2023-10-25 05:28:34 ET
Summary
- Investors are bailing on the ARK Innovation ETF, signaling a lack of confidence in its ability to deliver attractive returns.
- Overweighting of Tesla and other high-potential companies has hurt the ETF's performance.
- The ETF is in a vulnerable technical position, breaking key levels and potentially facing further downside.
The ARK Innovation ETF ( ARKK ) was an investor darling during the pandemic which is when the exchange-traded fund blew up and delivered hundreds of percent of returns.
Since then, however, a new normality has manifested itself that showed investors the risks of investing into a highly concentrated, thematic investment fund. Recent fund flow data for the ARK Innovation ETF shows that investors are bailing once again on Cathy Wood’s flagship fund.
Technically speaking, the ARK Innovation ETF is also in a vulnerable place as it recently broke through key levels. A new round of fund outflows as well as the battering of the stock of Tesla Inc. ( TSLA ) could make things even worse for the exchange-traded fund.
My Rating History
I am changing my classification from Buy to Hold due to recent fund outflows as well as a deteriorating chart picture. I continue to see the overweighting and overconcentration of highly-valued growth stocks as a problem.
Tesla Overweighting Hurts ARKK’s Performance
The ARK Innovation ETF makes shrewd and concentrated bets on a small number of high-potential companies that have attractive growth prospects. These growth prospects mostly come from new, innovative businesses that create new products and services and they are expected to disrupt their respective industries.
The case in point is electric-vehicle company Tesla which has made a major impact in changing in the entire auto industry and which has seen explosive growth in sales and market valuation.
Recently, however, the overweighting of Tesla has hurt ARK Innovation ETF’s performance again, primarily because the electric-vehicle company accounts for a whopping 9% of the ARK Innovation ETF’s investment portfolio.
Other disruptive ETF holdings that are overweight in the ARK Innovation ETF portfolio are Zoom Video Communications Inc. ( ZM ), streaming company Roku Inc. ( ROKU ), fintech Block Inc. ( SQ ) and crypto-platform Coinbase Global Inc. ( COIN ).
Top 10 Holdings (The ARK Innovation ETF)
The underperformance of Tesla in particular has hurt the ETF’s short-term performance. Tesla’s stock has seen a rather steep selloff lately as investors have become more concerned about the impact of price cuts on the company’s margins. The third quarter earnings release was not great and the decline in Tesla’s valuation has weighed on the ARK Innovation ETF’s returns as well.
The problem with thematic investing, as with all other narrowly-defined investment strategies, is that it may do well for a very short period of time, as it did during the Covid-19 pandemic, but then the magic starts to slowly disappear, leaving investors that bought into the hype with huge paper (and realized) losses.
In the case of the ARK Innovation ETF, the exchange-traded fund had a 2.3% negative annualized return in the last five years. Compared to the S&P 500, which delivered an annualized return of 9.92% in the last five years, the ARK Innovation ETF has greatly underperformed a much more widely diversified stock index.
Recent Fund Flows Not Favorable To ARKK
Cathy Wood’s ARK Innovation ETF is seeing new cash outflows, suggesting that investors don’t think that the exchange-traded fund can deliver attractive returns moving forward.
The flagship fund lost $430 million to fund outflows since the beginning of September and it had about $6.2 billion in net assets as of October 17, 2023. This is a far cry from the $28 billion the exchange-traded fund managed at the beginning of 2021.
The most recent fund outflows might signal that ETF investors overall is losing confidence in the thematic investing theme that has made the ARK Innovation ETF so successful during the pandemic.
ARK Innovation ETF: Technical Analysis
The ARK Innovation ETF, speaking purely in technical terms, is in a vulnerable setup: Two major down waves have manifested since July and we are presently in the third.
The correction caused the exchange-traded fund to break a number of key levels as well: It broke through the 50-day moving average line (presently running at 40.65) in September and then through the 200-day moving average line (presently running at 40.38) in October. The break of such averages represents sell signals and points to more downside in the short-term.
The next key level, from a technical chart perspective, is the $30 price level where the ARK Innovation ETF has found earlier support. A break of this key level would be a major negative from a technical/sentiment point of view.
Why The ARK Innovation ETF May See A Higher NAV Moving Forward
Exchange-traded funds trade at very small discounts and premiums to NAV and in the case of the ARK Innovation ETF the present NAV discount is 0.08%. The NAV trend will primarily depend on the valuation of key portfolio holdings such as Tesla, Coinbase, Zoom Video Communications and others.
The risk of not investing in the ARKK, if there is such a risk, implies that investors might lose out on upside gains should the thematic investing theme become popular again.
My Conclusion
The recent outflow of capital of Cathy Wood’s flagship exchange-traded fund, the ARK Innovation ETF, is a potential problem.
Redemptions/fund outflows are obviously a huge problem known to all investment manager as they might have to sell shares they don’t want to sell. The latest round of outflows could also make the technical situation for the ARK Innovation ETF worse.
The exchange-traded fund recently broke through both 50-day and 200-day moving average lines, which, amongst charticians, is understood to send sell signals.
As such, I would not be surprised for the ARK Innovation ETF to fall to new lows in the short term, particularly if investors continue to pull funds out of the exchange-traded fund. Hold.
For further details see:
ARK Innovation ETF: A Vulnerable Setup (Rating Downgrade)