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How a Flood of Money Submerged Cathie Wood’s ARK

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How a Flood of Money Submerged Cathie Wood’s ARK

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Fund manager Cathie Wood has become a superstar in 2020, after her ARK exchange-traded funds achieved some of the highest returns in history.

So far this year, ARK Innovation, the largest of Ms. Wood’s ETFs, is down more than 15%. Over the past 12 months, it has underperformed Invesco QQQ Trust, which tracks the tech-dominated Nasdaq-100 index, by 65 percentage points.

What happened at ARK flies in the face of the belief that ETFs are superior in every way to mutual funds. Over the past decade, investors have flocked to ETFs, which are, on average, much cheaper and more tax-efficient than mutual funds. ETFs have one critical flaw though: they can get too big too fast, and no one can stop it.

Almost all professional investors admit, at least privately, that success bears the seeds of its own destruction. It is much easier to rack up giant wins with a small fund than with a big one.

A mutual fund can alleviate this problem by closing off new investors, cutting off the inflow of cash. Over the years, when hot new funds threatened to inflate mutual funds to unwieldy sizes, companies such as Fidelity, T. Rowe Price and Vanguard closed some of them until markets are cooling.

This way, managers weren’t forced to buy stocks they wouldn’t normally touch, and investors didn’t pile in just before performance plummeted.

In my opinion, there aren’t enough mutual funds that have closed themselves to new investors, but at least they could.

Unlike mutual funds, however, ETFs generally don’t appeal to new investors. The ability to issue shares continuously is what keeps the price of an ETF in line with the value of its holdings.

Thus, ETFs almost never limit their own growth. This presents a paradox: the better a portfolio performs, the bigger it gets and the more likely it is to deteriorate. This isn’t true for index funds that track the market, but it’s true for just about any fund that seeks to beat the market.


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Rarely has anyone escaped this iron law of investment management, not even Warren Buffett himself.

When Berkshire Hathaway was small, “we only needed good ideas, but now we need good big ideas,” Mr. Buffett wrote in early 1996. “Unfortunately, the difficulty of finding them increases in direct proportion to our financial success, a problem that increasingly erodes our strengths.

Since writing those words, Mr. Buffett has beaten the S&P 500 by about half a percentage point annualized on average, a far cry from the impressive gains he racked up when Berkshire was much smaller.

What about the ARK? The company grew so quickly that it soon ended up owning significant percentages of many of its holdings. That could limit its ability to trade them without negatively affecting the price, says Corey Hoffstein, chief investment officer at Newfound Research, an asset management firm in Wellesley, Mass.

When a fund has to trade large blocks of stocks, it can inflate its prices when the fund buys and crush its prices when it sells. These moves can hurt returns.

“You can end up with a mismatch between strategy and structure,” says Hoffstein. “The ETF could have been a perfectly thin structure when ARK was smaller, but there comes a time when structure can become a drag on strategy.”

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ARK, which declined to comment, said its funds will be able to “scale exponentially” as its favorite industries continue to grow. This means, according to the company, that it could manage far more than the $54.7 billion managed by ARK as of December 31.

Ms. Wood also argued that shares of ARK’s innovative companies have fallen so much that they are “deep value” bargains that could generate average returns of 30% to 40% annualized over the next five years.

Either way, the inability of ETFs to deter speculative money poses a problem that no one can argue with: blood-chilling losses for investors.

Here’s how it goes.

In its first two full years, 2015 and 2016, ARK Innovation earned less than 2% cumulatively. Then it took off, growing 87% in 2017, 4% in 2018, 36% in 2019, and 157% in 2020.

Yet at the end of 2016, the fund had just $12 million in assets, so its titanic 87% gain in 2017 was achieved by a small number of investors. At the end of 2018, ARK Innovation had only $1.1 billion in assets; a year later, he still had just $1.9 billion.

It wasn’t until 2020 that investors started buying en masse. Fund assets tripled to $6 billion between March and July 2020. September 2020 to March 2021, Morningstar estimates,

investors flooded ARK Innovation with $13 billion in fresh money.

Just at the right time, performance peaked. ARK Innovation ended up losing 23% in 2021, even as the Nasdaq-100 index gained over 27%.

Few investors captured the fund’s biggest gains. A huge crowd of newcomers suffer their worst losses.

As a result, believes Simon Lack of SL Advisors, an asset manager in Westfield, NJ, investors in ARK Innovation as a whole have lost money since its launch in 2014, even though the fund has earned more on average. 31% at an annualized rate in recent years. five years.

In what Mr. Lack calls “an unfortunate downside of human behavior,” no matter how desperately you chase past performance, you’ll never catch it. You can only buy future performance, which may be hampered by a tidal wave of new money.

ETFs are powerless to prevent this tragic cycle. Maybe mutual funds don’t belong in the ash heap of financial history after all.

Write to Jason Zweig at

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How a Flood of Money Submerged Cathie Wood’s ARK

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