Feb 04. 16:48
Cathie Wood's ARK Registers the ARK Venture Fund (an Interval Fund!)
Cathie Wood Has Another Go at $ARKK's "Disruptive Innovation" Thesis Through a Less Liquid Vehicle
The new interval fund registration comes as the investment manager plays defense after most of its once-lauded ETF products finished 2021 with significant losses.
Today we'll cover the Fund itself, look at what's happening to ARK, and unpack how the interval fund structure can help protect the Fund and its investors from a repeat of 2021.
About the ARK Venture Fund
The Fund seeks to drive long-term capital growth for investors, by primarily investing in equity securities of companies that ARK believes will create "disruptive innovation." According to the Fund's prospectus, that means tech-enabled products or services that could potentially "change the way the world works."
In practice, the Fund intends to invest in privately placed or restricted securities (i.e. not publicly traded) of companies trying to innovate in fields like genomics, automation and manufacturing, transportation and energy, artificial intelligence, materials, next-gen internet, and FinTech.
For a $1000 minimum initial investment, ARK is looking to join the increasing number of asset managers piling into the interval fund space, offering low minimums and new access to previously out-of-reach private market segments. Fundrise and Finite, for example, have some of the lowest upfront minimums of any interval fund, and are each expanding retail access in their respective commercial real estate and solar/sustainable investment spaces.
The Fund shares some thematic overlap with the ARK Innovation ETF in terms of the targeted industry sectors, and both are registered under the Investment Company Act of 1940 ("'40 Act"). Finally, true to veteran ETF issuers, the Fund's prospectus cites that the Fund will consider ESG metrics, and in no way will they use that data to limit, restrict, or exclude companies or sectors from their investment strategy. But the similarities stop there.
As an interval fund, the Fund can invest in private companies whose valuations aren't nearly as sensitive to rapidly-shifting investor sentiment as public stock prices are. Also, like nearly all interval funds, shares will not be daily redeemable or tradeable on secondary markets – instead, the Fund will offer to repurchase 5% of outstanding shares on a quarterly basis.
Given the past year, it's easy to see why ARK would be attracted to a less-liquid fund structure and a strategy with lower market correlation.
What's Happening to ARK?
ARK Investment Management LLC, based in St. Petersburg, Florida, launched its flagship product, the ARK Innovation ETF ($ARKK) back in 2014. The ETF is actively managed and seeks long-term capital growth by investing in equity securities of companies that fit the aforementioned "disruptive innovation" theme.
Top holdings currently feature household names like Tesla, Zoom, Roku, and Spotify, and the ETF started making headlines when its market price more than doubled over the course of 2017. $ARKK would gain another 24% by the start of 2020, and then the pandemic hit, sending prices into the stratosphere.
$ARKK exploded on 3/17/2020, gaining over 300% during the next eleven months and ranking as the top-rated fund in Morningstar's mid-cap growth category before running into a brick wall.
Bond yields spiked in February 2021 and investors started leaving growth stocks – previously able to make a stronger case for long-term profitability when interest rates were flat – in favor of inflation-hedged value stocks and real assets.
Within two months, $ARKK's then-$2 billion monthly inflows sharply converted to its first outflows since October 2019, and by November 2021 the ETF was dead last in the mid-cap growth category it led less than two years prior, and severely lagging behind broader markets.
$ARKK is heavily concentrated, holding just 43 publicly-traded stocks, and 36 of them were over 40% off their 52-week highs at the start of 2022. If it weren't for an ~11% allocation to $TSLA the damage would be even worse.
Treasury yields jumped again to kick off 2022 and the bleeding worsened, with $ARKK facing more than $280 million in outflows in the first four business days of the year.
At the time of writing on the morning of 2/4/2022, $ARKK had lost nearly 56% of its value since its intraday high on 2/17/2021. Only two of ARK's other ETFs finished 2021 without taking absolute losses, and even those dramatically underperformed relative to DJIA, SP500, and NASDAQ. Ouch.
Cathie Wood remains publicly optimistic about her strategy, citing dip-buying opportunities on the media circuit and recently buying larger stakes in $HOOD and $TSLA, but 2021 undoubtedly hurt – and ARK's registration of this new interval fund shows they're hustling to pursue their "disruptive innovation" strategy through a vehicle that's better shielded from shifting investor sentiments.
Pursuing Long-Term Capital Growth in Private Markets, via Interval Funds
We can't predict the future, but as it stands today, pursuing capital growth by betting on the long-term profitability of a small handful of public equities is proving unsuccessful in these volatile and inflationary times. To us, it's clear why the interval fund structure makes sense as an alternate path for ARK.
Interval funds allow greater allocation to illiquid assets.
Any investor can open a smartphone app and, in just a few seconds, sell "liquid assets" like public equities and ETF shares at a price the market agrees upon. It doesn't demand much sophistication and the SEC, accordingly, doesn't require investor accreditation to trade liquid assets.
By contrast, "illiquid assets" are holdings that cannot be quickly and easily exchanged for cash at their fair market value. Think real estate, capital equipment, infrastructure, rights to private loans, or – yep – ownership stakes in private companies. Buying and selling illiquid assets generally means hiring appraisal or valuation services, bringing in lawyers, negotiating contracts, etc. It's a more sophisticated transaction that pays a premium to those who execute it well, but is traditionally out of reach for most people who lack investor accreditation and/or want faster access to their money.
Enter the closed-end interval fund.
While ETFs are restricted from allocating more than 15% of capital to illiquid assets, interval funds can invest up to 95% at a time (check out our comparison between ETFs and interval funds) – and because interval funds offer investors a degree of protection and transparency thanks to the '40 Act, investor accreditation is not a requirement.
This is important to ARK. Their new Fund aims to provide exposure to companies that aren't publicly traded, so the Fund's underlying securities are unlikely to face massive sell-offs if bond yields go up another 10 bps one day. Unlike shareholders of underlying $ARKK stocks, most people who own shares in private companies are in it for the long haul.
Interval funds don't offer daily liquidity, either.
Speaking of being in it for the long haul, ARK's new Fund will require investors to hold shares for at least a quarter after they first purchase them, which should – at least in theory – help limit panic-selling of Fund shares.
Investors might be wary of a $1000 minimum and 3-month cash lockup, but accessing similar private market strategies without interval funds requires a 6-7-figure upfront investment, and the ability to tolerate a 2-10-year cash lockup. Interval funds thus expand access in a unique way, and the quarterly redemptions serve as a "discipline hack" to prevent hitting the sell button based off a comment overheard on CNBC.
Last November we covered two real-estate focused interval funds that were able to invest opportunistically during the 5-week crash that marked the beginning of Covid-19. The funds temporarily lost just 2.5% and 8% of NAV, respectively, and were able to pick up discounted assets while publicly traded REITs were reeling off a 43% loss.
For both of those funds' investors, access to daily liquidity would have enabled hasty investment decisions that could have hurt them in the long run.
Still, the wrapper needs to match the strategy.
Operating a fund in a less-liquid vehicle doesn't offer the same advantages if the underlying assets are still liquid, and still subject to the whims of the market.
For example, look at the 5-year chart for the ACAP Strategic Fund ($XCAPX), a large interval fund that, like $ARKK, invests in publicly-traded stocks that the adviser believes are likely to innovate and "disrupt" at some point in the future.
Now look at $ARKK's chart.
It's uncanny. Both funds showed more-or-less steady growth for a couple years, exploded during Covid-19, peaked a day apart in February 2021, sputtered through the year, and are now careening off the latest bond yield news. $XCAPX's NAV is "only" down 30% from the peak vs. the 55% for $ARKK – possibly thanks to better diversification and that quarterly liquidity – but we've fielded enough calls from RIAs asking how to redeem $XCAPX shares to know that quarterly liquidity can't overcome sustained negative sentiment about the underlying assets.
Reflecting on a wild couple years for ARK and Cathie Wood, investing in private companies via interval funds – instead of public stocks in a daily redeemable ETF – makes more sense for a long-term capital growth objective that's dependent on companies to suddenly disrupt and innovate one day.
The biggest question now is whether investors will view the new Fund as a more thoughtful way to pursue $ARKK's once-promising thesis. Probably depends when they invested in $ARKK.
Research request? Send us a note at email@example.com, or just DM us at @interval_funds.
Note: This article is for information purposes only, and does not constitute an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or any other product or service referenced herein. 100% of the information presented in this article is supported by publicly available research.
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