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September 30, 2020 | Commentary
During the third quarter, broad-based equity indexes – as measured by the S&P 500 and MSCI World – continued to appreciate, hitting all-time highs. Much like other policymakers around the world, in an effort to prevent a relapse into recession, the Fed reinforced that it will err on the side of ease with an asymmetric response to inflation. Specifically, given the long period of time that inflation has hovered below its 2% target, the Fed will not react immediately to readings above 2%; yet, if inflation were to rise and then drop back below the 2% target, it will respond quickly. On the fiscal policy front, Congress remained deadlocked on the next round of fiscal policy measures to support the economy, leaving incremental stimulus measures to the Fed. Because global fiscal and monetary policy makers responded with record-breaking measures to “flatten the curve” and slow the spread of COVID-19, fears of an extended global recession appears to have dissipated, giving way to early concerns about “how much is too much”. The Treasury yield curve in the US, for example, steepened during the third quarter, as long-term yields increased while short-term rates declined.
Since the bottom of the market during the COVID-19 crisis, growth stocks – particularly those associated with companies solving problems created by the pandemic – have outperformed value stocks significantly. This divergence could be a function of fears that the economy will relapse into recession and that “creative destruction” associated with innovation will plague traditional value sectors like financial services, energy, and industrials. That said, cyclical sectors could benefit as producers continue to catch up with consumer demand during this expansion. The consumer saving rate in the US has dropped from a record high of 34% during the early days of the pandemic but still is nearly twice as high as the 8% recorded in March, likely mirroring high rates in the rest of the world and suggesting that pent-up demand will support the recovery now under way. Indeed, given the record-breaking drawdown in inventories in the US during the second and third quarters, businesses seem to have been caught off guard and are scrambling to catch up with demand, suggesting a much stronger than expected V-shaped recovery during the next year.
Relative to the S&P 500 Index and the MSCI World Index, ARK’s five actively managed ETFs outperformed during the third quarter. ARK’s two self-indexed ETFs turned in mixed performance.
To read a summary of ARK’s biggest contributors and detractors, please see below.
The ARK Autonomous Technology and Robotics ETF (ARKQ) outperformed the broad-based market indexes. Among the top contributors to performance was Tesla (TSLA). Tesla surpassed expectations for revenue and earnings during the second quarter, potentially setting it up for inclusion in the S&P 500 index at some point in the future. At Battery Day, Tesla presented plans not only to reduce battery costs by 56%, but also to increase range by 54% and reduce capital costs by 69%, enabling the production of an electric vehicle (EV) with a $25,000 sticker price during the next three years. In our view, Tesla is three to four years ahead of the competition in the electric vehicle space. In the absence of specific news, Materialize (MTLS) also contributed positively to performance, particularly after the COVID-19 pandemic highlighted the importance of its software in quick-turn manufacturing solutions and after Desktop Metal’s roadshow stirred investor interest in 3D printing.
Among the top detractors were Stratasys (SSYS) and 2U (TWOU). 3D printing company Stratasys disappointed second quarter revenue expectations with sales down nearly 30% on a year-over-year basis. Its new CEO, Yoav Zeif, is focusing Stratasys on plastic 3D printing and manufacturing. 2U detracted from performance even though colleges are adapting to COVID-19 by embracing remote education at an accelerated rate. During the second quarter, 2U exceeded top line expectations but missed them on the bottom line and raised roughly $300 million in a secondary equity offering.
The ARK Next Generation Internet ETF (ARKW) outperformed the broad-based market indexes during the quarter. Among the top contributors was Tesla (TSLA) for reasons noted above. Square (SQ) also contributed as its seller businesses recovered much more quickly than expected from the COVID-19 crisis, and Cash App also delivered stronger than expected growth during the second quarter. Square pivoted its offline sellers to online commerce, increasing the latter’s gross payment volume (GPV) by 50%. Roughly one third of its online sellers were new to Square.
Among the Next Generation Internet’s top detractors were Alteryx (AYX) and Slack Technologies (WORK). Alteryx delivered weak second quarter earnings as revenue growth dropped from 43% on a year over year basis in the first quarter to 17% in the face of flat bookings, triggering our exit. Slack Technologies detracted from performance after billings growth decelerated from 49% in the first quarter to 24% as its customers laid off users in response to the COVID-19 crisis. Slack Connect, which allows intercompany communications, saw a user growth of 200% in the quarter, enabling the company to capture new customers organically.
The ARK Genomic Revolution ETF (ARKG) outperformed the broad-based market indexes. Among the top contributors to performance was Seres Therapeutics (MCRB). Seres Therapeutics appreciated after reporting positive top line data from its SER-109 trial which tested a microbiome therapeutic for C. difficile. Invitae (NVTA) contributed to performance after it acquired ArcherDx, a precision oncology company focused on high-quality, decentralized molecular diagnostics. We believe that once the two companies integrate, Invitae is likely to offer the most accurate, comprehensive, and flexible oncology tests in the world. Moreover, its investments in telemedicine, AI, genetic counseling, world-class germline variant interpretation, pharmacogenomics, and clinical workflows should give Invitae an advantage over the competition.
Among the top detractors were Illumina (ILMN) and Inovio Pharmaceuticals (INO). Illumina detracted from performance primarily because the company announced its intention to increase its ownership of GRAIL, an innovative cancer screening company, from 15% to 100% for $8 billion. While GRAIL’s methylation-based approach to multi-cancer screening is accurate and cost-effective, we do not believe that it has a significant technological or IP advantage over other screening companies like Guardant Health (GH), Exact Sciences (EXAS), etc. Inovio depreciated primarily because the FDA placed a clinical hold on the Phase II/III trial of its COVID-19 vaccine, INO-4800. Inovio will respond in October, at which point the agency will have 30 days to decide whether or not the trial can proceed.
The ARK Fintech Innovation ETF (ARKF) outperformed the broad-based market indexes during the quarter. Among the top contributors were Square (SQ), for reasons noted above, and Zillow (Z). Zillow contributed to performance after a St. Louis Federal Reserve report that homeownership in the second quarter rose to levels not seen since July 2009. We believe that the residential real estate market and Zillow will continue to benefit from mortgage rates that have dropped to 50-year lows and from the premium now placed on personal space as a result of COVID-19.
Among the top detractors were Slack Technologies (WORK), for reasons noted above, and Splunk (SPLK). Splunk announced weaker than expected third quarter guidance. Also Sumo Logi, which offers “Splunk-like” functionality in the cloud, announced that it will conduct an initial public offering. We believe that the breadth and depth of Splunk’s products are difficult to duplicate.
With some of the highest conviction names from the Funds discussed above, the ARK Innovation ETF (ARKK) outperformed the broad-based indexes during the quarter. Among the top contributors were Tesla and Square, for reasons noted above. Detracting from performance were Illumina and Slack Technologies, for reasons noted above.
ARK’s self-indexed ETFs, The 3D Printing ETF (PRNT) and the ARK Israel Innovation Technology ETF (IZRL), appreciated during the quarter, with mixed performance. The 3D Printing ETF (PRNT) outperformed relative to the broad-based market indexes. Materialize (MTLS) was the largest contributor in PRNT, for reasons noted above. 3D Systems (DDD) was the largest detractor from performance after it missed analysts’ estimates for the second quarter and announced a restructuring focused on Healthcare and Industrial, spearheaded by new CEO, Jeffrey Graves. 3D Systems also appointed Jagtar Narula as CFO, who brings experience from Blackbaud, Xerox, and GE.
The ARK Israel Innovation Technology ETF (IZRL) under-performed the broad-based market indexes for the period. The largest detractor was Urogen Pharma (URGN), as its Phase 2 trial missed its primary endpoint of improving overactive bladder symptoms. IZRL’s top contributor to performance was Fiverr International (FVRR), the marketplace for freelance services, which benefited from the shift to online commerce in the face of the COVID-19 crisis.
ARK Innovation ETF
ARK Genomic Revolution ETF
The 3D Printing ETF
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