Market volatility affects all companies, but can be particularly fraught for innovative firms. It is not unexpected that companies that are creating ideas that will define the future could hit challenges in the present.
In the recent webcast, Innovation: How to Navigate Through Periods of Volatility with ARK Invest, ARK Invest client portfolio specialist Dan White, CFA, and National ETF Sales resolute investment managers vice president, Matt Murphy, CFA, CAIA sat down with ETF Trends and ETF Database managing editor Lara Crigger to discuss the market environment, why investors should monitor innovative companies, and how exposure to innovative companies can enhance and diversify an investment portfolio.
Heading into the pandemic, ARK’s areas of focus, namely energy storage, robotics, artificial intelligence, DNA sequencing, and blockchain, were gaining widespread interest. They were on the record anticipating an eventual correction, which came in the form of inflation concerns, interest rate fears, China, and the geopolitical turbulence that comes with a global pandemic. Innovation was hit hard, but the market has digested this in a short amount of time. Rather than cycle away from innovation, ARK doubled down on its high-conviction investments, taking advantage of reduced prices that come with volatile markets.
ARK’s house view on inflation’s dangers is informed by CEO, CIO, and portfolio manager Cathie Wood’s experiences in 2008, when she was concerned about inflation, only to find that the velocity required for inflation to become deeply problematic never manifested. Wood sees similar indicators today. Bank loan growth is tepid, which would not be the case if velocity was a factor. ARK sees three sources of deflation, two secular and one cyclical. Innovation, such as genome sequencing, is going to cut costs and cause a “good deflation.” “Bad deflation” will come from companies that aim for disruption, tap their investors, make some bad calls, and then fizzle out. The cyclical deflation factor is the pandemic. ARK sees many commodities as likely to unwind just as sharply as they increased. Supply chain bottlenecks and oil will be factors here.
Innovation is difficult for investors to analyze. It cuts across sectors and styles and is hard to pin down. Many analysts are put off by the inherent volatility of innovation. But volatility can be a positive. Thoughtful risk taking in swingy markets creates opportunities for incredible returns. During periods of expansion, ARK takes profits from their best performers, spreads it through the rest of the portfolio, and brings in new holdings: larger, liquid, innovative names.
During periods of contraction, thoughtful risk taking and active management begin to shine. Many managers will retreat to benchmarks and let go of the pure-play innovative firms in their holdings. ARK will sell their “big names” acquired during periods of expansion and buy these firms up, taking advantage of someone else’s panic to get helpful prices. They will consolidate the rest of their portfolio into their highest-conviction stocks as they shed the big name liquid companies they picked up earlier.
ARK’s general focus is long-term disruptive innovation. They have a number of funds with thematics that expand from that central focus including the ARK Innovation ETF (ARKK), the ARK Next Generation Internet ETF (ARKW), the ARK Autonomous Tech. & Robotics ETF (ARKQ), the ARK Genomic Revolution ETF (ARKG), the ARK Fintech Innovation ETF (ARKF), and the ARK Space Exploration & Innovation ETF (ARKX). These actively managed funds are joined by two passive funds, the 3D Printing ETF (PRNT) and the Israel Innovative Technology ETF (IZRL).
Financial advisors who are interested in learning more about this topic can watch the webcast on demand here.