Digging Into Ark Innovation's Portfolio

We reveal how the ultra-popular fund's underlying holdings stack up on 11 measures of equity-related risk.

Amy Arnott 19 February, 2021 | 9:40AM
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Ark Innovation ETF  wasn't quite an overnight sensation, but it quickly made up for lost time after a relatively quiet beginning in 2014. Portfolio manager Cathie Wood founded Ark Investment Management after successful stints at Capital Group, Jennison Group, Tupelo Capital Management, and AllianceBernstein. Wood and her colleagues look for companies that lead, enable, or benefit from disruptive innovation, an approach to business strategy popularized by Clayton Christensen and his colleagues in the mid-1990s. (Ark's investment strategy is sort of like disruptive innovation on steroids.)

The fund started gaining more attention after its 87% runup in 2017, as well as Wood's bullish call on Tesla in 2018. The fund posted a total return of more than 150% in 2020 and garnered about US$10 billion in net inflows for the year, plus an additional US$5.2 billion in net inflows so far in 2021 (as of Feb. 11). These torrential inflows make the fund--along with several other Ark offerings--one of the fastest-growing funds in the industry.

In this article, I'll use Morningstar's Global Risk Model to analyze the underlying characteristics of Ark Innovation's portfolio holdings. The portfolio stands out for its full-tilt approach toward growth and strong focus on volatile, momentum-oriented stocks. 

Under the Hood
Ark Innovation sports a compact portfolio of only 48 holdings, with roughly half of its assets concentrated in the top 10 holdings. Top holding Tesla--which has been a fixture of the portfolio since 2014--now accounts for about 11% of assets. Wood's pursuit of disruptive innovation isn't limited to the United States; the fund currently allocates about 20% of assets to international stocks such as Materialise, CRISPR Therapeutics, and Shopify. Wood targets stocks that can outperform over a five-year period, and portfolio turnover is roughly in line with the Morningstar Category average.

Only about 3% of the fund's portfolio replicates stocks held in the S&P 500, the benchmark identified in its prospectus. The fund's active share (a measure of portfolio overlap) stands at about 92%, indicating that only about 8% of its holdings replicate the index.

In contrast to many growth-driven managers, Wood hasn't loaded up on technology stocks. Instead, nearly a third of the fund's assets are in healthcare stocks, including a 17.8% stake in biotech issues. Communication services also looms large thanks to holdings such as Roku, Spotify, and Twilio. The fund's tech weighting--while a bit lower than average overall--includes numerous software apps and software infrastructure names. Meanwhile, the fund is underweight in economically sensitive sectors such as industrials and basic materials, as well as financials.

Ark Innovation's Sector Allocation 

Exhibit 1

Source: Morningstar Direct. Benchmark is the S&P 500. Data is based on portfolio holdings as of Dec. 31, 2020.

Let's take a deep dive into the fund's holdings using the 11 style-based factors in the Global Risk Model.

How Ark Innovation's Holdings Stack Up on 11 Different Factors
Morningstar's Global Risk Model includes 11 style-based factors that help shed light on a portfolio's underlying risk exposure. Six of the 11 style factors (valuation, valuation uncertainty, economic moat, financial health, ownership risk, and ownership popularity) are based on Morningstar's fundamental equity research and extensive ownership data. The other five factors (liquidity, size, value-growth, momentum, and volatility) are traditional risk factors that have been widely studied by academic research. We express each score in terms of the number of standard deviations from the average (also known as a z-score), with a score of zero indicating the average score for a universe of about 7,000 domestic stocks. We set the sign of each exposure so that positive numbers are generally associated with factors that have shown a positive effect on returns over time.

Ark Innovation's Risk Factor Exposures

Exhibit 2

Source: Morningstar Direct. Benchmark is the S&P 500. Data is based on portfolio holdings as of Dec. 31, 2020.

Volatility: Our volatility factor is based on a stock's range of historical prices over the past year. Ark Innovation's holdings score significantly above average for volatility, with a z-score of 1.20 versus negative 0.15 for the S&P 500. Larger holdings such as Tesla, Square, and Invitae have been significantly more volatile than broad market benchmarks. Wood does sprinkle in a couple of lower-volatility names, such as Intercontinental Exchange and Nintendo, but those are the exception rather than the rule. Not surprisingly, the volatility of the fund's underlying holdings has translated into some sharp ups and downs in performance; over the past five years, its standard deviation has been among the highest in the mid-cap growth Morningstar Category. 

Momentum: The momentum factor measures how much a stock risen in price over the past year relative to other stocks. Academic research has found that stocks with strong recent performance often continue performing well, at least over shorter periods. Ark Innovation's holdings score very high on momentum, with a portfolio z-score of 1.14 versus negative 0.01 for the S&P 500. Holdings such as Tesla, and Zoom Communications contribute to the fund's strong momentum orientation. Stocks with a strong momentum orientation have performed particularly well in recent years, which has been a tailwind for the fund's performance. 

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