. In recent weeks, Wood has made a series of mixed statements hinting that she may be growing more bearish.
Here’s what all investors should know about the losses at ARK, why they happened and where Cathie Wood stands on today’s market conditions.
The History of Wood’s ARK Funds
Cathie Wood rose to prominence as a notable stock picker while working for other investment companies, eventually going on to found ARK in 2014. Her approach to picking stocks is driven by identifying innovations that have the potential to disrupt multiple sectors and revolutionize global economics. Key areas of focus for Wood have included AI, blockchain and robotics.
For many years, ARK’s tech-heavy portfolio handily beat the market, averaging returns of nearly 45 percent each year. The run-up of 2020, however, made Cathie Wood and ARK famous in the investing world. In that year, all 6 of the company’s ETFs produced returns of over 100 percent.
By early in 2022, however, ARK’s edge over the S&P 500 was fading rapidly. In the subsequent months, a general selloff of high multiple growth stocks sent ARK’s funds far below the performance of the S&P 500.
Over the last year, the S&P index has lost just 4.77 percent. Meanwhile, the best-performing ARK fund over that time, ARKQ, is down 32.16 percent. ARKQ is also now the only fund that is still outperforming the S&P over the past five years
What Went Wrong for ARK?
In essence, ARK’s meteoric rise and equally spectacular fall track a classic bubble and bust cycle in the stock market.
While asset prices were rising, inflated dramatically by low interest rates and a steady flow of capital into the market from retail investors, the stocks held by ARK performed incredibly well. Now that those conditions are ending, however, Wood is left with an extremely risky portfolio in a much less friendly market.
As pointed out in a notable Morningstar analysis, the ARK funds tend to prioritize innovative companies that have the potential to disrupt their industries. However, the funds are constructed with very little regard to systemic risks, such as those presented by inflation or rapidly rising interest rates.
Many of the companies ARK invests in are also unprofitable and commanded valuations that were unjustified by their fundamentals. The prices of many of ARK’s stocks are highly correlated, leaving little room for shelter through diversification.
Is Wood Becoming More Bearish?
On the surface, the answer to this question seems to be a very straightforward yes. In a recent webinar, Wood specifically used the term “bear market,” suggesting that there were strong indicators that the market was slipping into bearish territory.
Wood has not, however, accepted the proposition that the companies her funds invested in were overvalued to begin with. Instead, she has principally leveled blame at the Federal Reserve for raising interest rates and short-sellers for opening positions against many of her preferred companies.
This view seems to ignore several key pieces of economic and market information that have played into the recent downturn.
To begin with, the Fed’s rate hikes come in response to inflation that now runs at an annualized rate of over 8 percent. While higher interest rates do pose a danger to companies, inflation can also raise costs for businesses and suppress consumer spending.
Thus, the Fed’s move to hike rates should be seen as a balancing act between systemic risks, rather than as a pure negative for the market.
It’s also worth noting that valuations have reached historic highs in recent years, a phenomenon that massively boosted ARK’s returns.
As the market begins to correct, some of that value is bound to be wiped out. Because of ARK’s heavy exposure to stocks with high valuations predicated on high levels of future growth, its funds are disproportionately exposed to this correction.
Where Does ARK Go From Here?
Despite encountering heavy losses and now falling behind the cumulative return of the S&P 500, Wood has doubled down on ARK’s investment approach.
Recently, she took to Twitter to defend the company’s investments in Zoom, disputing the idea that Zoom’s ultra-high valuation was only justified during the stay-at-home orders of the pandemic.
Naysayers lump Zoom $ZM into profit less tech, concept capital, stay at home stocks. Along with Microsoft, we believe that Zoom will be a prime beneficiary of the first “rip and replace” cycle since the early nineties in the $1.5 trillion global enterprise communications space. https://t.co/2IJ8WICB1D
— Cathie Wood (@CathieDWood) May 8, 2022
Wood’s arguments also seem to have resonated with many of her investors. To date, ARK has seen $1.3 billion in net inflows in 2022, despite its poor YTD performance against benchmark indices like the S&P 500. In large part, Wood argues, this is because of the transparency of ARK’s investment research.
Based on current trends, it’s almost certain that ARK will experience further losses in 2022. The Federal Reserve will likely have to continue its program of raising interest rates to fight inflation.
Investors who buy the dip on companies that were previously only being supported by cheap money could face significant headwinds as rates climb. This includes those who continue to invest in ARK’s portfolio of innovation stocks on the assumption that they must eventually regain their previous prices.
In the long run, the picture likely isn’t as bleak.
While many of Wood’s stocks were undoubtedly overvalued, there are still those that will pan out well and produce significant returns as they mature. However, the risks are still quite high.
Unprofitable companies fueled by inexpensive borrowing will not fare well in a higher interest rate environment. Lower growth prospects going forward are also likely to impair many of Wood’s historically more successful holdings, including Teladoc and Tesla.
So, while Cathie Wood is still bullish on her portfolio of innovation-driven companies, the current state of the ARK funds is a reminder that risk management is still critical in creating ETFs.
Wood’s admission that the market is entering bearish territory is a clear sign of the times for high-value startups. In the coming period, more conservative index and value strategies will likely produce better and more stable returns than the high-risk innovation strategy employed at ARK.
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