ETF Expert Corner

ARK Invest CEO Cathie Wood on Investing in Disruptive Innovation ETFs

August 16th, 2016 by ETF Store Staff

Cathie Wood, Founder & CEO of ARK Invest, offers her perspective on disruptive innovation and spotlights the ARK lineup of disruptive innovation ETFs.



Transcript

You can listen to our interview with Cathie Wood by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The focus of our show today is on investing in disruptive innovation, and I'm now pleased to welcome to the program Cathie Wood, founder and CEO of ARK Invest. ARK Invest currently offers five ETFs, all of which are focused around this theme of disruptive innovation. Cathie is now joining us via phone from New York. Cathie, welcome to The ETF Store Show. Great to have you on the program today.

Cathie Wood: Thank you very much Nate and Jason. I'm very happy to be here.

Nate Geraci: Cathie, since we haven't had you on the program before, for investors who may be unfamiliar with ARK Invest, first, can you just tell us a little bit about the company and, perhaps, how you became involved in ETFs?

Cathie Wood: I founded the company in early 2014. One of the reasons we started with ETFs is, at my prior firm, AllianceBernstein, one of the themes we were working on, the disruptive themes we were working on, was financial transformation. As we were digging into that theme, we were looking at share shifts taking place between mutual funds and ETFs and saying, "Goodness, what is that all about?" As we studied it, we learned that this was a shift from active to passive primarily, but we asked ourselves why did it have to be from active to passive, why couldn't we use an ETF wrapper for an active strategy, and so that is what we've done. Yes, we've taken disruptive innovation and we're innovating on top of it.

Nate Geraci: Cathie, before we get into some of the specific ARK ETFs, generally speaking, how do you define disruptive innovation and how do you go about identifying investment opportunities surrounding this theme of disruptive innovation?

Cathie Wood: In a very broad sense, disruptive innovation is technologically enabled and it changes the way the world works in some way very fundamentally and it cuts across economic sectors. It cuts across the world and it also cuts across the market capitalization spectrum. These are very big, broad, powerful themes. What we're really trying to do is capture what we call exponential growth. This is the kind of growth associated with S curves. Typically, you get that kind of growth when you see technology entering a sector and driving down costs, which then stimulates unit growth. You know this model very well from the PC market or the smartphone market. I think, generally, people understand it from that point of view.

Jason Lank: Cathie, this is Jason Lank. Just to clarify for our listeners, when you say "S curve growth," are you talking exponential growth or arithmetic growth? Help us understand that term.

Cathie Wood: In the early stages of innovation, you'll basically see a trend start off very slowly. It'll be perhaps the growth rate of the economy, and, right now, the economy's growth rate in nominal terms is in the 3% range, if that. As the cost curves drop and the products become more accessible to more people, the growth rate, the unit growth rate takes off and takes off to such an extent that it more than offsets the price decline that are stimulating the growth, and so you can get some spectacular growth rates. I mean, it doesn't surprise us to see Amazon's growth rate since its ... we believe it's in the sweet spot of the S curve, its growth rate last quarter accelerated from I think something like 28% to 29%. This is a huge company. The sales level there is well more than a $100 billion. Take Facebook. Its growth rate accelerated from 52% to 59%. Why is this happening? It's because mobile ads right now account for 16% of all advertising around the world. Whenever you get into the 10-towards-20%-share range, you get an acceleration in the growth. I think people are startled to see these kinds of growth rates from such large companies, but they are happening.

Nate Geraci: Again, we're joined today by Cathie Wood, founder and CEO of ARK Invest. Cathie, right now, your most popular ETF is the ARK Industrial Revolution ETF. The ticker symbol is ARKQ. Tell us more about this ETF. What does it hold and what's the ultimate investment goal of this ETF?

Cathie Wood: As you mentioned at the outset or in your introduction, 35% of this fund is focused on autonomous vehicles. We're actually becoming even more specific than that. Autonomous electric vehicles, that's where we think that market is going. Another 20% of it is focused on robotics and automation. We believe that leading the charge in the autonomous vehicle market is Tesla. Google has been there, although they are losing some talent right now. We're watching Tesla very carefully in the space, thinking that they've got the best mapping data now around the country and, perhaps, around the world, and they could accelerate the trend towards autonomous vehicles faster than people now anticipate. As far as robotics, we believe in 2014 Amazon rang the bell when it started the year with a 1,000 robots in its distribution centers and, by the end of the year, it had 15,000 and, now, we believe it has over 50,000, and that's without cutting any employment. They are just supporting incredible growth as I mentioned earlier. We think it's prime time for robotics and that a lot of other companies, anyone competing against Amazon, is going to have to move into using robotics or they will lose their competitive edge. Also, within this fund is 3D printing. We think 3D printing went through a height phase in 2011, '12, '13. It's gone through a massive shakeout as the market has finally figured out that this is not going to be a printer or a 3D printer on ever desktop, but this is much more about high-end industrial, high-end medical use. Eventually, it could get more towards the consumer, but, right now, we're talking about industrial. Right now, it's a $5-billion market. We think it could be $40 billion by 2020. That's about twice as much as most people think it will be. McKinsey thinks that, by 2025, it could even be a $500-billion market if 3D printing becomes incorporated into the industrial production process. Right now, it's used for about a quarter of all prototyping around the world. That's a very small part of the manufacturing world. When it becomes integrated into manufacturing, then, we're talking about a very significant growth ramp.

Nate Geraci: Cathie, we're talking about 3D printing within the ARK Industrial Revolution ETF, but I know ARK also recently launched the first 3D printing ETF on the market, the appropriately named 3D Printing ETF, ticker PRNT. Can you tell us more about 3D printing technology itself because I'm not sure everyone fully understand how this works? What is 3D printing?

Cathie Wood: If you go back to the days of the inkjet printer and you ... if you were to look at how an inkjet printer worked with different colors, it would work in layers, layer upon layer. You can transfer that to what we now call additive manufacturing. People call it 3D printing or additive manufacturing. Layer by layer, a combination of whether it's powdered metals and lasers or plastics and resins, layer by layer, we are building objects, and we're building them for very high-end aerospace and medical device uses. At least 95% of all hearing aids are 3D printed. Why? Because 3D printing allows for superior customization. Of course, hearing aids have to be customized or they work better when they are customized. Another example is Invisalign, the clear braces that we're seeing right now. All the molds to make those clear braces are 3D printed, again, highly customized. When you're talking about aerospace, we know that on one of Airbus' aircraft, and they have very exacting engineering standards, of course, so we take this even more seriously, they are 3D printing a hundred parts. Now, these airplanes are made up of millions of parts, so we think 3D printing will go from much more, from a hundred parts to much more than that in the future. Why? Because it cuts ... 3D printing collapses the time between designing something and producing it, it collapses the cost and it collapses the weight, which is very important to a lot of manufacturing sectors especially aerospace and the fuel saving that that allows.

Nate Geraci: If we look at the AKR 3D Printing ETF, I'm assuming this holds companies involved in the 3D printing process in some fashion. Is that right? Are we talking hardware or software print centers?

Cathie Wood: Yes, scanning, every part of the ecosystem is in this portfolio.

Jason Lank: Cathie, more of a technical question on your suite of ETFs, most investors associate ETF investing with the related tracking index, but four of your funds are actually actively managed, and so my understanding is they don't necessarily try to replicate any specific industry. Why did you choose this active approach for your ETF, these four ETFs before an index paced tracking approach?

Cathie Wood: The first four funds, the active funds, we wanted to ... we believe that if the ETF market is moved ... is going to move to the next level, it is going to move towards active, and it is slowly doing that with something called ... some people call it smart beta, some people call it strategic beta. Some people don't like those names at all and they'll call it something else, but those are still based on ... Those are still index based. There's some derivations of an index. We went purely active because what we're trying to introduce to our investor base is more transparency. We disclose our holdings at the end of every day. That's what our clients want. More liquidity, they can trade all day long, not just at the end of a day like with a mutual fund, more tax efficiency and lower cost, much lower cost than the traditional mutual funds. We think this is where the market is going, and we wanted to go to ... We wanted to put our puck to where the market is going, so that's why we decided to do it this way. We are also very focused on disruptive innovation, and we think this is an elegant wrapper for a portfolio.

Jason Lank: Cathie, whether index based approach or actively based, in an ETF wrapper, you're secret sauce is on display at the end of every business day. As you mentioned, the holdings are disclosed for not only your customers, but your competitors. Any thoughts on that? Does that prove to be any hindrance at all?

Cathie Wood: No, actually not, because of the way we manage our portfolio. Actually, we go one step further. Once we've placed trades in the middle of the day, we will post them on our website and, for people who would like to be pinged whenever we've made a trade, they can see what we've done if they so choose. We are taking transparency to its limit, and we take it very seriously. Why don't we worry about our competitors? We're focused on disruptive innovation. Disruptive innovation is inherently controversial. There is a lot of volatility, as you mentioned rightly, during your introduction, and we have the opportunity to trade around this volatility. We are what you would consider a liquidity provider. When people are selling our stocks for some very short term reason, which to us means nothing, except for maybe a growing pain or something, we will be adding to positions. We will be buying what people are selling. On the other hand, when people begin to hyperventilate about some of our themes, we know that controversy will rear its head once again and that we will have an opportunity to buy back in. We will take profits when people are getting very, very excited about our themes, so it actually works very well.

Nate Geraci: Again, we're visiting with Cathie Wood, founder and CEO of ARK Invest. Cathie, I did want to ask you about one other ETF, the ARK Web x.0 ETF, ticker symbol ARKW. This ETF is noteworthy because it was the first ETF to offer exposure to Bitcoin. Can you tell us more about what this ETF seeks to do?

Cathie Wood: This is our next-generation Internet ETF. To give you a sense of what we mean by next-generation Internet, Jeff Bezos, in 1997, said, "We're in day one of the Internet." In his shareholder letter, I think maybe 18 months ago, he said once again, "We're in day one of the Internet." This is even bigger than he thought it was going to be. What is one of the latest developments that has occurred because of the Internet, the Internet has enabled it? It's called blockchain. Blockchain technology actually we think is where the Internet was in the early '90s. Whenever we see a new general purpose technology platform evolve, we research the heck out of it. We want to know more about it than anybody else out there. As we were learning more about blockchain, we realized that Bitcoin could conceivably serve as a currency, and it is now in Europe and, I believe, Australia deemed a currency. Here, it has not been deemed anything. The different regulators are deeming it different things. We can see it being used as a currency, as a unit of account, a store of value, a means of exchange, as money. That's one thing. We also see the blockchain being used as a ... in the transfer of anything of value. We could see it being used in supply chain management. The blockchain, the Bitcoin blockchain, which is the largest right now in market cap, it's about $9-to-$10 billion in market cap, all told, it is being built out by Bitcoin. The miners are paid in Bitcoin for building out the blockchain. As we've seen this networking effect take place, we said, "Okay, we went through Mt. Gox. We saw Silk Road." Those were two big controversies that Bitcoin had to get over. It got over them. It stabilized, and then we started seeing during the Greek crisis some people were beginning to shift towards Bitcoin. That's when we decided to find a way to get into Bitcoin, and we found it through GBTC, which trades over the counter. It is a financial security. That's all we can hold in this fund. We cannot hold Bitcoin directly, so we did find that security. It's quite illiquid, but we've had great success with it in the past year since we put it in the fund.

Nate Geraci: Cathie, as we look at these different areas of innovation, whether it be blockchain technology, 3D printing as we talked about earlier, robotics, the speed at which this innovation is occurring is really staggering. I know you have a wonderful chart on your website showing the annual rate at which new technologies are being created now compared to in the past and it's significantly faster. Why is that the case, and why is that important for investors to understand?

Cathie Wood: We're seeing more breakthroughs in technology. An example of this is Moore's Law seems to be slowing down, but software and GPUs and other technologies are taking over so that we're not skipping a beat here. To give you a sense of how fast some technological breakthroughs or the rapidity that they're allowing innovation to take place, if you look at a breakthrough in DNA sequencing in 2007, after that happened, and this was Illumina buying a company called Solexa, which had the breakthrough, after that took place, the genomic revolution accelerated in its speed of development so that, now, it's moving three to four times as fast as Moore's Law, so that means, every six months, there are amazing changes taking places in the genomics space. It really is a function of technological breakthroughs and building upon other technology platforms that have evolved and innovating off of them.

Nate Geraci: All right, Cathie, we have a few minutes left. Generally speaking, where do the ARK ETFs fit in an investment portfolio, because we talk a lot on our program about building broadly diversified portfolios using ETFs, tracking major indexes? Were might the ARK ETFs fit in given that context?

Cathie Wood: Our portfolios have very low overlap. They have very high active share when we're talking about the broad market indices. The stocks in our portfolio or the companies in our portfolio are truly disruptive. What are they going to disrupt? They're going to disrupt we believe a lot of companies that are in the traditional industries. Our portfolios are great complements or you can consider them hedges to more traditional industries which are going to contain a lot of stocks that are going to be hurt by the innovation spawned by companies in our portfolio. For example, Wal-Mart is being hurt terribly by Amazon. It has taken awhile for people to figure this out, but had you held our portfolios, you would have had that hedge against Wal-Mart's disappointments recently. We're great complements. We're also hedges, as I mentioned, and we're also a portfolio for innovation enthusiasts, people who really want to hitch their wagon to the future. Where are the great growth opportunities? We would perhaps replace a slice of a traditional growth portfolio.

Jason Lank: Cathie, I want to ask a question about valuations. We all know there's been a tremendous market runs since the great recession 2009, and there's debate about whether valuations today are stretched or not, but, really, a two-part question for you, as you swim in your fishbowl looking for disruptive innovators, how do you generally see valuations and then, secondly, do valuations really matter if we're looking for companies with parabolic growth?

Cathie Wood: Valuation certain matters, but what you will find in our portfolios and what we like to see are companies who are at the leading edge of disruptive innovation and are ... have very high barriers to entry. Typically, those companies are investing aggressively, so they look very expensive on a PE basis, so we have to back up and look at them from another angle. Price to sales is one angle, and then, also, what we do regularly in our research is we size the market. We size the market potential that these companies are going after and we get a sense of what share of market these companies are going to get and, very often, if there's the networking involved, companies are going to get the lion's share of an enormous market. We like to take that longer-term point of view and just make sure that our companies are investing aggressively enough to stay at the leading edge so that they can capture that tremendous market opportunity. Amazon has taught us a lot. Many people used to make fun of anyone holding Amazon because they hadn't earned a penny if you look at the bottom line practically from the time they were ... they became a part of an index or the time they were founded. Now, of course, after years of investing, we are beginning to see Amazon's return on invested capital ramp, and we do believe Jeff Bezos when he says as he did way back in the '90s that he believes Amazon could be, its return on invested capital could move into the triple digits before all is said and done. We do believe that because he has invested in retail, in Amazon Web services, so infrastructure-as-a-service taking a huge share of that market. His next set of investments are logistics-as-a-service. We think he's going to have yet another leg on this business and even investing aggressively in logistics-as-a-service, those other two divisions are starting to ramp and show nice profitability.

Nate Geraci: Cathie, we're going to have to leave it there. There's no question you're in a fascinating segment of the ETF market, and we certainly wish you the best of luck as you continue to grow ARK Invest. Thank you very much for joining us today.

Cathie Wood: Thank you Nate and Jason. Our pleasure. Thank you for having us.

Nate Geraci: That was Cathie Wood, founder and CEO of ARK Invest. You can learn more about their lineup of ETFs by visiting ark-funds.com. As I mentioned earlier, this is a slick website. They have a nice investor education section which covers both disruptive innovation and ETFs, certainly worth checking out. Again, that website is ark-funds.com.