The overarching narrative of the stock market is in the midst of a deep realignment, with one of the largest shareholders of Coinbase, the U.S.-based cryptocurrency exchange, at the center of attention. As tech hype cools and interest rates seem poised for a big shift, more speculative “growth” investments, primarily equity in quickly expanding or innovative companies, are having a rough few months. In their place there’s more interest in so-called “value” investments, such as equity in companies that are already generating profits.
That has led to deep losses and varying degrees of embarrassment for investors who’ve made highly forward-looking bets. The tech-focused Nasdaq index has seen big volatility and is currently flat against its mid-January level. High-profile professional growth investors like Chamath Palihapitiya, just months ago a relentless and celebrated champion of a kind of less-transparent initial public offering known as a special-purpose acquisition company (SPAC), have taken both financial and reputational hits.
David Z. Morris is CoinDesk’s chief insights columnist.
A lot of attention has been focused on Ark Invest, which manages exchange-traded funds investing in things like fintech, genomics and space exploration. Ark CEO Cathie Wood had become something of an investing rock star in recent years, thanks to a rich 45% annualized return over the past five years in Ark’s flagship Innovation Fund (ARKK), which has grown to more than $50 billion in managed assets.
But the fund has dropped by close to 30% since mid-February thanks to serious collapses of its stakes in everything from gene editing to Tesla. ARKK is also one of the largest holders of Coinbase stock, which is similarly down 25% since its IPO on April 14.
By and large, these drops have been driven less by disappointing current performance than shifting expectations about the future – arguably the defining risk of growth investing. Because the present price of growth investments is so dependent on projected returns far into the future, small present changes in a company’s results, positive or negative, can translate into huge impacts on the stock. The pandemic has encapsulated this perfectly: Lockdowns created major spikes in “stay home” tech stocks because trendlines suddenly pointed to immense future growth. However, reopening has pulled those expectations back down to Earth, driving a lot of ARKK’s losses.
(This is, it should be said, far preferable to the way some prominent speculative investments worked in the past. A practice known as mark-to-market accounting was widely abused by entities including Enron and Lehman Brothers in the 1990s and 2000s, and basically amounted to letting growth companies disguise themselves as present successes by putting a price on their own future earnings and booking them as present revenue. But that’s a topic for another day.)
Perhaps even more significant than coronavirus pandemic reversals are increases in Treasury bond yields and inflation upticks that might lead the Federal Reserve to increase interest rates more quickly. Bond yields and interest rates in particular are a direct threat to growth investing because they create more attractive returns on very low-risk investments. At the same time, higher rates make debt and other capital more expensive for growth companies, which typically don’t have the cash flows to fund their own growth.
There’s no real way to escape these sorts of risks when you’re attempting to monetize the future. What matters is how a growth investor responds and, crucially, whether that response follows the same forward-leaning logic as the initial investing thesis. Wood is catching heat right now because of ARKK’s trouble, but her response has been nothing if not consistent. She has repeatedly and loudly declared that the slump in growth stocks is a buying opportunity, with falling prices only amplifying potential future returns.
Higher rates make debt and other capital more expensive for growth companies, which typically don’t have the cash flows to fund their own growth.
Because Ark funds publicize their trades, we know Wood isn’t just talking: ARKK has been steadily buying assets like Square, Twilio, and even Zoom as the stocks head south. The fund is also aggressively buying the dip in Coinbase, growing its position as of today to 624 million shares – 3% of ARKK’s holdings and, incredibly, more than 10% of all Coinbase shares. That’s particularly bold because Coinbase could be described as a growth investment squared: Its own growth is deeply dependent on demand for assets that are, in turn, highly speculative themselves.
I assume Wood’s belief in her bets is sincere, but it’s also just good optics for a growth fund. Halting buys on Coinbase or other bets as they go down would be an implicit admission that previous buys at higher prices were a mistake. Buying an asset that’s slumping in the short term is a strong signal of long-term belief.
Wood’s consistency, along with her track record, appear to have been fairly effective in helping investors keep the faith even in the face of short-term losses. It’s inevitable some will reflexively sell a ticker that drops 30% in four months but, according to Seeking Alpha, ARKK only saw $1 billion in capital outflows, or around 2% of the fund’s total assets, over the past week.
That’s far from amazing, and at that rate it could add up quickly. But it’s also far from a worst-case scenario. Selling future profits to present buyers is as much about credibility and faith as it is about numbers.