This season of “The Switch” is focused on the misconceptions that surround investing in innovation and the performance of innovation over traditional benchmarks. In this episode, Thomas Hartmann-Boyce, CFA and client portfolio manager at ARK Invest, is joined by Ren Leggi, client portfolio manager at ARK Invest, and Tom Lydon, CEO of ETF Trends, to discuss the outperformance of innovation compared to the benchmarks over longer timelines.

Leggi opens the discussion by explaining that the ARK Innovation ETF (ARKK), an innovation proxy, has actually outperformed the broad benchmarks over the course of the last five years.

“If you look at the S&P 500 and the Nasdaq-100, our research suggests that investors with a five-year time horizon have actually outperformed both of those indices 100% of the time, regardless of end-point sensitivity,” Leggi says.

This holds true over a three-year period as well, calculated using rolling returns; ARKK outperformed the Nasdaq-100 98% of the time over a three-year time span, and the S&P 500 100% of the time over the same time period.

“On that shorter basis, on that three-year basis, the outperformance is still pronounced, but as you get smaller, given the volatility within the disruptive innovation markets, the outperformance gets lower,” Hartmann-Boyce explains. “But again, it’s important to align the timeframe for investors with the timeframe that disruptive innovation tends to have on the stock markets.”

The Importance of Long Time Horizons With Innovation

ARK recommends that innovation be invested in over a five-year time horizon, as the disruption of the technology-driven innovations will impact industries for many years. Leggi explains that ARK believes that the market cap for these innovations will expand rapidly in the next five to 10 years and that short-term volatility is something that the company uses to its advantage.

“We’ve been very transparent that we can outperform in shorter time periods,” Leggi says. “That gives us an opportunity to take advantage of that volatility and consolidate our portfolio into our highest-conviction names, and over the longer-term, we’ve outperformed.”

Even during times of underperformance, the focus remains on innovation instead of trying to chase a benchmark and dial-up risk to try to boost performance. Leggi explains that ARK is benchmark-agnostic and instead focuses on its own internal benchmark based on annualized returns over five years. This means that in a risk-off environment, the portfolios consolidate, while in risk-on environments, ARK expands its portfolios.

“We’re committed to the process, we’re sticking to investment process and philosophy and we do see over the long-term a huge opportunity for disruptive innovation,” Hartmann-Boyce says. “Keeping a long-term time horizon is very important when allocating to the space of disruptive innovation.”

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