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Is It Luck, Skill Or Both: What A Fund Manager’s Fans Should Consider

Fund manager Cathie Wood has been flying high in recent years, but recent turbulence should remind investors what can happen if they follow her too close to the sun.

In 2014 Wood founded ARK Investment Management LLC, which at this writing has more than $50 billion in assets under management. Wood’s primary idea for ARK Invest, as it’s often shortened, was to package actively managed stock portfolios as exchange-traded funds. According to her company bio on the ARK Invest website, Wood “founded ARK to focus solely on disruptive innovation while adding new dimensions to research.” ARK Invest’s funds focus on innovative and disruptive companies. These include enterprises dealing with robotics, blockchains, artificial intelligence and DNA sequencing, among others. Perhaps most illustrative of the company’s ethos, Tesla has been a long-time favorite of Wood’s. In 2018, Wood drew skepticism with predictions of major jumps in value for the stock; her called shot became reality by the end of 2020.

As both the chief executive officer and chief investment officer of ARK Invest, Wood remains the face of the firm. Her success has earned her plenty of fans. Many financial professionals respect Wood, but she has secured even wider appeal through online communities, especially Twitter and Reddit. She even has swag: ARK Invest offers a line of branded clothing for boosters. (Profits go to charity.) Fans point to Wood’s long run of success as a stock picker, a result, in part, of her aggressive style and focus on future advances. Wood’s flagship Ark Innovation Fund returned an average of over 40% per year over the past five, according to Forbes. In late 2020, ARK Invest surpassed JP Morgan to boast the largest actively managed ETF by total assets under management. Her success has led some observers to wonder if she might be the next Warren Buffett.

Nate Geraci, who heads the investment advisory firm ETF Store, told Lexology in April 2021, “At this point, investors think anything Cathie Wood touches turns to gold.”

In reality, investors should remember that equities can move down as well as up. From its peak in February to its trough in May, the Ark Innovation Fund lost one-third of its value. Speculative biotech stocks and other growth companies dipped in value as concerns about inflation made investors wary of companies whose profits are years in the future. Such early-stage ventures, many of which are not yet profitable, dominate ARK Invest’s funds. This is not to count Wood out; some of the mid-May losses were erased by the end of June, with the Ark Innovation Fund bouncing over 20% from its bottom. Yet the turbulence still reminded investors – or should have – that Wood’s strategy, while potentially lucrative, carries risks.

Investors should also consider the climate in which ARK Invest has operated. As a relatively new firm, it has only had to navigate a generally strong stock market environment. The Ark Innovation Fund's five-year annualized return of 46% is undeniably high. But the five-year annualized return of the S&P 500 in that period was also high by historical standards, with returns in the high teens or above in four of the past five years. Even during a good period for the stock market overall earlier this year, the Ark Innovation Fund dropped by a third when growth stocks briefly fell out of favor. This followed previous bumps in the road: From peak to trough in February 2020 to March 2020, the fund dropped 42%. It dropped 18% from April 2019 to June 2019, and 16% from March 2018 to April 2018. From January 2016 to February 2016, it dropped 28%. Even when the market is strong overall, the fund carries risks and volatility that may be too much for certain investors to stomach.

Wood’s approach involves identifying innovative companies that have the potential to transform their industries. So far, this approach has paid off more often than it hasn’t. But as venture capitalists know, determining whether a cutting-edge approach will succeed in the long run is a process that is far from foolproof. This is why most investors will not benefit from picking individual stocks over time. Professional managers like Wood and her colleagues have a better chance at outperforming the market due to their training and resources. Even so, taking big risks means the opportunity for big losses.

There are other criticisms of Wood’s approach amid the widespread enthusiasm. ARK Invest was a primary player in the rise of themed ETFs. Yet some critics have claimed that themed ETFs, at ARK Invest and generally, do not accurately reflect the markets they claim to represent. Even those who admire Wood’s approach have sounded a cautious note. As Wall Street Journal columnist Jason Zweig observed earlier this year, size can impede the sort of nimble trading that contributed to ARK Invest’s early success. As assets under management balloon, fund managers face new concerns about liquidity.

ARK Invest’s latest offering illustrates the volatility at the heart of its strategy. In a collaboration with 21Shares, ARK Invest is promoting a new Bitcoin-focused ETF. While 21Shares will offer the fund if it secures permission from the U.S. Securities and Exchange Commission, ARK Invest’s seal of approval will boost its appeal to Wood’s fans. The Ark Innovation Fund already owns around $820 million worth of shares in cryptocurrency exchange Coinbase Global. My colleagues and I have written before about the risks and complexities of cryptocurrency. Yet Wood is a longtime booster. She has stated publicly that she believes Bitcoin’s value will reach $500,000, despite its recent setbacks. Whether Wood is right or wrong remains to be seen, but going all in on the cryptocurrency carries undeniable risks.

In general, investments feature a trade-off between risk and potential return. No investment strategy is risk-free, even if it has had a run of success over several years. Some cautious observers have compared the current enthusiasm for technology stocks with the dot-com bubble of the early 2000s. Regardless of whether it is true of the sector as a whole, some tech stocks will inevitably turn out to be overvalued. And, as with actively managed mutual funds, active ETF investors should stay alert to the costs of active management over time.

Wood’s results point to her skill, but they also involve a healthy dose of luck. Just because someone will win the lottery does not make playing the lottery a sound financial decision for every person who buys a ticket. ARK Invest’s results in the past five years do not guarantee similar results in the next five, ten or twenty. Investors can admire Wood, but should not let that admiration lead them away from their long-term investment plan.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, is the author of Chapter 20, “Giving Back,” in our firm’s most recent book, The High Achiever’s Guide To Wealth. He also contributed several chapters to the firm’s previous book, Looking Ahead: Life, Family, Wealth and Business After 55.