Is Cathie Wood's Flagship Innovation Fund a Buy After Falling 68%? | The Motley Fool (2024)

Famous investor Cathie Wood's flagship ARK Innovation ETF (ARKK -0.15%) has struggled since interest rate hikes poured cold water on a hot stock market in early 2022. The fund has mostly stagnated since midway through 2022, while the Nasdaq Composite has reached new highs.

Down 68%, is this exchange-traded fund worth buying today? Despite Cathie Wood's sterling career and Wall Street reputation, investors may want to pause before investing their money in the ARK Innovation ETF. There are some simple truths about actively managed funds and, possibly, a better alternative.

Beating the index is hard

This isn't a knock on Cathie Wood, ARK Invest, or the ARK Innovation ETF. But the simple truth is that actively managed funds have a tough time outperforming indexes over the long run. Below, you can see how Wood's fund thrived in a low-rate environment that was friendly to growth stocks.

But as you might already know, rampant inflation pushed the Federal Open Market Committee to dial up numerous rate hikes to cool the economy. The ARK Innovation ETF has roundtripped its gains and is only up 10% over the past five years versus the Nasdaq, which has more than doubled over the same period.

ARKK data by YCharts

Of course, that may not last. Circ*mstances could easily change, and the fund may enter a period of outperformance. The point is that investors need to have a ton of faith in the people managing these active funds because they can run very hot and cold, which can significantly affect long-term investment returns.

Pulling apart where the fund's returns come from

An active fund means that ARK has traded in and out of stocks over time, but as with many funds, a top echelon of stocks constitutes a majority. It's not a perfect comparison, but investors can see how the fund's top selections have performed over the past five years. Again, not all these companies have been public for five years, or the fund may not have held them for the past five years.

Still, it's an interesting comparison to give investors food for thought.

Chart by author. Holdings and weightings sourced from ARK Invest. Returns sourced from Ycharts.

You can see that much of the fund's returns over the past five years came from a long-standing position in Tesla, which is the trade that launched ARK Invest into mainstream popularity. Investors might be surprised to see how unbalanced this performance is, but even the pros are subject to the 80/20 rule, the tendency that a small input will produce most of the output.

Additionally, the ARK Innovation ETF carries an ETF expense ratio of 0.75%. The fee is standard practice and compensates the fund's management team. But that 0.75% can add up and dampen your investment returns.

An alternative strategy

Investors who bought and held the fund for five years are probably unhappy today. Unfortunately, the fund hasn't done well outside its winning Tesla investment. Again, that's not to say that the fund can't rebound. The fund has more than doubled since its inception (but still trails the Nasdaq).

Instead of paying an expense ratio and investing in the entire ARK Innovation ETF, research the fund's top holdings. Investors can cherry-pick what they like and then buy into positions slowly with a buy-and-hold mentality. Firms like ARK Invest purchase and sell stocks daily, which doesn't always benefit them.

Investing can be like making a good barbecue. Sometimes, the more often you mess with it, the worse it comes out.