As Fed Hikes Rates, Will ARKK Continue to Sink?

Cathie Wood's primary fund, ARKK, the ARK Innovation ETF, is down about -45 percent year to date, compared to the US Nasdaq 100, which is down roughly -16 percent.

When interest rates rise, companies with limited sales and incomes suffer the most.

ARKK may be having trouble owing to the profile of firms in which it invests, which is mostly linked to the present market situation.

INFLATION WEIGH ON US STOCKS, FED HIKES

Over the last few months, the fundamental backdrop for risk appetite has deteriorated: the global supply chain is in disarray; commodity prices have risen, threatening both companies' margins and consumers' spending power; and central banks have pressed ahead with reducing stimulus and tightening monetary policy.

It will be difficult for US equities markets to continue a strong rebound unless this underlying narrative changes. More precisely, in this context of less fiscal stimulus, tighter monetary policy, and squeezed company margins due to rising inflation, equities with lower sales and poorer profit profiles tend to be weighed down. 

Companies that are still in the early phases of development, those attempting to make breakthroughs that will revolutionize sectors or the economy — younger tech stocks, for example – suffer even more.

IN 2022, HOW HAS ARKK PERFORMED?

ARKK is the best example of this problem. "ARK defines 'disruptive innovation' as the launch of a technologically enabled new product or service that has the potential to revolutionize the way the world functions," according to the ARKK prospectus. 

Companies in ARKK rely on or benefit from the development of new products or services, technological advancements, and scientific research in the areas of DNA Technologies and the 'Genomic Revolution,' Automation, Robotics, and Energy Storage, Artificial Intelligence and the 'Next Generation Internet,' and Fintech Innovation."

CATHIE WOOD, HAS SHE LOST HER GOLDEN TOUCH?

'Yes,' is the easy and obvious response. After all, ARKK is severely underperforming the Nasdaq 100 in the United States.

However, the accurate and nuanced response is 'no, not necessarily.' Cathie Woods' investments are typically growth-oriented bets on the future: these companies are often newly founded, having recently gone public, and lack significant established revenues and cash flows, as well as significant pricing power within their industries (what Warren Buffet refers to as a company's "moat," akin to a castle's defense).

In fact, the firms that ARKK holds in its portfolio are exceptionally 'long duration' assets (yes, stocks by nature are long duration; but fledgling companies, particularly in the tech sector, to be on the longer end of the continuum). Duration may be thought of as follows: if I invest $1 now, how long will it take me to receive my money back? When interest rates rise, assets with longer maturities suffer more; this is particularly true for bonds.

The underperformance of ARKK in 2022 has less to do with Cathie Wood and more to do with the unique style component of its investments — assets that suffer greatly during times of increasing interest rates.