Cathie Wood’s ARK Invest recently launched three of its exchange-traded funds (ETFs) in Europe, including the firm’s flagship strategy ARK Innovation ETF.
The latter is an aggressively-managed fund aiming to identify businesses that can be transformational and have the potential to generate exceptional long-term growth.
As a result of this investment process, the ARK Innovation ETF has proven to be volatile and has struggled in risk-off markets when the growth investment style fell out of favour.
This description may remind UK investors of a fund they are perhaps more familiar with: Scottish Mortgage.
Alex Watts, fund analyst at interactive investor, said: “There are some similarities in philosophy and positioning. Both funds take unconstrained approaches to investing in disruptive businesses that are driving innovation and are at the helm of cutting-edge and growing themes.
“This naturally leads them to invest in higher-multiple growth stocks, compared with more conventional and benchmark conscious peers.”
Despite their similar high growth approach, ARK Innovation and Scottish Mortgage differ in many ways too. As an investment trust, Scottish Mortgage has access to additional tools, such as the ability to leverage its portfolio and hold unlisted assets. It is also subject to a premium/discount mechanism, offering investors the possibility to buy assets below their net asset value. As an exchange-traded fund, ARK Innovation does not have access to these instruments.
They also diverge in their respective investment strategies: ARK employs a more active trading approach, whereas Scottish Mortgage uses a buy-and-hold strategy.
At the portfolio level, there are also significant differences between the two funds. For instance, Tesla is the only common stock in both funds' top 10 holdings, although the two portfolios share a few other names such as Shopify, Roblox, and Moderna.
Dan Coatsworth, investment analyst at AJ Bell, said: “One could argue that ARK’s portfolio is higher risk than Scottish Mortgage’s, certainly judging by the top 10 positions. For example, it offers exposure to cryptocurrencies via Coinbase and Block. It also holds web conferencing platform provider Zoom whose share price soared during the pandemic and crashed soon afterwards when people started returning to work in offices and Microsoft’s Teams system became more widely used, and has flatlined for the past two years.
“In contrast, Scottish Mortgage has quite a few well-established businesses which are giants in their industries including Nvidia, Amazon and ASML. Its stake in PDD is also interesting as the Chinese company’s latest results show a highly profitable business that is growing fast, helped by the runaway success of its e-commerce platform Temu, which is the talk of the town in the retail industry.”
ARK is also less diversified in terms of the number of holdings as well as geographic distribution. The ETF only invests in 30-50 holdings compared to approximately 100 for the more diversified Scottish Mortgage.
The investment trust is also more global, with sizeable allocations to Europe and the emerging markets in addition to North America. In contrast, ARK Innovation is significantly US-centric, with 95% of its portfolio invested in the US.
In terms of cost, Scottish Mortgage boasts a lower ongoing charge figure of 0.34%, whereas ARK Innovation charges more than double those fees at 0.75%.
As for performance, the British investment trust has done significantly better than its American ETF rival since 2014, with the outperformance being even more striking over five years.
Performance of funds since October 2014 and over 5yrs
Source: FE Analytics
However, ARK Innovation long had the upper hand until late 2021 when inflation and interest rates started picking up. Although both funds suffered from this dramatic change in the macroeconomic environment, the ETF was even more impacted.
What are experts’ preferences?
When asked to pick a favourite between the two, most experts voted for Scottish Mortgage. Darius McDermott, managing director at Chelsea Financial Services, prefers Scottish Mortgage’s buy-and-hold approach, although he recognised that there have been some misses.
He said: “We like Scottish Mortgage’s desire to run its winners, however there have been occasional instances, such as with Moderna at its peak, where the team missed opportunities to take profit.
“Overall, Scottish Mortgage's core strategy demonstrably aligns with a long-term mindset. Also, we believe the trust’s private market exposure continues to be a significant advantage.”
Another expert speaking in favour of Scottish Mortgage was Gavin Haynes, co-founder of Fairview Investing, who holds the investment trust.
He said: “Whist it has had some tough times the long-term returns have been impressive. I like the trust structure which allows access to unlisted companies and the competitive charging structure.
“Although the glory days were largely under previous manager James Anderson, I believe that Tom Slater is now making his mark on the portfolio and the returns over the past year have been encouraging.”
As for Watts, he highlighted that Scottish Mortgage features in interactive investor’s Super 60 rated list but finds it "encouraging" to see new participants in the UK market offering investors access to disruptive growth strategies.
“It’s exciting to see Cathie Wood, who has such a following in the US, bring a highly active strategy via an active ETF structure to the UK market,” he said.
He warned, however, that there is a significant key-person risk with ARK Innovation as Wood is simultaneously the founder, chief executive officer and chief investment officer of ARK.