Cathie Wood Says Ark Is the New Nasdaq

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We're doing things differently, and sometimes the innovators attract a lot of criticism because we're disturbing the traditional world order.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe. The voice you just heard is Cathie Wood. She's the founder and CEO of ARK Invest, whose big bets on high flyers like Tesla, Bitcoin, and Spotify produced astonishing returns for years, followed by a plunge in value over the past year. In a moment, we'll talk with Cathie about whether the recent downturn has changed any of her thinking on individual holdings or her overall approach. We'll also hear from the creator of an ETF that bets against Cathie and from an MIT professor and money manager who specializes in trend following. Talking about financial trends, not country music, hip-hop crossover, or winter Crocs with that fur lining on them. Listening in, trendy as ever, our audio producer Jackson. Hi, Jackson. Hi, Jack. Feet staying warm in those winter Crocs? Bet. Did you say bet? Is that short for you bet? I'm trying to be on trend. You're too busy to say the you?

Bet.

Now, for anyone who's not familiar with Cathie Wood, she studied economics under Art Laffer, who became an advisor to Presidents Reagan and Trump and to ARK. And she spent more than a decade working as a researcher and portfolio manager, including at AllianceBernstein, where she gained a reputation as someone who outperformed during bull markets and underperformed during bear markets. Cathie wanted to launch an actively managed family of ETFs focused solely on companies that were innovative and often volatile, and AllianceBernstein thought the approach sounded risky. So with seed money from a trader named Bill Hwang, Cathie launched ARK Investment Management, which focuses on fields like artificial intelligence, blockchain technology, and energy storage. Side note on Bill Hwang: he ran Archegos Capital Management, which had a spectacular collapse last year. ARK got off to a slow start, but in 2017, its flagship ETF called ARK Innovation, ticker ARKK, returned 87%. Then it had a quiet year, followed by a 35% return in 2019 and a 153% return in 2020 that made Cathie the talk of Wall Street.

One of the most disruptive and innovative forces in the ETF world today. She's also one of the most successful.

Her portfolio of thematic active ETFs raking in some $30 billion in inflows last year, $8 billion in January, returns above 100%. Since then, the fund has been a top decliner and Cathie is still the talk of Wall Street. Cathie's ARK is sinking, and today we're going to uncover why.

It's a great lesson for us investors not to buy falling knives and not to get too committed to your own opinion.

We've talked on this podcast about how parts of the technology sector have slumped, but ARK Innovation has done much worse than tech as a whole. If you've held it for 5 years, you're still up 250%. But if you've held it for only a year, you're down 50%. ARK's experience illustrates an important point about returns for mutual funds, including ETFs. There's a big difference between how much a fund returns and how much investors make. And I'm not talking about management fees or sales charges or anything like that. I'm talking about investor timing. If you look at a chart of fund flows for ARK Innovation, you see only a trickle of investor money coming in until 2020, then a faster flow, and then a flood of cash coming in starting around December of that year and lasting through the following February. In other words, investors largely chased returns and they piled in at the top. What you've seen since then is a big drop in the fund's assets under management from a peak of $28 billion to a more recent $13 billion. But that's overwhelmingly due to falling prices for the fund's holdings, not to investors pulling out their money. Over the past year, investors have added more money to the fund than they've taken out. They're sticking with Cathie on the whole. So what does she think about recent declines for her holdings? And the prospects for a recovery. I reached out. Nice to see you again, Kathy.

Great to see you, Jack. How are you doing?

I asked about returns. The downturn in growth stocks seems to be linked in part to expectations that the Federal Reserve will aggressively raise interest rates to combat inflation. Kathy says she doesn't think that will happen.

And, and we do not think interest rates are going to move very far. We might get a March increase. And then, you know, in this midterm election year, I don't think we'll get another one.

That's a lot different from the consensus view. But Kathy says inflation is mostly due to supply problems, not demand, and that demand is slipping, which will soon fix the supply problems. She also says the bond market agrees with her. And she has a point. The latest reading on inflation is 7%. But bond investors are settling for a 1.8% yield on Treasury notes that come due in 10 years, which suggests that they think inflation will come down a lot and fairly soon. There's a counterargument to that, which is that the Fed has been holding down bond yields, so maybe they're not giving an accurate read. We'll see. Kathy invests in what she calls super growth companies, ones which she believed can grow their revenues by well over 25% a year. Top holdings in the ARK Innovation ETF recently included Tesla, Teladoc Health, Zoom Video Communications, Roku, and Coinbase Global.

Think Amazon in the early 2000s, right? Back then, Amazon was losing money. And by the way, we get hit with that criticism a lot. But if you look at the top 10 stocks in our portfolio, All of them are cash flow positive except for 2 in the genomic space, and one of those is almost there.

What Cathie does not own are the FAANG stocks. The F and G stand for Facebook and Google, which are now of course called Meta Platforms and Alphabet. The 2 A's are Apple and Amazon, and the N is Netflix. To Cathie, these are mature growth stocks., and although they generally outperformed her stocks last year, some are wobbling. Facebook had a huge drop this past week after it reported its first-ever decline in users. In Cathie's view, her stocks will ultimately prove better able to weather downturns than the FANGs. She also says that growth funds and index funds have started to all look the same, and her funds stand apart. And that investors will come to see that.

As investors look at all of their other equity portfolios, especially the broad-based exposures to growth and value, on the growth side, they see the same 8 stocks in their top 10. Our portfolios look nothing like the broad-based benchmarks. Even the NASDAQ and the S&P are beginning to look like each other. We are the new NASDAQ.

The new NASDAQ. That's a bold statement. Cathie makes a lot of bold statements about her approach and her stocks. They're based on strong beliefs. She believes the seeds of exponential growth in her areas of focus were planted back during the tech and telecom bubbles of the early 1990s, and they've been germinating for 25 years. And are now ready to flourish, but investors don't see that yet. And lately they've been, as Cathie says, running for the hills. If you're waiting for me to recommend Cathie's funds or bash them, you might be disappointed. ARK Innovation has some wonderful companies that appear too expensive for my tastes, like Tesla and Roku, and it has a company or two whose business model I just don't get, like Robinhood Markets. There's also plenty of crypto exposure, and I'm a crypto killjoy. When I write or say skeptical things about crypto, I get emails or comments that say things like, "Learn more, boomer." I'm trying. And also, I'm technically part of something called Generation X. You know, big hair, MC Hammer pants, The Goonies. Are you good? Hey, you guys, just because Cathie's funds appear too risky for my not-quite-boomer tastes doesn't mean I think they're bad. Investors who want spicy options deserve them, and Cathie brings the heat. I hear about some investors who use her funds to add a teensy bit of pizzazz to otherwise mundane portfolios. I'm allergic to pizzazz, but I get it. Sometimes I hear from people who have an emotional response to Cathie. Like they're rooting against her. That I don't get. What's not to like about a risk-taking entrepreneur with a consistent approach who tells people exactly what she's thinking, who posts her projections and financial models for her holdings online, and who's still fielding my questions instead of going into hiding at a low moment for returns? I like all of that. I asked Cathie about a couple of holdings. Tesla is the one she's probably most associated with, and she's as bullish as ever. She predicts that electric vehicle sales will jump from 4.8 million vehicles last year to 40 million by 2026. And she's unmoved by a recent push into electric by legacy carmakers like Ford.

Right now, Ford's revenue base is maybe 2 to 3% electric. What people are not focused on is the disintermediation disruption and ultimately destruction, we think, of the internal combustion engine-powered cars. So it's really fascinating to watch Ford's shares soar to 22-year highs because of electric when 98% of the revenue base is gas-powered. And that's where we're going to see some big problems.

Spotify had a big sell-off this past week after it issued a disappointing forecast for subscriber growth, and it's also seen some controversy. The musicians David Crosby, Stephen Stills, Graham Nash, and Neil Young say they're pulling their music from Spotify to protest vaccine statements made by the platform's biggest podcaster, Joe Rogan. You see, this is a perfect illustration of what I was talking about. Joe Rogan Born in 1967, Generation X. Crosby, Stills, Nash and Young, they were all born in the '40s, baby boomers. Generationally, I'm a Rogan. Though I'm also happily vaxxed and I know around half the words to Ohio. Jack, I think those guys are too old to be boomers. They're the Silent Generation. Thank you, Zoomer. Spotify, Kathy says it's a leader in podcasts and that its creator community is coming to life. And she compares it to Netflix, which used to rely entirely on licensed programming and shifted to producing more original content. I asked Kathy for her highest conviction holding, the one she just can't believe that everyone hasn't come around to loving, and she picked Zoom, the video conferencing company. She says investors dismiss it as a stay-at-home stock, but that it's really an enterprise communications company.

The communications part of the tech stack, enterprise tech stack, is the largest part of it. I think it's $1.5 trillion globally. Zoom and Microsoft are going to get most of this build-out.

Finally, I asked Kathy, are you aware of the passionate reactions people sometimes have when you come up in conversation and What do you make of it?

All I have to do is watch the TV for a little while or go onto Twitter and absolutely I hear it. I think, uh, ARK is disrupting the financial services industry, particularly the asset management part of our industry. We're completely transparent. We give our research away. We have a 5-year investment time horizon when most of the financial world has a quarterly or 1-year time horizon. We're doing things differently. And sometimes the innovators attract a lot of criticism because we're disturbing the traditional world order.

Thank you, Cathie. Let's hear from another ETF entrepreneur who recently launched his first big hit, a fund that bets against Cathie. That's next after this short break.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.

Welcome back. Matthew Tuttle has his own investment firm and a roster of specialty ETFs, including a 3-month-old one that's made a splash. Which fund has been your biggest hit so far? What's the one with the most assets?

So let me think. Uh, SARK. Not even close. I mean, you know, we got up to about $350 million We're probably around $300 million now. Without a doubt, that has been our biggest step.

When Matthew says SARK, S-A-R-K, he's talking about a ticker symbol. It comes from Short ARK, and the fund the ticker is attached to is called Tuttle Capital Short Innovation ETF. It bets against Cathie's flagship ARK Innovation Fund. I can't remember if we've talked about inverse funds in this podcast. I think so, long time ago. Just know that they typically use derivatives to bet against daily performance, not longer-term performance. And that distinction matters because it means the returns compound daily, and that can cause them to differ over time from what you would think they would be based on the target fund's performance. I don't use inverse funds. They're for active traders, and I think of them as short-term holdings only. Year to date, SARK has returned over 30% and ARKK has lost 27%. I asked Matthew, if you want to scoop up as much in assets as possible, why focus on niche funds? He disagreed with the premise.

People look at SARK and they're like, all right, it's niche, it's— you're betting against ARKK, you're betting against Cathie Wood. No, what we're doing is, in my mind, I've created a better hedge. You know, if you've got a negative view on the market, you'll go inverse NASDAQ or you'll go inverse S&P. What are you shorting? You're shorting FANG. That's not a great long-term investment thesis. To me, if I think we're going into a correction or a bear market, I'd rather short Zoom, Teladoc, and DocuSign, not Apple, Microsoft, and Google.

Matthew says he has nothing against Cathie. He says she attracted perhaps too much praise in the past, but that she's also getting too much criticism now.

To me, they're a sector fund, speculative technology, unprofitable, whatever you want to call it, they're a sector fund. When that sector does well, they'll do well. When that sector does poorly, they'll do poorly. So a lot of the praise they got in 2020, I thought was a little bit, you know, unfounded, but same with the criticism. It's kind of like, you know, if they were running a utility fund and utility stocks were getting creamed and they're losing money, Can't really criticize. What do you expect them to do? You know, she's not going to go to cash. She can't buy energy stocks, which is the only thing that's working this year. They go down with their sector. And that's why we designed the fund. There's no way for an investor to short spec tech. Now there is.

I asked Matthew, what's next for spec tech?

So a lot of people who are investing right now never saw a period where the Fed wasn't propping up markets. So I think what people are doing now is they're doing what's worked since, you know, 2009. Buy the dip. Multiples don't matter. Valuations don't matter. Earnings don't matter. Any downturn, the Fed's going to step in and save us. And again, assuming the Fed doesn't blink, which they could, I mean, at the end of the day, they've done nothing. They've just talked. But assuming they don't blink, we now go to an environment where the Fed's not stabilizing things, interest rates are not zero, and all of a sudden valuations matter, earnings matter.

When Matthew talks about the Fed blinking, he means that if it raises interest rates to fight inflation and if the stock market tanks, the Fed could lose its nerve and stop raising rates or even bring them back down. So will that happen? The answer to that question seems central to whether momentum stocks will bounce back or whether leadership will shift to value stocks or some other group and how the market as a whole will do. Let me share one other quick perspective on that.

Short signals on fixed income indicating that rising rates may be on the horizon this year has been a big theme, but also just sort of the general inflation theme cross-assets has been very discernible even in the data.

That's Katie Kaminski. She's an MIT professor and the chief research strategist at Alpha Simplex, where she manages money by using historical data and trends to predict where markets are headed next. Katie trained as an electrical engineer specializing in signal processing. She once worked at cell phone chipmaker Qualcomm.

And I think it turns out that a lot of what we do in finance is dealing with a lot of noise and trying to measure what signal there is in the noise, although it's way noisier than voice recognition.

Katie says she's seeing red flags in commodities and some signals in bonds that tell her that higher rates are coming and her team is preparing.

So things that will actually benefit from higher rates, you've already seen that in the banking sector. We're also thinking about maybe trying different asset classes, maybe buying things that have commodity commodity exposure and, and better exposure to the potential of inflationary pressures across the board.

Okay, but what makes Katie so sure? We've had plenty of false starts for inflation and rising rates over the past decade. Cathie at ARK says this could be another one. So what makes Katie so confident that the Fed will follow through?

What's happening right now is, for the first time in a long time, there is obvious pressure on central bankers. The mismatch between a CPI number at 7% and a 10-year at, say, 1.8% is huge. And so what that means is that the velocity of money is mismatched. And so the central bankers are going to have to go in and figure out how to, you know, sort of narrow that gap. If it takes a while to do that, then they're going to have to move interest rates up to catch up with sort of at least some of the level of inflation that we've seen.

I'm hearing 5 hikes, 6 hikes. I think one bank had 7 hikes this year. 7 hikes. How would we sit through 7 hikes and just shake it off? I don't know.

I'm going to see us get through one first.

Jackson, hit me with some country hip-hop crossover, some rugged and royalty-free. Thank you, Kathy and Matthew. And Katie. And thank all of you for listening. If you have a question you'd like answered, just tape it on your phone, use the voice memo app, and send it to jack.hough@barons.com. Jackson Cantrell is our producer. Subscribe to this podcast on your favorite app. You can listen to back episodes, tell your friends, write a review on Apple that will make Jackson blush. You like short messages of uneven quality delivered sporadically, you can follow me on Twitter. That's @JackHough. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.