As you might recall, Cathie Wood’s ARK Disruptive Innovation fund was up an amazing 60% in 2020.  The S&P 500 was up 16% that year. Thus the fund outperformed the S&P 500 by 46%! Last year it was down 25% underperforming by 50%. But that’s not why I consider the actively managed ETF a hedge fund. It’s because it has the macro based investment style that is often used by hedge funds.  Macro is a top down style attempting to identify a global event that could occur. George Soros, with the fall of the British pound, and John Paulson with the collapse of real estate loans (CDO’s) are prime examples.

But neither was an investment; they were directional bets. If correct, it can make a manager very rich. Both Soros and Paulson became billionaires. In a heavily correlated stock market, such as the past 15 years, it’s ideal.  If the bet fails, there’s no legal liability for the portfolio manager because, unlike the fiduciary manager of a separate (individual) account, it’s a pooled account. The manager simply closes the fund. Most of the assets come from pension funds. If an individual invests in a hedge fund, he has to demonstrate that he’s an accredited investor; income of $200,000 net worth of $1,000,000.

This hedge fund industry prequalification requirement does not exist for the Ark Disruptive Innovation ETF. It is not considered a hedge fund even though it has the macro investment strategy of one. It’s a one dimensional upside bet. In effect, it’s a “hedge” fund for the masses. The difference between the “Disruptive Innovation” fund and a normal hedge fund is that you know its stated “investment” focus before you buy it. But a normal hedge fund can change its macro thesis on a given day. ARK cannot; its thesis – innovation - is why it was bought. Underappreciated is that this could be a future problem.

A locked- in investment strategy can create dramatic upside; but only if it’s in the right place at the right time. Ark’s Disruptive Innovation fund definitely was in 2020. When such a macro bet works – as it did for Soros, Paulson and Cathie Wood - it is dramatic.  But a thematic macro bet also creates risk if the theme goes out of style. The portfolio then becomes over weighted on the downside. Macro style works best in a highly correlated stock market such we have had for the past 11 years. One that is driven by – unsurprisingly – macro events. But that is about to change as the Fed raises interest rates.

The Fed’s stimulus policy for the past 15 years has given rise to the venture capital funding of many profitless innovative companies.  Some have bad – even broken – business models. It’s called TINA. That’s the acronym for “There is no Alternative.” Ark AUM (assets under management) rose from 0 in 2014 to 61 billion (all of Ark’s assets) in the past 8 years. As of December last year, assets were down to 34 billion. The Innovation portfolio holds 44 positions. As of the end of last year, all of its holdings were down from their peak. Only six – out of the forty-four - haven’t entered a bear market. Half have fallen 50% from their 2021 peak. More importantly, few of the “innovative” companies make money.

Such has been the impact of 0% interest rates. There have been billions of dollars with nowhere to invest … other than the stock market. Thus for the past 10/11 years, trillions of dollars have flowed into the stock market from sovereign wealth and public sector funds which have future pension obligations. Therein is the “I hope” philosophy of the pension trustee. That has been the real basis of investing in the philosophy of the Ark Disruptive Innovation fund. Unfortunately, one Tesla holding out of 44 stocks - as we know - cannot carry the wrong thematic holding at the wrong time.