Interest rates

How rising interest rates can

The ten-year period of the “zero interest rate policy” (ZIRP) has had interesting effects on capital markets and investor behavior. The most obvious impact of the ZIRP, as I discussed earlier, has been the sharp curvature of the yield curve. The resulting compression of yields, visible in all categories of corporate and sovereign debt, has been a real boon for high growth companies, which have been able to take on historic amounts of debt at a historically low cost.

But alas, the ZIRP party finally seems to be coming to an end. The Federal Reserve and other major central banks have signaled plans to start raising rates within the next year. With rising interest rates on the horizon, the market has shown signs of growing skepticism of once high-flying growth stocks, especially those that are unlikely to turn a profit anytime soon. This is quickly becoming a problem for the ARK Innovation ETF (ARKK, Financial), the flagship $ 21 billion exchange-traded fund

Catherine Wood (Retail, portfolio) ‘s Ark Investment Management.

Rising blues rates

During the long ZIRP era, profitability seemed to become less and less important to investors even as forecast valuation multiples hit record highs. The market has rewarded many deeply unprofitable growth stocks with huge market caps based on expectations of bright, but often distant, futures. Capital poured in from investors and distributors who were looking for higher yields in an ultra-low rate environment.

This has proven to be the perfect environment for ARK Innovation, as it is made up almost exclusively of unprofitable, innovation-driven technology companies. However, with the rate hikes approaching, many ETF positions have gained the upper hand, as AJ Bell’s Russ Mold pointed out on December 6:

“There has been a ebb in enthusiasm for high growth tech stocks. Many Ark Innovations investments don’t make any money and in an environment where interest rates are expected to rise, this is not necessarily where you want to be. [There are also] some equity-specific challenges, which revealed very high valuations. “

See red

The carnage has not been isolated to a few names. Indeed, almost all of the stocks in ARK Innovation’s portfolio have been beaten recently. As of December 4, all but four of ARK Innovation’s shares were in full bear market territory.

Many of the ETF’s biggest holdings are now in the red, such as Teladoc Health Inc. (TDOC, Financial), which fell 53% during 2021. Zillow Group Inc. (Z, Financial) is another major holding company of ARK Innovation which, for a number of reasons, has seen its star fade lately. Zillow is currently down 55% year-to-date.

No way back to black

When market fears increase, volatile fund strategies tend to be viewed with more skepticism. ARK Innovation is particularly vulnerable to such conditions, due to its inherent sensitivity to fluctuations in volatility, as Morningstar analyst Robby Greengold pointed out on November 30:

“The fund’s relative performance tends to be up or down. Its relatively concentrated portfolio independent of benchmarks means investors should have a taste for volatility. “

The speed and scale of recent growth in ARK Innovation’s assets under management has only made matters worse. As I warned back in february, massive inflows could end up creating deep liquidity problems for ARK Innovation due to the ETF’s core strategy, which is to maintain a highly concentrated portfolio of a relatively small number of growth stocks. Judging by its performance in 2021, my first apprehensions about ARK Innovation seem to have been justified.

My opinion

Down 21.5% so far this year, the ARK Innovation ETF looks terribly bruised and bruised at the moment. However, I fear the worst is yet to come for Ark Invest’s flagship ETF, especially if the rate hikes go according to plan. In a rising interest rate environment, ARK Innovation’s particular investment brand is likely to struggle, in my opinion. If volatility also continues to escalate, things could get even worse.

Ultimately, I find little incentive to invest in this particular ETF.

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