At Marcellus, we are wary of the size problem in fund management – fund managers after a string of good performances tend to attract more capital only to eventually see their performance taper off. But the most spectacular scaling up of assets under management must be the now iconoclastic Cathie Wood’s ARK Investment Management which has gone from $2bn a year ago to touching $60bn earlier this month, thanks to its staggering triple digit returning performance in 2020. The Economist gives its typically balanced take on ARK.
The piece ties in ARK’s investment strategy to bet on ‘innovation’ and identify winners that demonstrate exponential growth in profits, to the size problem in a sense it actually helps overcome size problem i.e, if indeed, its portfolio companies become exponentially large.
“The companies she likes are those with the potential for “explosive” or “exponential” growth. A lot of Ark’s research contains optimistic ballpark estimates of “the opportunity” in, say, digital wallets or driverless taxis. Ark’s signature investment is in Tesla, the electric-vehicle maker, which spans nearly all of Ark’s five investment sub-themes.
The piece also touches upon another not so common aspect in fund management – marketing.
“Her advocacy of Tesla, and of bitcoin, has endeared her to the WallStreetBets generation of investors. Social media in general has proved an invaluable marketing tool for Ark.
Rivals carp that Ms Wood is selling not skewness but momentum. She certainly puts a lot more emphasis on “the story” than on valuation. There seems to be no stock price that a would-be disrupter could not grow into in time. Any sell-off in tech, such as this week’s swoon, is not a warning but an invitation to buy the dip. Disruption, reinvention and exponential growth are Ark’s shibboleths. The message may not be to all tastes. But you may at the very least applaud the skilful marketing. “The rest of us are stupidly fighting the tape, trying to build balanced portfolios,” says an admiring fund manager. Ms Wood is instead giving people what they want: a sex-and-violence portfolio undiluted by anything dull or tame.”
Then it touches upon the flipside:
“Skewness is a fact of life in tech businesses, where the best firms enjoy increasing returns to scale. But identifying the winners of the future is not easy. They may not even exist yet, much less be listed. And outside of a few strategies, such as index investing, asset management is subject to diminishing returns to scale.
Every successful asset manager finds there is a fund size beyond which the magic stops working or begins to do damage. Shovelling $60bn into a strategy in which smallish, illiquid stocks are prime targets is going to distort the market. Already Ark holds a stake of 10% or so in two dozen biotech names. If a lot of money flows out from Ark’s etfs, then the prices of some illiquid holdings could fall hard. The latent boom-bust dynamic is made worse by Ms Wood’s high profile, which only encourages copycat investors. These add to price momentum on the way up, but would also worsen a sell-off.
Should Ms Wood’s funds fall from grace, as envious rivals predict, she is unlikely to fall hard herself. She is now associated with an investment thesis that chimes with a big feature of economic reality, the superstar firm, even if it is speculative and prone to bubbles. The Ark effect is both brand new and as old as the hills. Many star fund managers of the past found it hard to sustain performance once they grew bigger. The good news for Cathie Wood is that none of them ended up in the poorhouse.”
If you would like to understand the method behind ARK’s madness, listen to their erudite Head of research on this podcast
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