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ARK's Cathie Wood Isn't Backing Down. She Explains Exactly Why. -- Barrons.com

Barron's · 01/06/2023 13:42
By Avi Salzman

Plenty of growth funds struggled in 2022, but few quite as spectacularly as those run by Cathie Wood.

Is Wood deterred? Not at all. She's doubling down on investments that got hammered last year, including Tesla (ticker: TSLA), saying they will be big winners in the long run as they disrupt established industries.

Her core ARK Innovation exchange-traded fund (ARKK) fell 67%, the worst in its category of 189 mid-cap growth funds tracked by Morningstar, and more than three times worse than the S&P 500's 19% decline. Wood has built a devoted following, with large audiences on YouTube and other platforms, but she has begun to lose adherents. After investors spent most of 2022 "buying the dip" in the ETF, many seemed to give up later in the year. From August through December, investors withdrew a net $600 million from ARK Innovation; in the year's first seven months, they had added nearly $2 billion.

Wood is completely unfazed. Even as investors fled Tesla this past Tuesday on weak delivery numbers, sending the stock down 12%, she added to her position. Overall, Wood has whittled the fund's holdings to 30, half as many stocks as it held in 2021.

"Investors are running for the hills, away from our strategy," she observes in an interview with Barron's. "They're running to their benchmarks. Guess where there is more risk? It is in their benchmarks, because the traditional world order is going to be disrupted and disintermediated here." Among Wood's top holdings today are Zoom Video Communications (ZM), Roku ( ROKU), Block ( SQ), and cancer-detection company Exact Sciences (EXAS).

ARK Innovation, with $5.9 billion in assets, is still the fifth-largest actively managed equity ETF in the U.S. out of 486, according to Morningstar. And the lightning that Wood caught in a bottle in the first year of the pandemic, when her flagship fund quadrupled, is still out there, she contends. She urges investors to wait five years for her thesis to play out. But the firm hit an unfortunate milestone in 2022 that could make her case more difficult. For the first time, ARK Innovation ended the year with its five-year performance in the red. Those who bought ARK's funds last year are already in a deep hole. Will they stick around that long as their investments evaporate?

In late 2021, Wood wrote an essay titled "Innovation Stocks Are Not in a Bubble: We Believe They Are in Deep Value Territory." At the time, ARK's current top holding, Zoom, was trading around $200. It's now $67.

Wood's critics contend that she relies on nonstandard earnings metrics to paper over the unprofitability of her portfolio's companies under conventional accounting. Cliff Asness, a founder of AQR Capital Management, complained last month on Twitter that value investors "have to ride out manias driven by people like her." Daniel Loeb of Third Point derided her as a "stonk hodler," terms associated with crypto and GameStop-like trading. The losses have emboldened her detractors. There's even an ETF, AXS Short Innovation Daily (SARK), whose sole strategy is to take the opposite side of the Innovation fund's bets. Since its November 2021 launch, it's up 78%.

Morningstar analyst Robby Greengold says that Wood is "dismissive" of risk management, which led to much steeper losses than other funds in her category last year. Unlike rivals, ARK doesn't have dedicated risk-management personnel, and holding relatively few stocks has "saddled the portfolio with greater risk," he says.

In response, ARK Investment says that Greengold is incorrect: "Risk management is so important to us that we have various teams focused on it in different capacities." And Wood argues that adjusting earnings gives a fairer picture of a company's growth trajectory than traditional earnings do.

Wood adds that investors in her fund want her to follow a consistent strategy. "When advisors and others buy into our strategies, they're looking for pure-play innovation; they're not looking for a generalist strategy that has staples and energy." Investors themselves can manage risk by selling some of their stakes after large run-ups, she says. Sometimes she nudges them to do so. "It never hurts to take profits and to keep some powder dry," the investment manager said in early 2021, predicting that there would be a "doozy of a correction" at some point over the next year.

Wood admits to making some errors on the macro side. She thinks the ARK team has been surprised by two things since the funds peaked in 2021: It didn't expect the supply-chain problems that boosted inflation to persist for so long, and it didn't anticipate the war in Ukraine, which caused commodity prices to soar.

Rising inflation has sunk ARK's stocks. When interest rates climb, investors tend to gravitate to steadier names whose value is based more on current cash flows. Wood, who worked as an economist in the late 1970s and 1980s, has experience forecasting inflation. In the '80s, she argued against the consensus view that high interest rates would stick around. She makes a similar claim today.

"We're going to see the other side of it now with falling inflation -- meaning much faster than expected -- even ending up in deflation for certain indexes," she says.

Wood thinks the U.S. has been in a recession since early 2022, and that businesses are just starting to grapple with the economic destruction. Prices of commodities such as oil have been declining, along with those of used cars, homes, and now consumer goods. "We're seeing price discounts of 25% to 50%," she says. "I've seen some electronics discounts for more than that."

This will force the Federal Reserve to change course, she asserts. "Our thought here is they've overdone it on the side of tightness, and that as inflation drops below 2% at some point [in 2023], they will be reversing these moves."

A sharp slide in interest rates would give Wood an easy stock thesis. Low rates tend to convince investors to buy riskier stocks, like the ones she holds. That was the key driver of the last bull market. But Wood's thesis about 2023 has more to do with corporate behavior.

"I truly believe that our companies are going to solve the problems that many corporations are facing now," she says. Corporations are "all seeing their margins come down. They're going to lose all kinds of pricing power, they're going to need technology to lower costs. Increase productivity, increase efficiency, that's what we do. And that's all we do."

While corporate travel picked up in 2022, Wood expects companies to cut back in 2023 and rely more on services like Zoom. "Whether it's a Zoom or a Teladoc Health [TDOC], many people have dismissed these as stay-at-home Covid stocks," she says.

To explain the future, Wood tends to look to the past. The recent past gives her courage in her convictions. "The media thought we were out of our minds in early 2019, when Tesla was cascading down," she says. "And we just kept our eye on the prize." But she also likes to reach further back into history -- say, 100 years -- to explain where she thinks society is headed.

In 1919, America was emerging from a war and a pandemic, and inflation spiked. Telephones, cars, and electricity were coming into their heyday in a flurry of innovation. "Once we got through that supply shock associated with a war and a pandemic, inflation went down and actually went negative. We ended up in the Roaring '20s," she says.

Wood thinks a new Roaring '20s could be around the corner.

"We think that's what we're going into again, when it comes to our strategy, because these platforms are ready for prime time," she says. The platforms she is referring to include artificial intelligence, energy storage, robotics, DNA sequencing, and blockchain technology. While investors have been riding the ups and downs of interest rates for the past year, innovation at companies such as Tesla has continued apace, Wood adds.

Its battery technology is much cheaper than its competitors', and should allow the company to sell its Model 3 for $25,000 in the next few years, down from about $45,000 today, she says, adding that competitors couldn't match that price without losing money. Tesla also is close to launching robo-taxis, she asserts, predicting a nationwide rollout starting in 2024. All told, Wood sees the EV maker's shares rising to $1,500 from a recent $110 in five years.

The rapid advances in technology and healthcare that lifted ARK's funds at the start of the pandemic haven't gone away, she continues. In fact, Wood predicts that a new era of disruption is about to dawn. "That was just a dry run for what we're going to see here now for the next five to 10 years," she says.

Most record-beating fund managers get one or two chances to prove their strategies can last. Already in the 2020s, Wood has experienced the market's highest highs and its lowest lows. Enough of her fans have stuck around to see if the coming decade will roar in just the right way to prove her right.

Write to Avi Salzman at avi.salzman@barrons.com

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January 06, 2023 13:42 ET (18:42 GMT)

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