2021 has been a tough year for the ARK ETFs.
Once the darling of Wall Street following years of stellar performance across many of its funds, sentiment has turned sharply negative as the company’s biggest ETFs, including the ARK Innovation ETF (ARKK) and the ARK Next Generation Internet ETF (ARKW), have corrected 30%.
Last year, ARK was drawing more money than it knew what to do with. This year, investors are pulling it right back out. ARK has seen more than $2.5 billion in outflows over the past month.
While some investors may have overestimated the return potential of investing in one of the ARK ETFs and underestimated the potential downside risk, there’s little doubt that next gen tech is a hot investment theme. Whether it’s autonomous vehicles, robotics, space exploration or genomics, there are endless technological opportunities being developed right now and investors want a piece of the pie.
If you’ve been turned off to Cathie Wood and the ARK ETFs, there are other alternatives available in this space. One of those funds I want to take a look at is the Innovator Loup Frontier Tech ETF (LOUP).
Innovator Loup Frontier Tech ETF (LOUP)
LOUP, like ARKK, targets companies that influence the future of technology including, but not limited to, artificial intelligence (AI), computer perception, robotics, autonomous vehicles, virtual reality, and mixed/augmented reality. It tracks the LOUP Frontier Tech Index, which tracks 30 different stocks.
A company can qualify for inclusion in the index if it meets the following criteria:
- derives 50% of its revenue from one of the identified sub-themes OR
- it meets two of the following three criteria:
- the company’s revenue related to one or more identified sub-themes grew by more than 25% year-over-year in the most recent calendar year.
- the company’s operating expenditures related to one or more identified sub-themes grew by more than 25% year-over-year in the most recent calendar year.
- the company’s capital expenditures related to one or more of the identified sub-themes grew by more than 25% year-over-year in the most recent calendar year.
According to the fund’s prospectus:
After establishing the selection set, the Index Provider ranks companies using the following metrics: (1) revenue growth; and (2) revenue growth acceleration ranking. Each of these two rankings will be weighted by 1/2 and summed to create a composite ranking for each stock in the selection set. The Index is weighted across the two ranking categories given the ranking of the selection set: a high conviction category of 5 stocks at 5% weight each, and a conviction category with 25 stocks at a weight of 3% weight each. The Index is rebalanced and reconstituted monthly.
There’s a fair amount to unpack here, so let’s try to break it down one piece at a time.
As always, the first step needs to be understanding the fund’s portfolio construction methodology and taking a look under the hood. One of my frequent criticisms of some ETFs is that while it may categorize itself as high tech or something like that, but it’s methodology ends up making it look more like a plain vanilla index fund.
One fund I pick on occasionally is the Capital Link NextGen Protocol ETF (KOIN). It describes itself as a blockchain ETF, but is willing to include any company that is engaging in even modest blockchain development. As a result, you’ve got a portfolio full of names, such as Microsoft (MSFT), PayPal (PYPL), Nvidia (NVDA), Cisco Systems (CSCO) and Visa (V). Sure, those companies may be involved in blockchain in some form or fashion, but it does it sound like you’d be getting pure blockchain exposure with this ETF? No way.
I like that LOUP is developed as more of a pure play on the sector, generally requiring that a company is heavily exposed to the theme or is in a period of rapid growth. I also really like the high conviction pick overweighting. A lot of ETFs use a set of criteria to identify a universe of stocks, but then will go and just market cap weight the portfolio. Equal weighting most of the portfolio helps spread out risk and avoids the large-cap tilt that exists in many funds. Giving higher weightings to the management team’s 5 highest conviction picks just makes intuitive sense and is in line with how many investors build their personal portfolios.
There are no Microsofts or Visas in this portfolio, although there are a handful of large-cap names, such as Ford (F), Micron (MU) and AMD (AMD) that make the cut.
Speaking of blockchain, Overstock (OSTK) is a name many are probably familiar with. It launched as an online retailer, but has since made a major strategic pivot towards blockchain development. You don’t typically think of Ford as a next gen tech play, but it’s begun making major investments into autonomous driving vehicles, so its inclusion is easily explainable.
Not surprisingly, the fund overall leans heavily towards the tech sector, but its 1/3 weighting to countries outside of the United States gives it an advantageous global tilt.
LOUP vs. ARKK
The obvious question is how LOUP compares to ARKK, the largest of the ARK ETFs and the one that includes all of the company’s best ideas regardless of sector or theme.
The big difference is that ARKK is actively-managed and LOUP follows a passively-managed index. When investing in rapidly developing industries, such as autonomous vehicles, blockchain or even marijuana, it makes sense to choose an active strategy that can pivot quickly as conditions change. LOUP’s index reconstitutes itself monthly, so there isn’t much of a lag, but in a vacuum I’d probably prefer active over passive. In core, broad-based, long-term portfolio holdings, passively probably wins.
There isn’t much difference in terms of cost. ARKK charges 0.75% compared to the 0.70% expense ratio of LOUP. In thematic offerings (especially ones that target next gen tech), you should expect to pay a premium. With such high return potential but also high downside risk, the expense ratio probably becomes less of a consideration, so we’ll call this a tossup.
From a fund composition standpoint, there’s very little in common between the two ETFs.
The two funds only have five holdings in common accounting for just 8% of assets overall. Clearly, the active management of ARKK and the targeting criteria of LOUP are currently producing very different results.
The biggest difference between the two ETFs is LOUP’s heavy overweight to tech and industrials compared to ARKK’s overweights in healthcare and consumer discretionary. Part of that is due to ARKK’s concentrated top holdings in names, such as Tesla (TSLA), Teledoc (TDOC) and Roku (ROKU). ARKK’s “all over” strategy also tends to grab more names from areas like biotech/genomics and retail as well.
Here are the five names that are common to both ETFs currently.
It’s also worth noting that LOUP is about 30% less volatile than either ARKK or ARKW and has produced better risk-adjusted returns over the past year.
LOUP is also just 15% off of its all-time high currently compared to ARKK and ARKW, which are both still 25-30% off of their highs, although to be fair drawdowns in the past have been similar for all three ETFs.
If you’ve decided that you’ve had enough of the ARK ETFs and are ready to move on, LOUP provides investors a nice alternative. It’s also more of a traditional high tech offering that stays away from some of the non-tech areas of the market that Cathie Wood tends to shop around in. Costs are comparable and risk-adjusted returns (at least over the past year) have been superior. LOUP has also demonstrated that it may not experience quite the severe highs and lows that ARKK has experienced.
I consider LOUP worth of consideration.