Saturday, October 8, 2022

Cathie Wood Just Can't Help Herself

By Sam Latter (View Archive)

Last week, Cathie Wood found herself in the headlines yet again...

The mainstream media fell over itself reporting that the founder and chief investment officer of ARK Invest is launching a brand-new fund focused on private investments.

The ARK Venture Fund will invest 70% in private companies and 30% in public companies... and retail investors will be able to participate with an investment as little as $500.

As Maximilian Friedrich, who's on ARK's Venture Investment Committee, told the Wall Street Journal...

We think retail investors should have the right to participate in the value creation of the most exciting and successful technology companies on the planet, even if they're private. That is a value add that sets us apart from traditional venture capitalists, which often do not have a broad reach and audience with retail investors.

Now, it's true that most venture capital ("VC") investing is off limits for normal, everyday investors. And on one hand, that's a shame... By the time a company goes public, its hypergrowth days are typically behind it, and private investors have reaped the rewards. In that sense, giving individual investors access to these types of companies before they go public is a good thing.

On the other hand, 90% of startups don't make it. Private companies are notoriously risky and volatile. And until they're publicly traded, their valuations are imprecise at best.

So your investment may not be much more than a lottery ticket... And funds like this only encourage individual investors to take more and more risk in search of reward.

But that's just one of many red flags with the ARK Venture Fund...

Just as worrisome, the fund will charge a 2.75% management fee and the total expense ratio will be an additional 4.22%.

Let's do some quick, back-of-the-napkin math here...

If Wood's new fund returns 10% per year, you're left with just 3.03% after paying nearly 7% in fees.

To put that into context, the Vanguard S&P 500 Fund (VOO) charges a 0.03% expense ratio... meaning you pay about $3 per year per $10,000 invested.

With VOO, after a decade of making 10% annual returns, your $10,000 turns into $25,867 after paying $71 in fees.

With Wood's new fund – assuming the same 10%-per-year growth – your $10,000 investment turns into just $13,478 after paying nearly half your profits ($12,459) in fees.

The longer you invest, the more money you put directly into Wood's pockets. Take a look – again, assuming somewhat generous 10%-per-year returns...

These fees would be hard to justify even if Warren Buffett were managing the fund...

Wood's investing drew heavy praise during the pandemic as investors flocked to riskier and riskier assets like cryptocurrencies, non-fungible tokens, and heavy options trading.

But this year, her ARK Innovation Fund (ARKK) is down about 60%, roughly twice that of the tech-heavy Nasdaq...

A $10,000 investment in ARKK at the start of the year would be worth about $4,000 today. Now, imagine paying 7% per year for that kind of underperformance.

And if you want your money back? Well, that's too bad...

Perhaps the biggest issue regarding the ARK Venture Fund is a complete lack of liquidity.

Now, most investors are better off never touching their investments. But you should be able to withdraw your money if you want to! What if you incur a sudden and unexpected expense like the death of a loved one?

Tough luck, I guess. Buried in the fine print of the fund's registration with the U.S. Securities and Exchange Commission ("SEC"):

An investment in the Fund, unlike an investment in a typical closed-end fund, is not a liquid investment. To provide some liquidity to Shareholders, the Fund will be structured as an "interval fund" and conduct quarterly repurchase offers for a limited amount of the Fund's Shares (expected to be 5%).

In short, because the ARK Venture Fund is investing in highly illiquid investments, it will limit customer withdrawals to 5% each quarter.

In Wood's defense, this actually does make some sense, as valuations for private companies don't update every day as they do in the public markets. A massive withdrawal from investors could lead to ARK Venture Fund having to liquidate its investments before they have a chance to play out.

That said, it does leave the overly complicated valuation of privately owned companies to Wood and her team, who until now have focused entirely on investing in and valuing publicly traded stocks.

As Wood openly admits in the SEC filing...

It is possible that a fair value determination for a security may be materially different than the value that could be realized upon the sale of the security.

Mind you, this is the same Wood who values bitcoin at $1.36 million by 2030, thinks electric-car maker Tesla (TSLA) will trade for a split-adjusted $1,800 per share by 2025 (up from around $240 per share today), and who six months ago predicted that her ARKK fund will return 50% per year...

A year ago, we thought our portfolios would deliver a 15% compounded annual rate of return. Now we think 50%. As a portfolio manager, my strategy is to average that. I think that's a very sensible strategy if you believe in our research and if you believe the ground is shifting underneath you.

Annual returns of 50% per year... very sensible? That forecast is so farfetched, you can only hope nobody will believe it and fork over money to the person who said it. As the fund's staggering 11-page risk disclosure section concludes...

The Fund should be considered a speculative investment that entails substantial risks, and a prospective investor should invest in the Fund only if they can sustain a complete loss of their investment.

My friend and colleague Herb Greenberg summed it up nicely in the October 6 Empire Financial Daily...

Between overhyped initial public offerings ("IPOs"), crypto scams, and meme stocks, it has never been easier to lose money in the markets.

In a world where American retirement funds are $7 trillion short of where they should be, you can throw the ARK Venture Fund onto the pile of ways to quickly incinerate your hard-earned cash.

Fortunately for you, Herb has found the perfect vehicle for you to put your nest egg to work...

You can think of it as a "bank account" that trades at a 25% discount to the S&P 500 and yields 3.5% – twice that of the market. In down markets, it keeps your money safe. And in up markets, it outperformed stocks through virtually every period over the last decade.

In other words, it's about as close to bulletproof as it gets in today's market. Get the full details right here.


Sam Latter
October 8, 2022