Kass: The 'Vicious Cycle' of Cathie Wood's ARK Invest

An ARKK ETF 'flash crash' is not inconceivable.

I have argued that ARK Invest's (ARKK) "virtuous cycle" of ETF inflows and disruptive tech outperformance is likely to morph into something more hideous -- a "vicious cycle" grounded in tech stock weakness, and a continued pivot from growth to value, likely ETF redemptions and, ultimately, in reduced ETF liquidity, forced stock sales and lower ETF prices.

Ark Invest continues to reduce its positions in large cap liquid stocks and into smaller cap illiquid stocks today - according to their activity email. $ARKK's virtuous cycle is turning vicious. @jimcramer @tomkeene

- Dougie Kass (@DougKass) March 4, 2021

ARK Invest and its accompanying exchange-traded funds have ridden the wave of interest in disruptive technology -- the money management has too quickly became "the flavor of the month", as, in the last 12-15 months, ARK's assets under management (AUM) have climbed from about $10 billion to a recent peak of approximately $59 billion.

ARK Invest is an incredible marketing machine (reminiscent of previous flavors at Janus Funds, First Hand Funds, the Manhattan Fund and the three Freds (Fred Mates, Fed Alger and Fred Carr) - whose money management firms also captured the imagination of retail and institutional investors near/at other market peaks - and then fell precipitously as the cycle reversed.

Upon closer examination, as I have written, Cathie Wood's investment performance has not been stellar - at her disappointing 12 year stint managing thematic portfolios at Alliance Bernstein and, even at ARK -- which had only two excellent years - in 2017 and in 2020 - since being formed nearly eight years ago.

As a whole, during ARK's 2013-2021 existence - ARK's performance, on a risk-adjusted basis has not been stellar. On two important metrics and historically grounded risk measurement techniques (the Sharpe Ratio, which measures investment returns relative to the standard deviation of those returns, and the Fama/French factor model), ARK's investment returns failed to be much better than (QQQ) or benchmarked small cap/momentum/growth funds.

Here are some recent columns I have posted which outline the risks in ARK Invest's strategy and the vulnerability of ARKK, which I believe should be sold/shorted:

* "You Done Tore Out My Heart and Stomped That Sucker Flat"

* "Are Ark's Results Skill or Luck?"

* "The Anti Cramer Surfaces"

* "Seeing More Tesla Clarity"

*"Spec Tech as In Dreck"

*"Planning to Fill Up The ARKK"

* "ARK Innnovation Is Taking Lots of Water"

* "Wooda, Shoulda, Coulda"

* "Good Stuff from The Bear Cave Letter on ARK Invest"

* "An Overloaded ARKK"

*"Its About To Rain For Forty Days and Forty Nights - Will Cathie D Wood Need Her ARKK"

* "The Last Poker Table"

* My Barron's Comments (On ARKK) in Barron's"

* "Living in Cathie Wood's World"

* "Trade of the Week (Short ARKK $140)"

Signs of a Crack In the ARKK

ARKK's shares peaked at $159 in mid-February and were trading at $112.25 in premarket trading this morning.

ARK Invest's Cathie Wood has begun to engage in a potentially dangerous portfolio strategy - of raising liquidity by selling less volatile, large cap tech stocks (e.g., Amazon (AMZN) , PayPal (PYPL) , and Facebook (FB) ) in favor of buying higher octane, more volatile small cap tech stocks in which ARK has a substantially rising percentage of float/outstanding shares.

Should tech shares continue to decline and ARK Invest ETFs' redemptions accelerate - the absence of liquidity will be profound and it is possible that a "flash crash" (and loss of liquidity ) in some of their ETFs would be increasingly possible:

.@DougKass ARKK $155 to $114, week three of selling the liquid to buy the illiquid? How does that hold up (sustainability speaking) on the redemption front? https://t.co/0CDH3FMJ8n

- Lawrence McDonald (@Convertbond) March 25, 2021

Bottom Line

I remain negative on the U.S. stock market.

ARKK may be viewed as a leveraged short - vulnerable to a continuation in disruptive tech share price weakness and a continued pivot from growth to value. In its extreme, rising redemptions could cause an adverse liquidity event in ARKK and in ARK Invest's other exchange traded funds.

I would sell/short ARKK.

(Amazon and Facebook are holdings in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells these stocks? Learn more now.)

(This commentary originally appeared on Real Money Pro on March 25. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)

At the time of publication, Doug Kass had no position in the securities mentioned.