ARKK - XT: I'll Take This ETF Over ARKK Any Time

2023-04-07 03:11:16 ET

Summary

• XT and ARKK both seek to profit from investing in innovative companies. But they take different approaches to do that.
• ARKK is wildly popular and controversial. Cathie Wood, its founder, is a media star, thanks to ARKK's dramatic performance in 2020. But ARKK is down about 75% since then.
• XT, on the other hand, has been a more consistent performer, and its equal-weighted approach.
• I continue to like XT as an aggressive equity role player in my portfolio. And I continue to be surprised at how ARKK remains so highly-regarded.

I just don't understand all of the hype surrounding ARK Innovation ETF ( ARKK ). Of course, I give credit where it is due. Lead manager Cathie Wood and her team absolutely crushed it during the pandemic. But so did sales of protective masks and hand sanitizer. Those days are hopefully gone. And from my view, so are the halcyon days of ARKK making all other growth funds look like inferior rivals for the part of a portfolio that seeks aggressive growth, and expects a bumpier ride.

That's why I am such a fan of iShares Exponential Technologies ETF ( XT ). To be fair, ARKK is actively managed, and XT is an index fund. But does that really matter when you consider that ARKK's historical trading turnover is 55%, but XT's is higher (69%)? That, despite only rebalancing and reconstituting (revisiting and adjusting its positions) annually. To me, that means that whether you are tracking innovative businesses actively or passively, who's winning and who's losing from an attractiveness and forward-looking standpoint is not a set it and forget it exercise.

ARKK's performance and the asset surge it led to are the stuff of recent investment legend. From off the radar to $24B in AUM in under 2 years? That's enough to make your CIO a star in the media. It is also a star that burns slowly, as we continue to see ARKK attract assets at rate that flies in the face of investment industry logic. Typically, AUM growth follows performance, like clockwork. Everyone wants to own what they wish they had owned last quarter, or last year. But ARKK has continued to rake in the dollars, which have offset its negative performance (-44% over the past year). As noted in the headline of the chart below, its asset base in line graph form looks like Space Mountain at Disney World.

Innovation versus innovation

But enough about ARKK! After all, that's the point of this article about XT. That ETF, from a relative standpoint in the innovative ETF space, is the Rodney Dangerfield of funds: it gets no respect. XT trades "only" about $5mm in dollar volume on a daily basis, despite being a product of the giant iShares ETF family.

The iShares.com website has some helpful material for those seeking to understand XT at a high level. Here are a couple of graphics I curated, which show that this ETF belongs in the same class as ARKK or any of the top "innovation-themed" ETFs.

XT covers the bases in terms of breadth of innovation areas it invests in. Yet no holding currently accounts for even 1% of assets. That makes XT akin to what private equity firms do, only in the public sphere. XT is essentially a public company-filled, daily-liquid basket of high-potential stocks. Many of those may flame out. But a relatively small number of the ETF's more than 200 stocks could drive XT's value higher long-term, as has been the case since its 2015 inception. ARKK's dramatic price spike during the pandemic was similarly-fueled by group of stocks that went parabolic in price. But since ARKK is actively-managed and holds only 30 stocks, that sets it up as more of a "hit or miss" situation for investors. And that's exactly what the ARKK track record shows in this chart.

The bottom-line for me is that XT is my preferred way to be an "agent of innovation" as the obnoxious series of TV commercials for Invesco QQQ Trust ( QQQ ) states. I am not anti-QQQ by any means. But when it comes to ARKK, I just wonder if investors really know if there's a solid, and historically more successful alternative in XT.

1-year rolling return comparison: an eye-opener

XT is on a nice winning streak versus ARKK. How nice? Since October of 2021, XT has outperformed it famous peer on a 1-year basis every single time. That's 18 periods in a row. Really, the only time XT did not outperform ARKK over a 1-year period was during the ARKK spike periods in 2017-2018 and of course during the 2021-early 2021 pandemic-inspired feeding frenzy. Given all of the assets that flowed into ARKK, I suspect that was partly investors wanting to invest in innovation, and partly self-fulfilling prophesy. After all, the Fed is not the only entity that can flood a market with money and make its price go up. ARKK was a beneficiary of that in 2020. The question is, will that ever happen again to nearly that magnitude? Rather than hope for that (since hope is not a strategy!), I'm siding with XT as my go-to innovation position.

In case you want to see my full table comparing 1-year rolling returns of XT versus ARKK, I have attached it at the bottom on this article. It is divided into 2 parts: the 1-year periods where ARKK performs, and the 1-year periods where XT performs. A couple of notable highlights from the data:

1. If you add up all of the periods where XT performed better than ARKK, XT's average performance during those periods was actually just below zero (-1.8%). However, ARKK's average performance was 24.5% in those periods. Translation: in rougher markets, XT hangs in, while ARKK crashes.

2. If you add up all of the periods where ARKK performed better than XT, ARKK's 1-year return averaged 60%. But XT posted a very satisfying 24% gain during those same periods. Furthermore, about half of that performance spread was generated during that pandemic period, which as noted above, we might not ever see again. If you take out the first 9 lines of the "ARKK outperforms" table, the average performance drops to 36% for ARKK and 17% for XT. Quite a difference.

Past performance: what is it good for (and not good for?)

When I analyze past performance of a single investment or to compare multiple investments, I am not looking for which one did better. To me, that is the one guarantee of past performance: you can't have it, it is in the past!

What I focus on is consistency, low standard deviation-type analysis. I want to assess the probability of multiple outcomes, including tail risk events. When I do that with ARKK and XT, I see that ARKK's tail is as long as some dinosaurs, and XT's is more like a dog's tail. ARKK investors who bought at the top have seen $100 turn into $25. XT investors have yet to see $100 drop to more than $66. I know this is higher-risk investing, and XT is currently the most aggressive position in otherwise very conservative portfolio allocation. So unless something like ARKK was bought in a very, very small position size, I'll take XT over it any time.

Table: 1-year rolling periods where XT outperformed ARRK, and vice-versa, from common inception date through 3/31/2023.

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