Morningstar - Q1 2022 - 20

Dispatches
TRENDS
Many ARKK Investors Missed the Boat
The downward trend of ARK Innovation ETF ARKK
over the past few months, in the wake of its
spectacular rise in 2020, has taken shareholders
on a wild ride. Because the actively managed
exchange-traded fund didn't attract widespread
popularity until late 2020, the returns most of
its shareholders have experienced have probably
been far lower than its reported total returns.
To estimate how ARKK's shareholders have
fared, Amy Arnott, a portfolio strategist
at Morningstar, looked at monthly asset flows
since inception, as well as asset totals at the
beginning and end of each period. She
then used these monthly cash flows to calculate
an internal rate of return, which measures
performance for the average dollar invested in
the fund. Various complicating factors make
it difficult to pin down exact investor-return
numbers for ETFs, but the numbers in the exhibit
should be directionally accurate.
Investors' actual results lagged reported
total returns over all four trailing periods-by
large margins. Over the past five years, for
example, the fund's 41.3% annualized return
places it among the top five best-performing U.S.
equity funds and ETFs, and it trounced the
S&P 500 (the benchmark listed in its prospectus)
by more than 15 percentage points per year.
After adjusting for the timing of cash inflows and
outflows, though, Arnott estimates that investors
earned less than one fourth of that return.
ARKK's estimated 9.9% investor return over the
past five years lagged its benchmark by about
8 percentage points per year.
The investor-return gap hasn't been quite as
large over the past 12 months, but absolute
performance has been considerably worse. She
estimates that shareholders suffered a 12%
dollar-weighted average loss, which is almost 3
times deeper than the fund's 4.3% reported
loss over that span. What's more, ARKK
has experienced breakneck volatility, making any
risk-adjusted measure of its dollar-weighted
returns even worse.
.
Home Bias Thwarts
Diversification
Traditionally, foreign stocks were considered
riskier than U.S. stocks, and a 20% to 25%
weighting in foreign fare was an aggressive stance
for a typical U.S. investor. Studies suggest,
however, that foreign stocks add diversification
and are not as risky as many think. U.S.
investors have increased stakes in foreign
equities in recent years, but many may still be
underweighted there.
In 2019, FTSE Russell released a research paper
on home bias, showing that U.S. pensions
were overweight domestic stocks by 10 percentage
points. Home bias occurs when an investor
prefers domestic to foreign securities (for whatever
reason) and consequently owns more than a
market weighting in those securities. That's what
most Americans do. According to Morningstar
mutual fund and exchange-traded fund data, as of
Sept. 30, 2021, investors held $12.5 trillion in
U.S. equity funds and $4.2 trillion in internationalstock
funds-or a 75%/25% home/abroad
split. The FTSE All-World Index, on the other hand,
had a 59% weighting in U.S. stocks and 41%
in non-U.S. stocks.
Investor Returns Versus Total Returns for ARK Innovation ETF
Gap
Investor Return (%)
Total Return (%)
50%
41.3
36.1
28.1
9.7
-12.0
-4.3
-7.7
-26.4
-31.5
Investor returns are based on estimated monthly net asset flows
and total assets as of the beginning and end of each period.
Returns for periods greater than one year are annualized.
1 Year
3 Years
Source: Morningstar Direct and author's calculations. Data as of 11/30/2021.
5 Years
Since Inception
(10/30/2014)
20
-25
-50
9.9
9.8
-18.3
25
It's worth noting that home bias in the U.S. is
less pronounced than in other countries because
U.S. stocks make up more than half the global
market. FTSE Russell data shows that investors
elsewhere have a much worse home bias.
Japanese and British stocks have just 8% and 6%
weightings, respectively, in the global index,
but their pensions' equity stakes are roughly 35%
domestic. The world champion of home bias is
Australia. Australian stocks have only a 2%
weighting globally, but its pensions devote 52%
of equity assets to Australian equities. As
two sectors, financial services and basic materials,
take up half the Australian equity market,
that geographic bias also creates significant
sector risk.
There are valid reasons why a U.S. investor
might want an above-market weighting in
domestic companies. Investing abroad can cost
https://www.morningstar.com/etfs/arcx/arkk/quote https://www.morningstar.com/authors/2350/amy-c-arnott
Morningstar - Q1 2022

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