ARK Funds: The Tail that Wags the Dog?

The popularity of the company’s funds raises a tricky question, says Morningstar columnist John Rekenthaler

John Rekenthaler 2 March, 2021 | 1:08PM
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'Tis the season for investment spectacles. While GameStop embarked on the most dramatic round trip in modern stock-market history, boomeranging from $40 per share to $480 and then back to $40, the ARK family of funds made its own history. On February 9 and then again on February 11, ARK funds received more than $1 billion of inflows.

If ARK's receipts weren't an all-time record (they were well above Vanguard's best run rate, but I don't have access to Vanguard's daily figures) they were without doubt the highest ever notched by a niche fund company. Unlike other fund industry sales leaders, ARK is new to the scene (founded in 2014) and until recently was tiny. One year ago, the company's US funds held only $3 billion in assets.

Investing by Theme

ARK's funds are highly specialised; the right funds, one might say, for the right time. In the United States, the company operates seven exchange-traded funds, each of which pursues an investment theme.

You can completely, utterly, and unreservedly judge these books by their covers. The funds' portfolios are as their names suggest, stuffed with companies that are high on promise and low on earnings. For example, the median price/sales ratio for ARKK's companies is 22, as opposed to 2.5 for the overall stock market. Only one third of those businesses are currently profitable.

In short, these funds will terrify those with a strong sense of investment history. Finance professors widely prefer cheap, unheralded companies to stocks that carry steep prices and similarly steep expectations. Practitioners tend to be swayed more by personal experience than do academics, but most veterans reach a similar conclusion: emerging businesses usually disappoint.

Although ARK's investment strategy is familiar, the company's sales success is not. Its inflows raise the question: is the fund tail wagging the stock market dog? That is, have ARK funds performed so well (ARKK is up 11% this year after gaining a breathtaking 152% in 2020) because when its funds put their new monies to work, they boost the prices of the stocks that they already hold?

Indexmania Running Wild?

Such queries are nothing new. They have long been asked of equity index funds, which have been called self-fulfilling prophecies. However, the maths doesn't support that argument. Although tracker funds are enormous, their inflows are not strong enough to do anything more than nudge stock prices.

This occurs because of two reasons. One is that index funds have been a long, slow build. Yes, such funds control $5 trillion, but that figure was attained after decades' worth of sales, plus market appreciation. In no calendar year have the net annual sales for US equity index funds of all stripes, offered by all providers, including both mutual funds and ETFs, surpassed $230 billion.

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John Rekenthaler

John Rekenthaler  John Rekenthaler is vice president of research for Morningstar.

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