(TheStreet) - In 2020, it felt like popular investment manager Cathie Wood could do no wrong.
Her flagship ARK Innovation ETF (ARKK) - Get ARK Innovation ETF Report soared over 300% after the pandemic lows from March of that year, an epic rally that was fueled by fiscal stimulus, historically low interest rates, and strong investor sentiment towards innovative growth stocks.
It got to the point where traders were checking for any new ARK purchases at the end of each session, as almost everything Cathie Wood touched turned to gold during this period.
Seasoned investors recognized that a looming correction was on the horizon for these high-flying funds, but few imagined the sharp selloff that was to come for the ARK ETFs.
The ARK Innovation ETF has plummeted roughly 54% since hitting 52-week highs, while many of the other ARK funds are deep in the red for 2022.
Ms. Wood is undoubtedly a brilliant person that’s easy to root for, but investors are beginning to wonder whether or not her stock-picking skills can right the ship in a truly treacherous market environment.
It doesn’t help that many of the core holdings in ARK funds like the Innovation ETF and Genomic Revolution ETF are businesses that could be years away from profitability, which is a big problem given the macroeconomic backdrop we are dealing with at the moment.
On the other hand, these funds have been so beaten up that there’s definitely a chance a bottom is in sight, which might tempt some investors to add exposure to the ARK family.
Regardless of where you think these funds are heading in the short term, gaining a better understanding of Cathie Wood’s investing strategy and what’s going wrong for her funds this year can certainly provide valuable context for future investing decisions.
An Unconventional Strategy Leads to Unconventional Results
A big reason why ARK funds are so unique is due to Cathie Wood’s unconventional investing strategy.
Her approach is distinctive in that instead of building out a diversified list of holdings across many different sectors in the market like traditional fund managers do, the ARK ETFs are essentially solely focused on holding growth stocks.
A lot of these are businesses with massive upside potential if they are able to execute on their vision, but can also subject investors to significant volatility.
To quote the ARK Invest website, “We invest solely in disruptive innovation.”
While this sounds like an intriguing approach to investing on paper, growth stocks are considered to be a very high-risk area of the market.
These types of investments can generate massive returns in the right environment, but will also get pummeled during market corrections, evident in the massive downside ARK holders have been subjected to lately.
Adding to Cathie’s recent underperformance is her heavy concentration in many of the same stocks across different ETFs.
There’s nothing wrong with investing in disruptive technology companies with a long-term investment horizon, but including the same core holdings in several different funds is a bit of a head-scratcher.
For example, the telemedicine and virtual healthcare company Teladoc Health (TDOC) - Get Teladoc Health, Inc. Report, which is down over 29% year-to-date, is a top holding in the ARK Innovation ETF, the ARK Next Generation Internet ETF, the ARK Genomic Revolution ETF, and the ARK Fintech Innovation ETF.
Each one of these ETFs has a different theme, but it’s difficult to justify including a healthcare company in a fintech ETF.
The lack of diversification due to Cathie including holdings like Coinbase (COIN) , Shopify (SHOP) - Get Shopify, Inc. Class A Report, Roku (ROKU) - Get Roku, Inc. Class A Report, and Zoom (ZM) - Get Zoom Video Communications, Inc. Class A Report in many of the ARK funds has resulted in major underperformance and makes you question why investors would want to own multiple ARK ETFs.
Other unconventional moves from Cathie Wood include averaging down in losing positions, which many consider a cardinal sin in investing and has contributed to even more downside for ARK.
The bottom line is that these funds were major outperformers when growth stocks were in favor, so naturally, they are underperforming the market during a correction.
What’s Next for ARK?
It’s easy for the media to criticize a stock picker like Cathie Wood during extended periods of losses, and her strategy certainly has some questionable traits.
With that said, the ARK Innovation ETF has delivered a 5-year return of 29.47% as of January 31, which is outperforming the S&P 500 even after the fund’s huge decline.
This is a reminder of the power of growth investing if you can stomach some down years.
Growth stocks might have trouble finding a bottom given the upcoming interest rate hikes from the Federal Reserve, and many of the stocks in ARK ETFs may never see their highs again.
There are also plenty of trapped buyers with positions in these stocks at higher prices that will likely look to unload shares every time ARK funds begin to rally, making the possibility of a trend change even more difficult.
While it's difficult to bet against innovation for the long term, until we see something different from the overall market in addition to high-multiple names, ARK funds could continue facing selling pressure.
By Sean Sechler
March 7, 2022
