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A Morningstar analyst who got a personal tour of ARKs operations by Cathie Wood herself unpacks why her funds are unlikely to meet her lofty goal for exponential growth in 5 years

Published by Business Insider on Wed, 09 Jun 2021

<p><img src="https://static4.businessinsider.com/image/5ffefaacfe7e140019f7ea2e-1334/DSC_4107 (1).png" border="0" alt="Cathie Wood" data-mce-source="ARK Investment Management" data-mce-caption="Cathie Wood is the founder, CEO, and CIO of ARK Investment Management."></p><p></p><bi-shortcode id="summary-shortcode" data-type="summary-shortcode" class="mceNonEditable" contenteditable="false">Summary List Placement</bi-shortcode><p>Megawatt money-maker Cathie Wood has some of the world's most loyal investing fans, drawing legions of social media crowds for her ARK funds and her unquestionable charisma.&nbsp;</p><p>Yet, one of her most vocal critics is also someone to whom she has given unprecedented access to her inner sanctum.&nbsp;&nbsp;</p><p>"Well, they've [her team] been very generous with their time and they have granted us several interviews," Robby Greengold, senior research analyst at Morningstar, said in an interview with Insider.</p><p>"We've met with Cathie Wood on several occasions, at least three occasions. She's essentially taken us on a tour, a verbal tour, of what their process is like, what personnel they have. We have visibility into what their team looks like, and how they think about risk, and that's really our core source is just them themselves," he said.</p><p>Equipped with this intimate insight, Morningstar's analyst team published a harsh review of her operations in March. The Chicago-based research group gave the $21 billion US-listed active flagship ARK Innovation ETF a rating of neutral. The ETF describes itself as being focused on "disruptive innovation" stocks in areas that include biotech, robotics, artificial intelligence, blockchain and financial technology.&nbsp;</p><p>"Its lone portfolio manager, inexperienced team, and lax risk controls make it ill-prepared to grapple with a major plot twist," Greengold wrote at the time.</p><p>Wood took to her company's YouTube channel to quell any concern among her investors three days after Morningstar's assessment back in March.</p><p>"I know there's a lot of fear, uncertainty and doubt evolving in the world out there," she said in a video posted on March 6. "But we're doing a lot of original research, we have a 5-year investment time horizon. And we are truly excited about the opportunities the last few weeks have presented us."&nbsp;</p><p>She added that "what these last two weeks have done is for those who are averaging into these types of strategies - any innovation strategy - a gift. Because we do believe we're on the right side of change."</p><p>As of June 7th, the flagship ARKK fund has lost 9.48% so far this year, compared with a 7% gain in the tech-heavy Nasdaq 100 index, although there's no denying the fund has made its long-term investors significant gains, with the one-year return up 78% and the five-year return up 43%. And in 2020, Wood's fund beat 99% of competing funds, according to Morningstar's own data.</p><p>However, roughly two and a half months after his most recent assessment, Greengold is not convinced Wood is going to be able to turn around her fund's performance and hit her own <a href="https://www.reuters.com/business/no-inflation-fears-here-arks-wood-says-portfolio-should-triple-five-years-2021-06-08/">forecast</a> for a "tripling" in its value in five years.<br><br>"It's hard to see what that path would be for them, just given that we don't see any advantages to either the team or the process that they have in place," Greengold told Insider. "It could certainly happen, but we don't see, we don't think that it's probable."<br><br>In the past few months, there has been a distinct shift among investors into so-called value stocks, those that are linked far more closely to the state of the economy, from growth stocks, whose value is derived more from future expectations of profitability.</p><p>This rotation has undermined the appeal of the high stakes technology and innovation-based firms that have typically made up a large portion of Wood's portfolio. Despite her public pronouncements, including reinforcing her conviction that a "rotation back to growth is probably close at hand" in an Ark Invest webinar on Tuesday, Wood has been shifting her strategy.</p><p>Around 30% of the fund's total holdings are in just five companies and ARKK has reduced its concentration in several of these battered technology firms.&nbsp;These include Tesla, its top holding that accounts for almost 10% of the fund, followed by Teledoc Health at 6%, Roku at 5.5%, Square at 4.5% and Zoom Video Communication, at 4.4%.&nbsp;</p><p>It's her tolerance for the risk around some of these big-name tech holdings that gives Greengold cause for concern.&nbsp;</p><p>"Cathie Wood has said that when she sees a stressed market environment, or a drawdown in the market, her game plan is to sell the portfolio's large-cap, liquid positions, and concentrate the portfolio to around 30 of what she calls her favorite pure-play positions," he said.</p><p>"Those are going to be some of these illiquid names. That's their approach, and that brings its own risks. It really just amplifies the portfolio's risk in such a scenario, but they seem unprepared to grapple with a wide range of scenarios," Greengold said.</p><p>By virtue of the fund's fledgling performance, the philosophical approach of running an innovation-led ETF could also lose its soul.</p><p>"The flagship ETF, at least, is too large to invest in the small and micro-cap companies that it has invested in over the past five years, and it can't do that anymore," Greengold said. <br><br>Insider reached out to Ark Invest for comment on this story. The team did not provide one at the time of publication.&nbsp;</p><p><a href="https://www.businessinsider.com/ark-invest-cathie-wood-may-struggle-to-hit-her-5-year-target-morningstar-2021-6#comments">Join the conversation about this story &#187;</a></p> <p>NOW WATCH: <a href="https://www.businessinsider.com/bpa-plastic-containers-bad-health-risks-obesity-heart-disease-diabetes-2019-2">Why I'm throwing away every plastic thing in my kitchen ASAP</a></p>
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