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Nikko AM ARK Disruptive Innovation Fund – where now?

Nikko AM ARK Disruptive Innovation Fund – where now?

It wasn’t a good year for tech stocks in 2022. Although almost all markets fell, technology was worst-affected. Whereas the S&P500 fell by about 20% in the calendar year, the Dow Jones US Technology Index shed more than 35%, with the NASDAQ not doing much better with a decline of 33%.

This wasn’t great news for the Nikko AM ARK Disruptive Innovation Fund, the GBP2.2bn tech-heavy, growth-orientated fund managed by Catherine Wood and Brett Winton of ARK Investment Management out of Florida. Nikko Asset Management are investment advisors for the strategy.

The fund had a punishing 2022. Over the last year the fund lost 26.7%, by way of comparison the Morningstar category US Flex-Cap Equity shed 1.8% over the same period and the Disruptive Innovation Fund found itself at the bottom of the league tables.


Tech-pocalypse

Last year was bad for tech in a number of ways, combining into something of a perfect storm. The inflation caused by the War in Ukraine was impactful in its own right, as with the cost of fuel and staple products rising, overheads increased for companies that were heavily reliant on postage of goods to their customers. Companies like Amazon NASDAQ:AMZN.

To combat inflation the Federal Reserve led central banks globally on an ever-escalating round of interest rises. Many tech companies had grown on the back of cheap, available debt. As interest rates rose and the banks started pulling up their drawbridges, life became more uncomfortable for companies like Oracle NYSE:ORCL which was running an 800% long term debt-to-equity ratio as recently as 2020 according to Statisa.

The tech giants built themselves on ‘good ideas’ and ‘potential’ and funded their growth with cheap debt and lots of expensive equity. However, as the spectre of recession emerged, investors became more defensive and cautious, and started looking for income and dividends – something tech companies were not known to offer as they weren’t really profit-making machines – and opted for investment in the main street as opposed to the Yellow Brick Road potential of technology firms.

This led to tech giants, including Alphabet NASDAQ:GOOGL, parent company of Google and Meta NASDAQ:META the parent company of Facebook, instituting mass staff layoffs and efficiency savings.

The economic uncertainty also saw a drop-off in advertising, a source of revenue for many tech firms, something that affected the earnings of Alphabet, Meta and Twitter, the latter of which became private-owned late last year as Elon Musk bought the site. A strong dollar didn’t help things either with the big American tech giants bringing in much less revenue from their foreign ventures.

Trend finder

So last year was not a good year to be in tech. Unfortunately for the Nikko AM ARK fund, this was its main playground. The Nikko AM ARK Disruptive Innovation Strategy seeks to capture long-term capital growth by taking advantage of changing trends caused by technology-enabled innovations that cut across economic sectors, industries and geographic regions. In other words, they are looking at the existing disruptors and seeking the next disruptors that can change the way the world works.

The fund managers believe “innovation is key to growth”, and that disruptive innovation is the introduction of a technology-enabled product or service that changes an industry landscape by offering simplicity and accessibility, while driving down costs.

Wood believes that many disruptive technologies are misunderstood, overlooked and undervalued by traditional investors and the ‘special sauce’ that she brings to the table will outperform broad-based benchmarks over the course of a full market cycle, with low correlations of relative returns to traditional growth and value strategies.

Thematic, concentrated

The fund is run on a thematic, concentrated “high conviction” equity-only portfolio of around 40 to 60 stocks with over half of assts under management often concentrated in the top-10 holdings. Top-down analysis is used as an initial screen to create the investment universe, and then applied bottom-up research to identify stocks.

The areas that the fund focus on is industrial innovation, genomics, next-generation internet, and fintech innovation. Wood is benchmark agnostic, and her team will invest in any geography or sector or market capitalisation in an attempt to capture quickly changing themes.

Although 2022 was a bad year for the fund, this year has seen a bit of an uptick in performance – nosing back into positive territory, with three-month performance to the end of March being 29.9% as tech stocks started a slow recovery. By comparison the MSCI World Total Net Return Index returned 7.7% over the same period.

The fund is a UCITS qualifying, Luxembourg-domiciled SICAV.

Nikko AM ARK Disruptive Innovation Fund Top Five Holdings

Company  Weighting 1yr Performance
Tesla NASDAQ:TSLA 9.4% -45.9%
Roku NASDAQ:ROKU 8.6% -46.9%
Zoom NASDAQ:ZM 8.2% -40.7%
Block NYSE:SQ 6.0% -41.8%
Exact Sciences NASDAQ:EXAS 5.1% 14.9%

*Data as of 3rd May

The Nikko AM ARK Disruptive Innovation fund was one of the worst performers last year. It is unique in that it is not diversified and invests in a sector that is highly speculative and hard to value. It is not a short-term play, instead if you believe that technology will have the effect on society that the hype says it will, it is an investment to make (with an element of trepidation) to stash away and leave.

Also, disruptors are harder to find by the very nature of the industry they operate in – technology – as information and data is more easily accessible and collectible; so ARK’s USP is diminishing. When ARK emerged, it was putting up massive numbers, but in the last few years the fund manager has taken a battering. Sometimes it is good the be strong and wrong, if over the longer-term your hunch is proved true.

ARK also has become a victim of its own success. Wood’s funds have now become so big they are unwieldly, and unable, through their quantum to find the small innovator that will become the next big disruptor. That’s why the fund is smattered with bigger, household names, that have themselves become unwieldly and less innovative than they were at start-up.

With tech we don’t know where a lot of these companies will end up over the next few years. Some could shoot to the moon – literally and figuratively – some might spectacularly crash and burn, like Virgin Orbit [VORBQ]. For many (including me) this isn’t a fund that brings a lot of comfort, but if ARK gets it right, someone will make a lot of money.

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