Sometimes, how you handle success is more telling than how you handle failure. Hardly any investment manager enjoyed more success recently than Ark Invest.
According to Morningstar, their flagship fund, Ark Innovation ETF (ticker: ARKK), has outperformed 98% of all other funds over the last five years.
ARKK invests in “disruptive innovation,” focusing on companies that will “change the way the world works.”
It sounds like a winning strategy, right? Why own boring old companies like Ford and P&G when you could own Tesla and Zoom? Why own a brick-and-mortar bank when you could own Robinhood? Hindsight is always 20-20, but doesn’t it seem like ARKK was destined to crush the competition?
Well, founder and CEO Cathie Wood certainly thought so. Please, take one minute and watch the video halfway down this page: https://ark-invest.com/badideas/
Quite a victory lap, isn’t it? As a huge proponent of the broad-based indexes that Ark is mocking, I won’t deny that this video bothered me. I also won’t deny a touch of schadenfreude for what’s happened since.
Here is the performance of ARKK and a popular broad-based index since the video was posted:
ARKK continued its hot streak into the start of 2021, but the performance has been dreadful since last February. As you can see below, ARKK investors lost half their investment over the previous 11 months:
The ARKK party was a rager but the hangover has arrived and is threatening to linger (as I write this on Monday, thousands of Bengals fans know exactly what I’m talking about).
How is this possible? Hasn’t Zoom redefined workplace interaction? Isn’t Tesla leading the inevitable tidal wave into electric cars?
The answer is simple: the stock market doesn’t simply reward investors for investing in good companies instead of bad ones. It rewards investors who identify companies that will perform better than expected. Even great companies can be terrible investments if stratospheric expectations lead to an overvalued stock price.
The market is awesome at aggregating expectations. The price of any individual stock, and the stock market as a whole, balance the expectations of millions of people. To beat the market, you must have better insight than the collective group. Said another way, it’s not about how smart you are, it’s about how smart everyone else is.
Ark’s video from 2020 shows that Cathie and her team were cocky while times were good. Now that times are bad, Cathie is doubling down. In her December commentary, she defended her fund, predicting it would average 30-40% gains per year over the next five years.1
Cathie and her team had a historic run, but they are facing some tough questions if they are going to recapture the magic. Is this a temporary decline or is the strategy broken? More importantly, how much of their past outperformance was due to the fickle, humbling element of luck?
I won’t pretend to know what ARKK will do, but I know better than to mock others because the market’s collective wisdom has a habit of humbling everyone. There isn’t a single strategy that outperforms in every market environment. Right now, we’re seeing the “disruptive innovators” get disrupted by the fact that reality might not reach their lofty expectations. Those stocks might make a comeback, or we could see international stocks, energy stocks, or any other strategy enjoy some time in the sun.
Whatever happens, there is one competitive edge that is timeless — humility. Enjoy when times are good while recognizing the role of luck. Embrace the tough times as an opportunity to reevaluate. Nobody escapes unscathed, but humility can be the difference between a battle scar and a mortal wound.
1I’m surprised her compliance team would approve such a prediction. I think 7% annualized returns are probably a more prudent expectation for stocks, but then again, I don’t have a fund to sell.
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