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Kathy Wood of Ark Investment Management created an interesting video in which she criticizes passive funds, especially those that track broad market indices. So, let's take a look at some of the points she made in this video, see why her funds were so successful, and analyze historical examples that are similar to the situations we see today .
Remember , if you want to know what's happening in the markets and learn about economics and the relationship between them , sign up for our free weekly market roundup . You can see its link in the description below and above. Now, let's look at the comments made by Ark Invest and Kathryn Wood about passive indices in more detail .
This is not a recommendation. If you need advice, take it according to your specific circumstances . Seek independent financial advice. It is now common for active managers, who believe it is their job to beat benchmarks, to say that those benchmarks themselves are useless . So, this response can be seen as part of a longer discussion of what could be called a 'passive attack'.
Next to me here is Kathryn Wood , founder and chief investment officer of Ark Investment Management. She is making a series of very entertaining YouTube videos . If you haven't seen them yet , I definitely recommend you do . But in this Twitter thread and some recent interviews, she has been highly critical of passive benchmark tracking funds .
Her argument is that the S &P 500 and NASDAQ indices are filled with many companies that are not doing well . She calls these 'value traps' , meaning there's a reason they're cheap, and she believes they'll stay cheap forever . Her investment thesis says that those companies will be pushed aside by the companies she invests in due to innovation and change.
She stated that the passive and benchmark-sensitive investment approach is leading to the largest capital abuse in history. Because benchmarks are determined based on market capitalization . We tend to buy shares of large companies because they have been successful in the past . However, it seems a bit excessive for her to say that this will put the US behind in the competition compared to countries like China.
This reminds me of what the Alliance Bernstein report said about passive investing being almost like socialism . There is a very humorous video embedded in this Twitter thread, in which they satirically criticize passive investing. But they do it in the kind of style you see in hundreds of corporate videos , where you start with an open-plan office like this and a gentle voice- over says, "Are you an investor looking for long-term capital appreciation , but concerned about the short-term volatility associated with innovative companies ?" Well, you're not the only one.
It seems that many investors are afraid of companies that offer new, fast, cheap, and creative products and services. Now, you can avoid these innovative companies . How? Ask your advisor today if investing in a traditional broad-based index is right for you. However, that is not entirely true because broad-based indexes also include these innovative companies .
And it reminds me of what Jack Bogle said , which is, if you can't find a needle in a haystack , she thinks she can, then buy the whole haystack. And the video reiterates that the broad-based index is market cap weighted, so it gives importance to past performance . And it makes fun of companies that generate predictable cash flows because that would be so boring , right?
Because in this new world, we wo n't need anywhere to live. We do n't need to transport physical objects because at that point, we'll have uploaded them to the cloud . But actually, I'm just kidding . If you want to see the report, it's available for free on their website and it's really interesting .
And by any measure , the performance of ARC funds has been excellent . The exchange- traded fund sectors categorized by ETF DB are at the bottom of this graph . And each black dot on this graph tells you how much return a single fund has made . And I have highlighted ARC funds with this red ring so that you can compare them with other funds in the same category .
And no matter what category they chose, you can see that they did very well. So this is the return for the year. And if we look over a long period of time and this is the return of the last three years , and some of the ARC funds are not visible now because they were issued in the last three years , but you can still see this very impressive excellent performance .
Now you can measure the success of an active manager on how much money they bring in, because remember what they really earn is a percentage of the assets under their management . And in terms of asset acquisition, it's been a fantastic year for ARK. So the green bars you can see here mean that money is coming into the fund and the red bars indicate that money is going out of the fund.
This is just one of their funds . This is the Ark Innovation Fund, ARK, which has received over $7 billion in investments in the last 3 years . Investments were fairly stable before 2020 , but in 2020, a massive $ 5 billion investment came in within six months. You can probably guess what the reason is.
Investors generally look for those that perform well . So, if any fund has performed well recently, money will flow into it . ARK funds are no exception. Here are four of their funds , all of which performed excellently in 2020 after the March sell-off . But all of that performance wasn't just due to ARC's stock-picking skills .
Part of that performance comes from the sectors to which ARC has allocated its capital . So in the graph we'll look at next, we'll subtract the returns of the QQQ fund, which tracks the NASDAQ . Much of the cumulative returns we are seeing now are attributable to ARC 's stock selection skills . They are getting paid to find needles in a haystack of benchmark stocks , that's their job.
The picture we see now is very different. For example, funds like Arc Industrial Innovation underperformed the NASDAQ in 2015 , and also underperformed in 2018 and 2019 , but achieved better results in 2020 . The ARC Next Generation Internet ETF has been nearly flat compared to the NASDAQ in 2015 . This did not provide much additional benefit .
Its alpha is zero. It then underperformed in 2019 , but achieved excellent results in 2020 . The Genomic Revolution ETF also remained stable for a few years , then delivered very good results in 2020. And the ARC Innovation ETF didn't do much until 2017 , but performed brilliantly in 2020 . Now, Arc takes great care in picking their stocks, with Tesla being one of their favorites.
Before the criticism in the comments, I have to say one thing, I really like Tesla. I really like their products. Maybe one day I'll buy one too , but I can't say that their stock is cheap . And if we look at the ETFs with the highest holdings of Tesla, three of them are ARC ETFs , while the Industrial Innovation ETF has a holding of around 11.9%, while the Innovation and Next Generation Internet funds have a holding of around 10% .
If we look at the holdings of the ARC Innovation ETF , you will notice that Tesla is in first place. But the truth is that many of these stocks are overvalued . So it's no surprise that ARC achieved incredible growth in 2020 , as it invested in growth stocks that have performed exceptionally well during this period .
But people should ask themselves whether growth will always continue to be better . Value stocks have a 200- year decline . So will value companies never have a chance anymore? I do n't think so. While it is true that we are moving away from internal combustion engine cars towards electric cars, the valuations and share price movements we are seeing clearly say that we are in an EV bubble .
You can see here that FT journalists also have a sense of humor. Jamie Powell says this is a completely normal price movement for a company called Archimoto, which is listed on NASDAQ . We all remember the recent news headlines about Nicola. The FT quotes a short report from Hindenburg Research here , which everyone will remember as Nikola overestimated its technology, overpaid insiders and rolled a truck down a hill to prove its vehicles would work .
I should say that Arc never invested in Nikola. They invest heavily in Tesla. One sign of how crazy EV valuations have become is that they are using a new valuation metric . This new metric divides a company's value, i.e. its enterprise value, by TAM, or Total Addressable Market . Now, that's the revenue you get if you have 100 % market share .
Will any company ever have that much of a stake? No. But what this does is, by dividing by a larger number , it makes the company not look as expensive . If you like this video , please hit the like button. You can support us directly on YouTube and you will receive a beautifully designed badge. That badge.
Now, it's always useful to go back in history and look for similar situations . Things will never be the same, but some similarities are bound to appear. So, I'm going to talk here about the bicycle mania that took place in the UK in the late 19th century . Now, the first factor is low interest rates.
This is the Bank of England bank rate, which fell from 10% in 1866 , but then fluctuated between 2% and 5% for many years. And the black line represents the interest rate on UK government bonds , which were then called British Consols. That is also very low compared to history, but not as low as it is now.
The effect of low interest rates is that people are forced to move their money into riskier assets . If you can't earn a high return with a very safe government bond , you have to take on more risk . So all that money is looking for risky ventures that have the potential to yield higher profits. The second point is innovation.
That innovation must be practical. It should make a previously difficult task easier . Now let 's look at a difficult task. Riding a penny farthing bicycle. It's actually a difficult task to get to grips with these things, and it's very important not to let go of them. You can imagine what would happen if you fell.
Also, note that there is no bicycle chain here. So, if you had to cycle up the hill, it would have been very difficult . As expected , a great discovery was made at that time . It is called a safety bicycle for obvious reasons . It is certainly safer than a penny farthing . It looks like a bicycle we buy today .
Notice how comfortable the ride is now with air-filled tires . Ball bearings reduce friction in the wheels, so we don't have to pedal as hard. At that time, new processes for making seamless steel tubes also became available. This is a revolutionary change. Many people are now able to afford bicycles and they have become very popular .
If you walk down the street , you can see people riding these bicycles. So interest rates are low. A visible discovery has been made. You can probably guess what happened next. Looking at the share prices of bicycle companies listed in the Birmingham Daily Mail, I must say that my family, who lived in Birmingham in the 19th century, also worked in such metal industries , and many companies at that time turned to making bicycles.
So, within a period of about two years, the number of companies with listed share prices has increased exponentially. If the Arc Innovation ETF had existed back then, you can bet it would have definitely bought one of these companies . The index with the black line here is made up of the share prices of these bicycle companies .
The dotted line represents the performance of the broad index. During this period, "Why would anyone buy a broad index?" I'm sure people will ask . You just have to go for these innovative, revolutionary bicycle stocks . Again, you can probably guess what happened next. If we extend this graph from the end of the century to 1903, those bicycle stocks that had performed so well began to lag behind in performance ; In fact, as all of the disruptive stocks failed or were merged into larger companies through takeovers, they fell below the level of the blue chip index , and then they simply started to follow the blue chip index .
Because the disruptive innovative company that exists today will become a blue chip stock tomorrow . So, don't get me wrong . I think ARC has done an excellent job of explaining what they do . I like their reports and their YouTube videos , but I do n't think they eliminate the need to invest in broad passive ETFs.
I think there is nothing beyond them as the foundation of one's investments . And here we can see ARC's six funds . And this column represents the expense ratio. And remember , you can track one of those broad indexes for just 0.05% of the cost . But the charges charged on an annual basis for these funds are very high .
They are all around 0.75% per year. So while I like their investment approach, transparency, and investor awareness efforts , I think you're paying too much for these funds . And there is always the risk that you will confuse the two . Passive investing and thematic investing. Is it possible to do theme-based investing with a passive fund?
Yes, that is possible. There are other funds available , but here are several passive funds that track certain themes . As very large asset managers like BlackRock enter the field , perhaps it will also increase the pressure on asset managers like ARC to reduce fees . And the investment performance of some of these passive thematic investment funds is quite impressive .
This is a global clean energy fund from BlackRock. And like many of those ARC funds , it performed excellently in 2020 . While the cost ratio isn't cheap, it's much lower than ARC . However, I must say that this somewhat blurs the boundaries of what constitutes an active and passive fund. Ultimately, it depends on index providers, such as S&P Global Indices , who offer such clean energy indices.
Here is S&P's explanation of that index . And the great thing is that multiple providers of passive funds can track the same index, which creates competition and reduces fees. So if we see a reduction in fees, meaning a reduction in costs for us as investors, it will come primarily from passive providers, not active providers like ARC .
I do n't think it's helpful for active managers to criticize passive benchmark-based investments. If they are truly experts at their job, they should be able to justify the high fees they pay for active management . If you want to learn more about investing , joining our online community through Patreon is a great way to get involved.
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