The strategy of allocating capital in actively managed funds over passive index funds provokes lively debate in investing circles. Over recent years, shareholders of Scottish Mortgage Investment Trust (LSE: SMT) and Cathie Wood’s ARK Innovation ETF (NYSEMKT: ARKK) have been rewarded with gains that often exceeded those of the FTSE 100, FTSE 250 and S&P 500 by considerable margins.
However, the recent drawdown in growth stocks delivered a blow to the share prices of both actively managed funds, raising questions about the sustainability of their market-beating performances. Let’s explore how they got to where they are and where they could go next.
A FTSE 100 constituent with over 100 years of history
Scottish Mortgage is Baillie Gifford’s flagship investment trust. Its stated aim is “to add value over five year time frames, preferably much longer”. Scottish Mortgage Investment Trust has succeeded in the past decade, delivering huge share price increases of 328.2% and 1147.2% over five and ten-year time frames to 31 December 2021 respectively.
Launched in 1909, the Edinburgh-based fund has not cut its dividend payment since the Great Depression and today owns total assets in excess of £20.65bn, with a substantial US weighting. Scottish Mortgage currently invests in tech and growth stocks with a high risk-reward profile. Familiar names such as Moderna and NIO feature in SMT’s top 10 holdings in addition to less well-known corporations, such as DNA-sequencing outfit Illumina.
There are good reasons to believe that these companies will be at the forefront of developing the technologies of the future, but they constitute some of the riskier stocks in the market. Scottish Mortgage Investment Trust shareholders also gain exposure to unlisted equities, currently representing just under 20% of its portfolio.
Over the past few months, the Scottish Mortgage share price has tumbled as growth stocks led a selloff that saw the S&P 500 touch correction territory. I see further room ahead for heavy selling in the corners of the market SMT invests in, if not the potential for a full-blown stock market crash. Accordingly, although the long-term bull case for Scottish Mortgage Investment Trust remains intact for me, I am reluctant to buy shares while volatility is elevated.
A fund focused on disruptive innovation
Ark Investment Management LLC, which boasts its ARK Innovation ETF as its largest fund, is a relatively new kid on the block compared to SMT. Launched in 2014, ARKK has attracted plentiful media attention drawing contrasts between Cathie Wood’s conviction stock-picking centred on innovative companies spearheading a fourth industrial revolution and Warren Buffett’s value investing philosophy.
In common with SMT, ARKK has a high concentration in Tesla. ARKK’s top holdings also include more speculative plays, such as cryptocurrency exchange platform Coinbase. Cathie Wood doesn’t lack ambition, forecasting annualised returns of 40% for ARKK over the next five years. During the worst of the coronavirus pandemic ARKK enjoyed blistering growth, but these gains have largely been given up following a 23.4% loss in 2021 and a further 25% decline this year to date. This has poured some cold water on Wood’s predictions.
My concerns about stock market volatility ring even more true in the case of ARKK, but I will be watching this fund with keen interest to see whether Cathie Wood can continue to surprise.