Hot take: The new ARK Space Exploration ETF (ARKX) is a disappointment.
Let's be clear. This isn't an indictment of Cathie Wood or the ARK Invest company's success. She has worked incredibly hard, achieved an impressive degree of success and deserves every bit of it.
But if I'm being completely honest, ARKX isn't, in my opinion, living up to what I thought it would be.
To be fair, the space exploration industry is a pretty narrow segment of the market. There are few companies out there that can boast that a significant chunk of their bottom line is dependent on this theme. There are far more companies that are exploring or building the technology and/or equipment that could end up in space, but it's such a small part of their overall business strategy that you'd be gaining a lot of exposure to non-related business activities by owning the stock. It's a real balancing act trying to obtain real space exploration exposure without watering down the portfolio.
That's why it's so important to look under the hood of the fund. Investors may assume that by investing they're getting access to the latest cutting edge technology. In reality, they may be surprised to see a number of the names that made the cut.
Cathie Wood just laid out her vision for ARKX in a recent interview with ETF.com and that gives a nice overview for why the fund is constructed the way it is, but I still have a couple of concerns about the fund moving forward.
Overinflated Return Expectations
Over the past decade, the S&P 500 has posted an average annual return of nearly 14%. The Nasdaq 100 has returned 20% per year. These kinds of returns are unsustainable. This is especially the case given that a lot of these gains have been fueled by trillions of dollars in stimulus payments and Fed bond purchases as well as long-term zero interest rates.
Valuations have also gotten excessive. According to the Shiller P/E ratio, the equity markets have been this expensive at only one other time in history - the tech bubble. According to the website for the iShares Core S&P 500 ETF (IVV), the S&P 500 is trading at 30 times earnings. The Invesco QQQ ETF (QQQ), which tracks the Nasdaq 100, says the index is trading at 50 times earnings.
With interest rates and inflation expectations on the rise, the risk of multiple contraction is growing.
Consider historical forward-looking returns based on the P/E ratio. If history holds, we're looking at low single digit returns over the next 10 years.
This graphic quotes a P/E of 25 for the S&P 500. Based on that number, we could reasonably expect 2-3% annual returns going forward. If you consider a 30 P/E like the number that BlackRock is quoting, negative returns over the next decade is a distinct possibility.
Many of the ARK ETFs achieved their huge returns in an environment when all of the stars aligned in their favor. What happens if broad market returns are minimal and/or high growth stocks fall out of favor. The ARK ETFs could be significant laggards. A fund like ARKX, which doesn't have the huge track record to fall back on could quickly get ignored.
Cathie Wood says in the ETF.com interview, "The compound annual rate of return we expect from this portfolio during the next five years is 20% on average per year, as of today." I think expectations are way too high and investors could be left disappointed.
Some Curious Fund Holdings
I published the list of ARKX holdings earlier this week, but I'll list them here again.
Wood talks about how the fund will focus on two major themes - mobile connectivity and hypersonic flight. She notes that when people think of space exploration, they think of travel to the moon or Mars and space tourism. She thinks of it more along the lines of satellite communications and the ability to connect people to technology all around the world. It's an important distinction and helps explain the composition of the portfolio.
But I'm not sure most people will get that. That's part of the reason why I've recommended people avoid the Capital Link NextGen Protocol ETF (KOIN). It falls under the blockchain ETF umbrella, but includes names, such as Intel, Mastercard, Microsoft and Amazon. These are companies that are investing in blockchain, but it's such a small part of their overall business that you're getting essentially no blockchain exposure at all. I think something similar, albeit to a lesser degree, could be at play with ARKX - investors not getting much pure space exploration exposure.
Consider some of the fund's more curious holdings.
- John Deere - No, this isn't a play on tractors inhabiting the surface of the moon. This is a play on satellite imaging and, to a lesser degree, autonomous vehicle development. Deere is developing the technology to use satellites for mapping farmland in order to optimize and maximize agricultural yields. The company is also developing autonomous tractors in order to save on human capital.
- Amazon - What does one of the world's biggest retailers have to do with space exploration? Well, the company is planning on launching its own satellites. Again, think connectivity and bringing broadband access to areas of the world that currently lack it.
- Netflix - The company just developed the Space Force series with Steve Carrell and has a number of documentaries on their platform, but that's not why it made the cut. Like Amazon, Netflix is banking on satellite connectivity to expand its service worldwide. Greater access to high-speed internet means greater subscriber growth.
- Workhorse - This company is developing electric vehicles, but it's the planned use of drones to enhance supply chain speed and reduce costs that qualifies it for inclusion in the ARK ETF.
- JD.com - Same story here as Workhorse. Wood says that the company is "one of the most sophisticated logistics companies using drones especially to help with supply chain management."
In reality, ARKX could be better described as a next-gen communications ETF rather than a space exploration ETF.
I find it a little curious that Tesla didn't make the cut. Its affiliation with SpaceX along with ARK's well-known affinity for the stock in its other ETFs seemed to make it an easy choice. Virgin Galactic, another stock that figured to get a heavy allocation, barely cracks the top 20. Wood explains that as the company being focused on tourism as opposed to ARKX's core themes.
Overall, I think most of the fund's holdings are defensible given Wood's explanation of what the portfolio is targeting, but it's running the risk of casting too wide a net, like KOIN. Can ARKX be successful? Of course. Cathie Wood has already proved that she's an elite stock picker, but I think it's facing some headwinds and investors are going to get confused about what this fund is all about.