[This article appears in our August 2018 issue of ETF Report.]
Conventional wisdom says active management doesn’t work—that ETF investors aren’t interested in active products; that they only want passive, predictable—and cheap—index funds.
Catherine Wood, CEO and founder of ARK Investment Management, LLC, doesn’t believe that’s true.
“The pendulum shift toward indexation might have run its course,” says Wood, whose firm has grown to $2.2 billion in ETF assets under management, almost entirely on the strength of its unique active strategies. “There’s tremendous saturation in the market and me-too portfolios that no longer differentiate.”
There’s nothing me-too about ARK’s lineup of active tech ETFs, nor about their sky-high returns. Over the past three years, three of ARK’s four core active ETFs have outperformed the SPDR S&P 500 ETF Trust (SPY) by at least 10%—one by almost 25%.
That kind of sustained outperformance is unheard of, especially for active ETFs.
“We’re a strange animal,” says Wood.
Scrappy Nobody To Success Story
ARK Invest is an overnight success three years in the making. Though the firm debuted its first ETFs in the fall of 2014, it wasn’t until 2017 that those funds began to amass substantial assets. In the past 12 months, ARK’s funds have taken in more than $1.6 billion in new net money, or 90% of their total lifetime flows.
Then, this past March, ETF.com’s panel of independent judges gave ARK the “Most Innovative ETF Issuer Of The Year” award. ARK’s largest and best-performing ETF, the ARK Innovation ETF (ARKK), won “ETF Of The Year.” Not bad for a scrappy nobody selling stock-picking to ETF investors deeply distrustful of active management.
ARK’s secret sauce, says Wood, is its focus on “disruptive innovation.” The firm seeks out and invests in the “trillion-dollar technologies” that cut across sectors and create new ones. Think the internet, or the smartphone.
“It’s about changing the way the world works,” she adds.
ARK Invest focuses on five disruptive innovations: genomic sequencing, automation, energy storage, next-generation Internet and blockchain technology.
These ideas are packaged into five ETFs. Three are active: the ARK Web x.0 ETF (ARKW), the ARK Genomic Revolution Multi-Sector ETF (ARKG) and the ARK Industrial Innovation ETF (ARKQ). Two are passive: the 3D Printing ETF (PRNT) and the ARK Israel Innovative Technology ETF (IZRL).
The sixth fund, ARKK, blends the firm’s three active strategies into one wrapper. (ARKK is also actively managed.)
Though ARK is well-established now, success wasn’t always assured. When ARK first launched ARKG, ARKQ, ARKW and ARKK in 2014, the ETFs met with more skepticism than enthusiasm. For two years, the company’s assets stayed below $20 million, much of that from seed capital.
“What we did not understand was that the ETF world didn’t really get active investing,” says Wood. “They either didn’t agree with it, given how long active had underperformed; or they didn’t understand it.”
It didn’t help that ARK had also priced its funds too high. Their four initial funds launched with expense ratios of 0.95%, a price tag that undercut many comparable mutual funds but was still too high for most cost-conscious ETF investors.
So, in 2016, ARK dropped its fees and partnered with distribution experts like American Beacon Advisors (now Resolute Investment Management) and Nikko Asset Management to get their funds before more investors.
ARK went a step further and rolled out passive products. In July 2016, it launched PRNT, and IZRL followed in December 2017. However, the new funds failed to gather assets.
“We tried to build a bridge to the ETF world,” says Wood. “I can’t tell you it really worked.”
By May of 2017, however, it didn’t matter. Assets for the firm’s four active ETFs had begun to take off—in large part because of bitcoin.
Buying Bitcoin At $250
In September 2015, ARK purchased shares of the Bitcoin Investment Trust (GBTC) for ARKW and ARKK, making it the first—and, to this day, only—ETF manager to hold bitcoin. (Due to IRS regulations, '40 Act funds cannot own bitcoins directly.)
At the time, the price of bitcoin was just $250.
“We think the ramifications of blockchain technology [which underpins bitcoin] will be more profound than the Internet,” Wood said. “Now, it’s in the earliest stage platform. But it’s going to transform every sector.”
ARK’s timing was fortuitous. Bitcoin’s price began its meteoric rise in the late summer of 2017, just as ARK’s distribution deals had begun to pay off and the firm’s funds found their way onto advisor platforms, like Morgan Stanley’s. ARKK and ARKW’s bitcoin allocation—originally just 1% of the funds—helped propel both funds to jaw-dropping 87% returns in 2017.
Investors took note, chasing that performance by pouring $157 million and $283 million into ARKW and ARKK in the last half of the year.
The Taxman Cometh
This year, however, ARK has had to trim back its bitcoin allocation for tax purposes. In ‘40 Act funds, only 10% of gross profits can come from unqualified income (such as bitcoin); anything beyond that, the IRS will confiscate in full.
“Obviously, we never dreamed we’d hit that amount of unqualified income,” says Wood.
To prevent a nasty tax shock to investors, ARK unwound its bitcoin position to ensure its unqualified income fell below the 10% limit. Now they’re waiting for the fiscal year to end, as well as for more guidance from regulators on whether cryptocurrencies will be classified as a security or as a commodity.
“The ground could still shift beneath us,” says Wood. “But we feel like we’ve done right by our clients.”
ARK’s bitcoin unwind hasn’t hurt the funds’ performance. Year-to-date, ARKK and ARKW are still up 22% and 20%, respectively.
For a larger view, please click on the image above.
Wood, who founded ARK in January 2014, has been a devotee of disruptive innovation since the 1970’s, when, as an economist at Jennison Associates, she first stumbled upon a “fall-through-the-cracks stock” called Telerate.
Telerate’s business model, which was to aggregate financial data and provide it electronically and in real-time, made it an early precursor to the Internet. She invested in the company, which was then sold to Dow Jones and later to Reuters.
“That’s when I learned that when there’s a dismissal of an idea, or a sense that it just won’t be big enough in the near term, those are the ideas that I’m most interested in,” says Wood.
After leaving Jennison, Wood co-founded Tupelo Capital Management, a hedge fund dedicated to global thematic strategies that was at one time the world’s largest female-led hedge fund. She then moved on to AllianceBernstein, where she spent 12 years as their CIO of Global Thematic Strategies, before leaving to start ARK.
Luring Talent To ‘The Dark Side’
Though Wood herself is in her sixties, she has surrounded herself at ARK with young, fresh faces and talent from all walks of life. Half of her team is women; almost 40% are people of color. Their professional backgrounds range from academia to real estate, from Silicon Valley to the United Nations.
“I didn’t start out with a diversity strategy,” says Wood. “In fact, the vast majority of people at ARK never dreamed they’d work for the financial services industry. A few of them even thought it was the Dark Side.”
Even though there’s a lot disrupting the ETF industry and the world economy right now, Wood isn’t nervous. In fact, she’s downright excited.
“One of the things that I’ve witnessed over my 40 years in the business is that during periods of uncertainty and turbulence, disruptive innovation takes hold even faster,” says Wood. “Because disruptive innovation is all about doing things better, cheaper, faster.”
“So, when consumers and businesses are in trouble or on edge, they tend to think about doing things differently,” she adds. “And that’s very good for us.”