This season of “The Switch” is focused on how innovation performs in times of market turmoil. For this final episode of the season, host Dan White, client portfolio specialist for ARK, is joined by ETF Trends’ CEO, Tom Lydon, and CIO and director of research, Dave Nadig, to discuss why innovation should be a key component of an equity portfolio.
White opens with discussing the volatility of the ARK funds and saying that most advisors on first pass are looking at the standard deviation and tracking error against a benchmark of their choosing for ARK’s funds. He explains that in isolation, an ARK fund is generally going to look like it’s higher-risk compared to more traditional funds.
“Standard deviation is a backward-looking metric on how prices have moved; there’s no forward view there. When we’re constructing portfolios, that’s the key. We need to be focused on the future, not what has already happened,” White explains.
Most advisors and investors these days are driven primarily by an inherent risk aversion that the last two asset bubbles have helped to cement, and therefore rely more heavily on measurements that look back historically.
ARK believes that because of the increased investment into passive, most investors are actually under-allocated to innovation. Many of the larger, market cap-weighted markets contain companies that are susceptible to disruption and could catch an investor unaware, should they be impacted. The solution that ARK sees is to include innovation as part of an overall portfolio strategy.
A model portfolio that ARK made as an example of adding in innovation was built with a global equity approach. The portfolio has 60% to domestic allocation, 30% to international developed allocation, and 10% to emerging markets; ARK then goes in and adds innovation at 5% intervals while still maintaining the overall 60/30/10 split.
When looking to add innovation, the process should be considered at both the research step and the portfolio creation step because it will allow for the diversifying nature of innovation to be better seen and understood.
“It’s our belief that by adding in innovation into a total portfolio, you can enhance your long-term, risk-return profile of a portfolio,” White says.
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