Invest like ARK’s Cathie Wood

How to be your own ETF manager.
Invest like ARK’s Cathie Wood
December 13, 2021

Table of contents

More passive, less active. 

That’s the crude trend we’ve seen investors follow as we continue to question the ability of money managers to consistently beat their benchmark for us.

And it’s a theme ARK’s Cathie Wood has had an eye on for some time. 

For the joint CIO and CEO, a steady shift into passive strategies since the bubble and 2008 financial crisis, coupled with large asset managers searching for innovative companies to invest in, created an opportunity.

All aboard the ARK?

ARK exists to specifically target what it sees as the biggest innovative drivers of our future. 

Most investors will have got to know the firm through its tech-based exchange-traded funds (ETFs).

Artificial intelligence, energy storage, robotics, DNA sequencing and blockchain technology are the core themes guiding ARK’s research. 

And it’s this research that Wood points to as a key differentiator between the firm’s range of ETFs and the broader market. 

ETFs tracking proprietary indices continue to pop up, offering investors the opportunity to tap into themes like clean energy or cloud computing. 

But rather than being heavily research-based, sometimes the resultant funds can seem somewhat inelegant in Wood’s eyes, containing firms far from the cutting edge of the central theme.

Take active ETFs tracking a bunch of cannabis or social media stocks. The concern here is that any old firm can feature in there, as long as they fit the sector.

ARK aims to solve this through wider pools of research sources including academia and social media. 

But, with MiFID II regulations making the ARK range difficult for non-sophisticated investors to access in the UK, do investors on this side of the pond simply have to watch from the subs’ bench?

How to run your own ARK-inspired portfolio

Thankfully, no. We might not have access to the actual ARK portfolios but really what Wood is all about is a simple and effective approach to investment research.

The firm takes a bird’s eye view of the world, the broad shifts in social and cultural demographics, and how that’s shaping the ways we live. 

It then tries to identify the companies supporting and driving these changes, and who looks set to benefit.

And there might just be a few ways investors can adopt these guiding top-down and bottom-up principles, and miss out the negative aspects of ARK’s proposition too.

Here's one I made earlier...

First, let’s look at why it might be easier to run your own ARK-inspired fund than mirroring other types of pooled portfolio.

Whereas unit trust or open-ended investment company (OEIC) managers only have to reveal their top 10 holdings, ARK is very transparent about what its ETFs contain. 

If you like the way they think and research there is nothing stopping you from using those holdings as a blueprint for your own investing.

A quick look at the top 10 names in the ARK Innovation portfolio (ARKK)  as of 12 February 2021 shows Tesla, Roku, Teladoc, Zoom, Coinbase, Unity, Spotify, Twilio, Exact Sciences and Shopify. All available on Freetrade.

That’s another point - ARK is committed to public equity markets, so there aren’t any private funds in there or invite-only investments that normal investors aren’t allowed to access.

What’s more you can see the holdings’ weightings and keep up with the portfolio as often as you like. So, you get to draw on the research and detailed allocations, and can then do it yourself.

And there’s one key reason that might be attractive over the actual ARK instruments.

Price is what you pay, value is what you get

Fees are one of the key decision-drivers among personal investors and have been a big influence on the rise of passive investing. 

When the shine started to come off the active industry we began looking at index-tracking OEICs and then simple ETFs in search of market-matching performance at low cost.

The trouble with active ETFs like ARK’s is they can bring those fees right back up. ARKK charges 0.75% per year which is vastly more expensive than some S&P 500 ETFs with expense ratios in the 0.03-0.07% range. 

In terms of charges, it actually sits alongside a lot of the active OEICs investors tend to write off because of their apparent expense. But, choosing to look past the fees, investors pumped $19.6bn into the ARK suite of funds in 2020, with $17.7bn flowing into the tech story from June to December.

It turns out not to be cost, but value that investors are interested in.

Where does that value lie in ARK’s strategies? 

Ultimately, while funds tend to judge themselves on exploring and meticulously delivering on an aim like investing in innovation, investors tend to associate value with how returns compare to fees. Does the gain justify the cost?

But it’s worth breaking down what those costs go towards. In ARK’s case, the company puts effort into creating and maintaining its proprietary indices, investment research and rebalancing the portfolio allocation in line with its aims.

The question for personal investors is whether they feel they can do some of that heavy lifting themselves and avoid the 0.75% fees. In the case of UK investors, it might even be the only way they can aim to replicate what ARK is trying to do.

A few more considerations

ARK’s popularity exploded in 2020, and for good reason. Performance was strong, thanks to its thematic approach to innovation taking off. But 2020 wasn’t like other years. While innovation and ARK’s full range of forward-thinking investments had once thrust the company onto investors’ YouTube recommendations, things don't look so peachy at the tail end of 2021.

Source: Charles Schwab; one year ARKK Portfolio Holdings Performance Change, as at 10 Dec 2021.

Aside from Tesla, all of ARK's top holdings are looking a bit under the weather. While many of these were pandemic winners, they seem to have lost some lustre.

This brings in the need to use thematic strategies as part of a broader, diversified portfolio, because themes come and go. Even long-term change has stumbling blocks.

And this is where the ETF industry has changed too. The main selling point among the big index-trackers used to be their cheap access to widely diversified portfolios. 

With active ETFs, and particularly thematic ones, the only diversification is between companies. And the lion’s share of tech is US-based meaning investors looking to spread risk in this case often end up concentrating it instead.

Quality, or just quantity?

Another issue is that honing in on one idea means limiting your scope of view and can mean excluding quality businesses in favour of mediocre ones just because they fit the profile of the ‘type’ of company you want to hold.

This might be what ARK is trying to avoid but personal investors might find they can be even more selective, even less restricted and, ultimately more free to cherry-pick their highest conviction stocks. Leaving out the sector laggards can have as much of a positive portfolio effect as selecting the winners.

This might be a reason to look at what you actually want in your portfolio and how it contributes to diversification by sector, geography and asset class.

There is nothing wrong with casting your net wide and wanting to access certain themes through active ETFs. 

But if you have a strong view on the haves and have-nots in those sectors, don’t be put off by the idea that individual stocks afford less diversification in this instance, because that might not be true. 

In fact, with closer attention to your own portfolio construction, you can ensure that diversification from the ground up, and leave out some of the undesirable index constituents while you’re at it.

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