You can do just as well or better than the ARK Innovation ETF
ARKK
over the longer term while nevertheless incurring significantly less risk. That’s important for traders to bear in mind since over the past three weeks this ETF has produced an extraordinary return.
Since the stock market’s low on Oct. 27, the ARK Innovation ETF has soared 26.1%, versus 11.7% for the Invesco QQQ ETF,
QQQ,
which is benchmarked to the tech-heavy Nasdaq 100
NDX
index. A three-week return that high has not surprisingly begun to attract return-chasing momentum players.
An entirely different picture emerges if we expand our lookback period to more than just the last three weeks. As you can see from the chart below, an investor willing to incur ARK Innovation’s well-above-average volatility would have made a lot more by investing instead in the QQQ with sufficient leverage to match that volatility. (This hypothetical QQQ-plus-leverage portfolio would have been 83% on margin; this portfolio’s return reflects the interest cost of this margin.)
I calculate that over the entire period since the ARKK’s inception in October 2014, this hypothetical QQQ portfolio beat ARKK by 12.2 annualized percentage points. This isn’t Monday morning quarterbacking for me to point this out. In March 2021, when ARKK was riding high during the meme stock frenzy, I pointed out that the ETF’s market-beating returns were dependent on incurring outsized amounts of risk. That in turn meant the fund would incur outsized losses when the market went south.
That’s exactly what happened, particularly in the bear market that began in January 2022. Since the date of my March 2021 column, the ARK Innovation ETF has lost a total of 64.4%, according to FactSet, equivalent to negative 32.2% annualized.
Concentrated bets
One reason the ARK Innovation ETF is so risky is that it’s heavily concentrated in just a handful of stocks. As of Nov. 15, for example, the ETF’s 10 largest holdings represented 62.9% of the fund’s entire portfolio. To put that in context, the top 10 holdings in the S&P 500
SPX
currently represent 32.0% of the index, while the top 10 in the Nasdaq 100 represent 49.8% of the index.
So ARK Innovation is significantly more concentrated than the Nasdaq 100, which is in turn significantly more concentrated than the S&P 500. No wonder the ETF is so much more volatile than the QQQ.
One of the core principles of finance theory is that the markets reward investors only for incurring unavoidable risk — risk that cannot be diversified away. Since ARK Innovation’s risk is quite avoidable, theory predicts that followers will incur that risk in vain — that the ETF will continue to significantly lag the market on a risk-adjusted basis.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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