[This article appears in our July 2019 issue of ETF Report.]
Actively managed ETFs are a small but growing field of the industry, and their issuers (naturally) say the time has finally come for these ETFs to offer investors a cheaper, transparent alternative to mutual funds and something besides passive indexing.
Some actively managed ETFs have delivered serious outperformance, such as the ARK Innovation ETF (ARKK), which ended 2018 on a positive note, and rose a staggering 87% in 2017. Others are still trying to establish an ETF track record that matches their own mutual fund history, like Davis Funds; while others, like Legg Mason, are teaming up with affiliates to launch products.
What makes these funds tick? Research, many of them say. So ETF Report took a look at several active funds out there to parse their strategies.
Top-Down, Long-Term Focus
ARK Funds, known for its focus on disruptive technologies, has five actively managed ETFs, with four feeding into the fifth: ARKK.
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Renato Leggi, client portfolio manager at ARK Funds, says ARKK holds the firm’s “best ideas” from their other strategies.
ARK Funds takes a top-down research process to identify innovative platforms or themes that have reached a tipping point in cost declines and have become cheap enough that exponential growth is possible, Leggi says: “That’s when we know these technologies are ready for prime time.”
The five technologies ARK Funds focus on are DNA sequencing, robotics, energy storage, artificial intelligence and blockchain, all of which have seen steep price declines, he explains. For example, when the first whole human genome was mapped in the early 2000s, it cost $2.7 billion, but today DNA sequencing is roughly $1,000 to $2,000.
Innovation is inherently controversial, Leggi says, and ARK Funds takes a different view toward these disruptive technologies than other active and passive ETF firms or Wall Street analysts. ARK looks for companies investing aggressively in research and development to gain long-term opportunities, and the firm seeks to hold companies for at least five years to give these companies time to gain future market share.
ARK’s long-term focus doesn’t mean simply buy and hold, he says. ARK trades actively, buying on dips and selling to rebalance, but not timing the market. It’s what drives the firm’s outperformance, and how ARKK ended 2018 up 3.5%, rather than being flat, Leggi notes.
Using its No. 1 holding, Tesla, as an example, Leggi says that, had ARK Funds simply bought and held Tesla for the full year, the stock would have contributed less than 0.2% to the firm’s overall performance.
By trading around Tesla news, such as when founder Elon Musk tweeted about going private, the firm added 1.76% of alpha to the portfolio return, Leggi says. Ultimately, ARK Funds did that with several names, trading around volatility and market noise, he notes, which added about 3.2% to the portfolio’s performance.