Cathie Wood and Ark – Hype or Substance?
This article is based on a presentation from John Mauldin’s 2021 Virtual Strategic Investment Conference, which is being held from May 5 to 18. To register for this conference, click here. The Strategic Investment Conference was just approved by CIMA and CFP for 19 hours of continuing education credits.
Cathie Wood may be the most polarizing and controversial figure in finance. Her acolytes believe her vision will make them rich. Her detractors credit her sales skills but question her investing acumen.
I heard her speak for the first time yesterday. Count me among the detractors.
Wood is the founder, CEO, and CIO of Ark Invest, the investment management firm she founded in 2015. Ark’s flagship fund is ARKK, an actively managed ETF with approximately $53 billion in assets. She spoke on May 12 at this year’s Strategic Investment Conference, hosted by John Mauldin.
ARKK has had a spectacular run, achieving 43.5% returns over the last five years. It has benefitted greatly from being positioned in the best-performing growth stocks over that period, and it has had a large position in Tesla, which has greatly helped ARKK’s performance. Most of that outperformance was in just two years – 2017 and 2020.
I’ll review what she said in her talk, highlighting those comments that I doubted.
Her investing focus is on disruptive technology. But she has a view on macroeconomics, having studied under Art Laffer, the economist who became influential during the Reagan administration. Wood discussed how her funds, which are highly concentrated in stocks with high P/E multiples, have fared this year.
“We have been hit hard,” she said.
Her funds are down approximately 35% from their peak, which was in mid-February.
She described the economic backdrop that she faced in the first quarter. The bond market had a “heart attack,” she said. In three months, interest rates doubled. Yet equities were up. The hedge fund Archegos failed and there was fear of leverage and of a “systemic issue or crisis”. “We seemed to get through that,” she said. Then President Biden proposed a doubling of the capital gains tax, which she said would be a “killer” for her funds, given their high appreciation. “That was a headwind,” she said.
What she left out was that Bill Hwang, who ran Archegos, was a seed investor in her fund. When Archegos failed, her performance suffered, potentially because it became a forced seller of ARKK.
The bull market has strengthened and rotated into value. “This is not the kind of market we will do well in,” she said. Wood compared it to the fourth quarter of 2016, when President Trump was elected and there was a big rotation to value. The bull market broadened out and her confidence increased; 2017 turned out to be a great year for ARK.
Now, she said, the economy is facing deflation in the longer term. She spoke on the day when the core CPI release showed a 4.2% gain over the prior year. The core CPI will stay at 3% to 4% and headline CPI could be 6% to 10%, according to Wood. But that is all due to supply chain issues that will self-correct, Wood said. Goods are only one third of GDP services are the rest. Businesses are scrambling to keep up with demand and have tripled or quadrupled their orders, building up inventory. “We will end up with a massive inventory problem,” she said, which will be deflationary.
There will also be what she called “good” deflation from technology-driven innovation and increases in productivity. There will also be the corollary, which she called “bad” deflation. She predicted that as many as half of the S&P 500 companies will be disintermediated or disrupted by the five forces that underly her investment thesis: DNA sequencing, robotics, energy storage, artificial intelligence (AI) and blockchain. To cut their debt, she said, those companies will have to cut prices.
Innovation will solve the wage pressure and job vacancy problems the U.S. economy faces, Wood said. But she was not clear on this point. She also said there will be job losses through automation from robotics in manufacturing and that workers in the service sector will be replaced by AI. She was not clear how innovation would solve employment problems if there were corresponding job losses from automation or AI.
Wood cited research claiming that 47% of all jobs in the U.S. will be lost in the next 20 years. But she said GDP will be $12 trillion greater than predicted based on its trend line. That growth will be jobs we cannot imagine, she said, and her investing is in part based on identifying the winners and losers over that time. She did not identify any industries that would emerge to fill that $12 trillion gap.
Wood looks for “stranded assets” as an investment theme. Value investors focus on book value, she said, and her team can identify assets that will become useless. But she did not explain how value investors’ focus on book value created opportunity for her. She cited retail stores and railroads as examples of stranded assets but did not explain how she could create value from them. She expects trucks to become more effective at transporting goods than railroads because they will be driverless. But she did not explain how she could create value from the “stranded” rail assets.
She said, “Looking out five years, S-curves will feed one another as technologies converge.” I don’t understand that statement. She offered an example that did not clarify what she meant: Three of the five major platforms for driverless cars will rely on three of her investment themes – robotics, energy storage and AI. Nonetheless, she said, “The growth will be explosive. Most people don’t understand this because they don’t do the kind of research we do. There will be a lot of confusion and if you are on the right side of change the opportunities will be enormous.”
Count me among those who don’t understand.
In health care, she said that over the next five years, DNA sequencing and AI will allow you to understand and diagnose diseases as they evolve. “The key is that genomes will be sequenced for $100, and AI will tell when a genome is getting set up to mutate.” For example, she thinks that we will be able to diagnose diabetes before it afflicts people.
In energy, she said Tesla is the “quintessential technology convergence company.” Energy demand in the next 10 years will drop 25% to 35%, which means oil prices will drop to $10, where it was in the 1970s before the oil embargo. The only explanation she gave to back up that decrease in demand for energy was her prediction of rapid increases in productivity. The only example she gave was that she is installing solar panels on two houses she is building and expects them to provide excess power to the grid (something that most solar-powered homes already do, at least at non-peak usage times).
In finance, she called bitcoin “the reserve currency of the ecosystem.” It will be one of a few currencies, along with ether, that will be part of the “fat protocol thesis.” That thesis says that, unlike the internet where nobody makes money on the protocols and instead everyone makes money on the applications, the “grand slams” of cryptocurrencies will be the most secure protocols, like bitcoin. The speed and expense of cryptocurrencies are better than the traditional banking system, she said, which is burdened with “paperwork and checks and balances.” She did not address the common objections to cryptocurrencies, such as their volatility, lack of acceptance as a store of value, and ecological problems.
She discussed some of the stocks she has recently added to her funds, such as Palantir, which works on technologies “we cannot even fathom.” She also bought Unity, a gaming platform that will help “digital and virtual worlds to converge.” It is “way ahead of the game in AI,” Wood said, and is way ahead of the game from an “interoperability viewpoint.” She did not explain why she invested in a company with technology she could not fathom, or what it means for digital and virtual worlds to converge.
Is the current era analogous to the dot-com boom-and-bust era?
As you would expect, Wood doesn’t think so. The seeds for today’s innovation were planted then, she said, and it took the last 20 to 25 years to develop the technology and lower the costs. “Investors will be astounded at what this gestation period of 20 to 25 years will deliver,” Wood said.
Ark has $70 to $80 billion under management, including what is under advisement through sub-advised funds and separately managed accounts. She was asked a capacity question – whether she can continue to achieve strong returns if her funds should benefit from additional flows.
“If we are right about how exponential growth technologies will scale exponentially, then our capacity should scale exponentially. Companies will need funding to win, and those with the biggest pools of data and the highest quality data will be in the pole positions to win in their respective spaces, which is why Tesla will win in the autonomous taxi space.”
That did not answer the question. An appropriate answer would address the size of the markets in which her companies operate, their respective market shares, the growth rates of those markets, the competitive dynamics and much more.
But to invest in Ark is to believe that “exponential growth” will solve everything.
Robert Huebscher is the founder and CEO of Advisor Perspective