- ARK Innovation’s (ARKK) concept isn’t backed up by credible ETF research, and that’s why it has capitulated under changing market circumstances.
- The fund’s information ratio suggests that it’s not managed efficiently. Additionally, active management doesn’t make sense for a thematic fund.
- Current economic circumstances are headwinds to ARKK. Thus, I wouldn’t even suggest a “buy-the-dip” approach for now.
ARK Innovation (NYSEARCA:ARKK), an innovative tech exchange-traded fund (ETF), made a brief recovery towards the end of last week after many market participants circled out of crypto assets and back into risk-on meme stocks. However, when looked at in isolation, past price isn’t an indicator of future price.
I decided to write this article to prevent investors from falling for the “ARK Innovation fad” all over again. It’s critical for every market participant to understand why the ARKK fund isn’t fit for long-term gains and why it most likely reached its peak during the earlier stages of the pandemic.
ARK Innovation is an actively managed growth stock vehicle. Catherine Wood’s (chief investment officer) central argument is that industrialization will lead to dramatic cost-cutting, which could support growth stocks into perpetuity.
Although Wood’s argument might hold up in economic philosophy, it remains a folk tale to the stock market. I base my claim on the fact that smart-beta ETF construction theory has found no evidence supporting ARKK’s mandate. In fact, smart beta theory suggests that the market still considers growth stocks as cyclical plays that only outperform the broader market when an expansionary economic environment aligns with momentum-based investor sentiment.
Also, ARK manages its ARKK fund actively, which makes no sense at all. The ETF’s portfolio is thematically correlated, with assets that don’t provide any diversification benefits. My case can be substantiated by examining ARKK’s below-par information ratio of -1.90, which suggests poor portfolio management attributes. The information ratio looks at the fund’s risk-adjusted returns relative to its benchmark.
Will Matters Change Soon?
No, matters won’t change soon, and the ARK Innovation ETF will likely resume its downward spiral. I say this because the current economic climate isn’t supportive of growth stocks. For instance, we’re in a high-inflation, high-implied-interest-rate environment, which is geared towards dividend, quality, and value stocks.
Furthermore, risk-aversion has clearly settled in, as liquidity is being dragged out of the stock market at a rampant pace. I personally could see this trend continue during the expected economic downturn as investors tend to opt for safe-haven assets whenever times are tough — hence marginal utility cycles.
Additionally, I suspect that many of ARK Innovation’s underlying assets have lost the support of their initial investment base, and luring in a new base right now could be difficult given their recent poor performance.
A Few Other Concerns
I want to run through a few idiosyncratic data points to end this article.
ARKK’s expense ratio exceeds its asset class average by 1.58x, yet the fund’s skill ratio (information ratio) is worse than its peers’. Furthermore, ARK Innovation’s three-year tracking error (how well the fund “tracks” its index or benchmark) of 33.02% is astounding, especially with the median number under 10%. I mean, how can you claim to have a valid quantitative mandate if your execution is all over the place?
To conclude, I believe ARK Innovation ETF is a sell until we reach another growth cycle in a few years time. We’ll also have seen various new thematic ETFs brought to market by then, subsequently leaving ARK Innovation ETF as a story of the past.
On the date of publication, Steve Booyens did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.