Exceptional returns in any asset class/fund tend to attract investors a lot. The tulip bubble, the gold rush, the many many bull runs that have happened over the last few decades all share the same story. In fact, it's quite common to see investors chasing the recent best performing mutual funds and not looking at other factors like longevity, drawdowns, etc.
A similar story happened with a fund company ‘Ark Invest’ and its investors.
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Cathie Woods is the founder of Ark Invest. She is well known for her investment thesis of investing in disruptive businesses that will change the way people live in the future. Some of her flagship investments include the electric car maker ‘Tesla’, a payments company ‘Square’ etc. She was hugely celebrated in 2020 when her Ark ETF performed extremely well delivering a 142% return in the year.
As a result of recent outperformance and the whole narrative build up around tech, a lot of investors started investing in the fund.
The party however didn’t last much longer. In 2021, the ETF dropped 25% and dropped another 20% in the first few months of 2022. Recent investors have lost almost 50% of their capital.
Now you might be wondering what’s the big deal about this? There are a lot of stocks in the markets that correct this much. However, it is important to remember here that the Ark ETF had over $23 Billion in AUM when it peaked out. Many investors who were chasing the recent best performance and who believed in the story of ‘Tech stocks can be bought at any valuations’ would have lost a huge part of their savings.
Even though the thesis might actually play out and the fund might end up performing well, we must notice the consequence of not diversifying the right way and buying at any valuation, a 50% drawdown.
Here are some common lessons that all investors should take from this
Risk and Returns are always correlated - Whenever you look at a fund or any asset outperforming everything else, beware. In this industry, you cannot focus only on returns to judge a fund's performance, you have to look at risk adjusted returns and also determine how sustainable the performance can be.
Let me explain this quickly. If firm A and B both generate a return of 10% but firm B took a higher level of risk to achieve this return then the performance of A has to be considered better even though they generated the same returns.
Are you truly diversified - Ark Invest had 9 ETFs and all of them shared the common thesis of investing in disruptive businesses. Because of this there was a huge overlap in the holdings of these funds. For example, ‘Ark Innovation’ and ‘Ark Next Generation Internet’ might sound like two funds with different kinds of investment goals, however they have two thirds of their portfolios in common. This led to the investors believing that they were diversified while they actually weren't.
Understanding your goals - The most important metric to measure investment success is to see whether it was successful in achieving the investment goals of the investor. For that it is important for the investor to be clearly aware of his/her goals. As we mentioned before, the correction in Ark ETF could be temporary and the fund could very well rise and continue to perform well. However, you should only invest in it if you are looking to invest in a high risk, high volatility fund with a concentrated investment in the tech sector for a time horizon of 5-10 years.
Just because a fund is performing well doesn't mean that it suitable for all.
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