As part of ARK’s open-research and knowledge-sharing ethos, the firm’s analysts build communities on social media and push out their research to—and engage with—experts in various fields ranging from artificial intelligence to genomics.
“These outside people weigh in on some of our research, which kind of battle-tests some of our assumptions,” Leggi says. “We’re trying to predict exponential growth over multi-year periods. You can make a mistake in that process, but we learn from our mistakes, and that enables us to constantly enhance our process.”
One of those “mistakes” relates to 3D printing, a formerly hot next-big-thing technology that has since cooled off. ARK’s 3D Printing ETF (PRNT), which launched in 2016 and is one of its two passive U.S.-listed ETFs, has a three-year annualized return of just 0.6%.
“One thing that’s challenging is determining inflection points on these technologies,” Leggi says. “3D printing was one of those where we missed the mark on the adoption rate.” He notes that while ARK still includes 3D printing among its 14 transformative technologies, it didn’t factor in the regulatory environment, and where 3D printing took hold was in the heavily regulated aerospace industry.
“So we were off in our adoption rates, and we weren’t as conservative as we should’ve been regarding the regulatory environment,” he explains, adding that since then the firm has put greater emphasis on this factor when stress-testing its analysis on the adoption curve rate of a particular technology.
Creation/Destruction
“As we dive into specific technologies, we begin to see how impactful they’ll be to other industries around it,” Leggi explains, noting that ARK’s research on autonomous vehicles shows the impact they will have on both the fossil fuel and transportation industries, including trucking and railroads.
And that gets to the flip side of ARK’s basic conclusion about disruptive technology—namely, it’s both a force for creation and destruction. “There are a lot of industries such as fossil fuel-based energy, big pharma and banks that are potentially going to be disintermediated,” he says. “These sectors comprise a big weighting in broad-based indices such as the S&P 500, which investors have as their core within their equity allocations.”
For that reason, Leggi suggests, investors can consider ARK’s strategies to be both a hedge against wealth destruction caused by disruptive innovation and an opportunity to reap the potential upside of said innovation.
In his role as ARK’s client portfolio manager, Leggi works with investors to explain how the firm’s strategies can fit into portfolios. His take is that the concept of disruptive innovation will evolve into a sub-asset class much like the emerging markets did in the latter two decades of the 20th century.
“Many advisors are still style-box oriented, but we’re seeing some advisors create a new bucket called ‘opportunistic equity,’ and that’s where they’re starting to build a more strategic allocation to innovation,” Leggi says. “We think these strategies can eventually become core as these disruptive themes and technologies create a tremendous amount of wealth creation and value.”
But chasing exponential growth doesn’t come without risk. According to Morningstar, ARK’s ETFs tend to have higher betas, standard deviations and maximum drawdowns than their category averages—sometimes by significant amounts.
Leggi claims this analysis misses the point. “Yes, our strategies will move and be more volatile, but I think the biggest risk we see is the destruction happening in core. And if you stay very passive and maintain exposure to industries that are vulnerable to destruction, I think that’s a bigger risk.”
He adds that disruptive innovation is inherently fast moving and volatile. “Higher volatility creates opportunities for us to generate trading alpha over time.”
ARK Invest talks big, but so far it has delivered big, too. The firm has been one of the ETF industry’s biggest success stories in recent years, and its leaders see themselves as being at the vanguard of the fully transparent, actively managed ETF movement. Based on their track record, they might be on to something.