It’s an argument you often hear, and it’s backed by tons of research: Index funds generally beat actively managed portfolios, largely because they minimize fees and trading, while the stock-picking crowd darts in and out of equities in a big way, and charges a king’s ransom for their supposed expertise. I just stumbled on a stunning case study of this phenomenon, courtesy of the current meltdown in tech high-fliers. Despite all of Cathie Wood’s praise for her team’s skills in unearthing tomorrow’s champions of “disruptive innovation,” the ARK Invest founder’s flagship has lagged plain-vanilla Nasdaq 100 index funds over the past four years. Those robo-run pools don’t bet on individual names at all, but simply hold all the Nasdaq stocks more or less in proportion to their market caps as a share of the total for the 100 members.
ARK Innovation loses to the Invesco QQQ
Wood’s ARK Innovation ETF (ARKK) is renowned for going all-in on the riskiest, most glamorous players in tech, pharma, and crypto, a group that encompasses Tesla, Robinhood, Coinbase, Teladoc, and Block. If you measure its performance from its origins in late 2014, ARKK beats the overall Nasdaq by a good margin. But it’s hit hard times of late as the big shift from growth to value pounds the outsize valuations of many of its holdings, from Shopify to DraftKings. ARKK’s price has dropped 50% since its summit in February, and shed 18% from the start of 2022 alone.
That quicksilver slide has severely damaged its record in recent years, measured alongside the tech-laden Nasdaq. As expensive as the Nasdaq is, it’s much less overpriced than ARKK because investors’ money stretches across a much broader portfolio, and isn’t nearly as leveraged to the loss-making biotech contingent that carries so much weight in Wood’s fund. It’s fair to measure ARKK’s performance over the past four years since that’s the period when it did the vast bulk of its investing, when its assets under management mushroomed 70-fold from $400 million to a peak of $27 billion.
From Jan. 18, 2018, through Jan. 18, 2022, Wood’s ARK Innovation ETF gained a total of 104.8%, or 19.6% a year. In the same span, the Invesco QQQ Trust ETF (QQQ), an index fund that tracks the Nasdaq 100 and holds over $200 billion in investor assets, gained 130%, or 23.1% annually, beating ARK Innovation by roughly 23% over the entire period.
Wood’s been collecting big fees for that less-than-stellar performance
During those four years, however, Wood has collected big fees for performing the analysis and research that’s built that now-cratering portfolio. It charges a lofty expense ratio of 0.75%, versus just 0.2% for the QQQ. (ETF returns are calculated net of fees.) If ARKK had offered the same deal as QQQ, it would have handed investors an additional two percentage points over the four-year span, and narrowed the gap with the giant index fund.
According to the most recent annual report on ARK Invest’s funds, ARK Innovation charged investors $132.8 million in management expenses for the 12 months ended July 31, 2021. In the July-to-July stretch from 2019 to 2020, when its assets under management were far lower, ARKK generated $18 million in fees. Although ARKK’s assets have plummeted recently, it’s a good bet that since mid-July of last year, the fund’s amassed tens of millions more for its owners, bringing the four-year total into the $200 million range.
Garnering $200 million in fees for chasing the hottest of hot stocks when investors could have fared a lot better in the QQQ––while shouldering less than one-third the fees––recalls the 1930s song, “Nice Work If You Can Get It.” Wood got it because the market’s craziness lent credence to her claims that the traditional fundamentals no longer applied. “We saw this movie before in 1998 to 2000, and we know how it plays out,” says Rob Arnott, founder of Research Affiliates, a firm that oversees investment strategies for $166 billion in mutual funds and ETFs. Wood got incredibly lucky—until she didn’t.
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