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Morningstar Cuts ARKK Rating to Negative

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What You Need to Know

  • Morningstar has downgraded Ark Invest's flagship fund, the Ark Innovation ETF, to negative from neutral.
  • Reasons include that the fund is too narrowly focused in losing stocks and lacks any risk-management personnel.
  • ARKK has taken a

Morningstar downgraded Ark Investment Management’s flagship fund, the Ark Innovation ETF, last week to negative from neutral. The $12.2 billion ETF, run by manager and CEO Cathie Wood, has fallen from grace since its incredible rise in 2020 of 156.91%. That was followed by a 23.38% loss in 2021 and a 28% drop year to date in 2022.

As Morningstar strategist Robby Greengold wrote in his analysis, “Invest at Your Own Risk,” the ETF has had a “wretched 45.5% loss over trailing 12 months through February 2022 and lagged the 7.9% decline of the average fund in the technology Morningstar Category and the Russell Midcap Growth index’s 4.3% loss.”

The big downfalls of the ARKK ETF, and the firm in general, include that the ETF in the past year has dropped the number of stocks to 35 from 60, “thereby amplifying stock-specific risk,” Greengold wrote. Further, in the aggregate, it makes Ark Invest its largest shareholder.

In addition, he wrote, “the firm has no risk-management personnel.”

Process, People, and Parent

Morningstar assesses funds through “People, Process and Parent pillars.” For ARKK, each of these areas has been downgraded, Greengold noted.

Some of the factors behind the downgrade include:

Wood’s use of instincts to construct portfolios is a “liability”: Greengold stated that the firm’s exposure to “technology platforms the team thinks will revolutionize how sectors across the globe operate” is high risk, especially as it “favors companies that are often unprofitable and whose stock prices are highly correlated.”

Instead of doing risk simulations, “the firm uses its past as a guide to the future and views risk almost exclusively through the lens of its bottom-up research into individual companies.”

This, he said, “can make or break” a fund’s performance as well as poorly position it to “prepare and react.”

Heavy concentration: Not only is the fund more likely to sell liquid, large-cap stocks, it does this to focus on “pure plays” — that is, typically “unprofitable small caps with extreme volatility and far less liquidity.” He added that its largest 10 holdings make up 60% of the assets, which is one of the “most severe asset concentrations” in the category.

Lack of seasoned staff: A key problem is that there is no succession plan for Wood. As the firm’s portfolio manager, CEO and chief investment officer, Wood is the main force of the firm. Her backup, Brett Winton, director of research, has no portfolio management experience, Greengold said.

But mostly the strategist bashes the firm’s “inability to develop and retain talent” as its main fault, noting that the nine analysts still on staff lack any deep industry experience.

Boom or bust: Despite its 12-month drop in performance, the firm since October 2014 through February 2022 has had a 20.6% annual gain, which has beat the 12.5% gain of this Russell Midcap Growth Index category benchmark, and beat out its peers in the category.

This might explain its ability to attract and retain its investors, Greengold said. The firm still has more than $23 billion in assets under management; that number, however, was $50 billion in February 2021.

He added, though, that this return isn’t as impressive when compared with tech fund returns, of which ARKK most resembles with its narrow focus on aggressive-growth stocks, he said. The S&P North American Technology Index gained 21% annually since 2014.

Greengold noted that most of ARKK’s returns were between 2017 and 2020, while it was one of the worst performers from 2021 through the first quarter of 2022.

He concludes that despite the fund’s low fees, “we think this share class’s alpha relative to the category benchmark index will be materially negative.”