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Should ARK Invest Apply a Little More Caution?

Individual fund managers come in as many different risk types as there are types of highway drivers. Some will try to get where they are going as fast as possible, even if this risks everything, and others will always drive cautiously slow. Others change their driving based on perceived conditions at the time. ARK Invest was reportedly founded by Cathie Wood after she regularly disagreed with her former employer over her lack of caution. Her boss at Alliance Bernstein recently told the Financial Times that “her biggest blind spot is managing risk and volatility.” In fairness to them both, there are two ways to run managed funds, the first is to always stay fully invested in your advertised style and let those that enter and exit change their exposure based on their own risk tolerance, and the second is to occasionally take your foot off the accelerator if there appears to be the potential to crash. Like the little old lady from Pasadena, Cathie Wood can’t take her foot off the accelerator.

Source: Koyfin

A couple of months ago, Ms.Wood was the keynote speaker at an investment conference in South Florida. Her company’s flagship fund ARK Innovation (ARKK) was down about 50%, and some of her better-known aggressive positions in future-looking tech companies like Coinbase and Robinhood had been proving themselves to be disappointments. Despite ARKKs huge fall-off in performance, she was greeted as a keynote with the kind of awe and adoration bestowed on rock stars. At the event, she doubled down on her support for her holdings. Wood had previously been forecasting that ARK Invest funds would deliver annualized returns of 15%; in April, from the podium, she told investors, “Now we think 50 percent.”

If you get in the car with a driver that insists on driving 110 mph regardless of the road conditions, you may get to where you’re going faster than driving with anyone else, you may also not ever make it.

Since her prediction of a 50% return by year’s-end, ARK Innovation is down another 34 percent.

The firm still has substantial assets under management (AUM), more than $16 billion. Her aggressive optimism and success, especially during the pandemic, had caused her AUM to have once grown to $60 billion. Almost all of her funds are full speed ahead in the riskiest investments on the market, including cryptocurrency and other new tech. Last fall, she put a $500,000 price target on bitcoin, a few months later, as bitcoin’s price sank, she raised her forecast to $1 million. In fairness, she could still be right, but her funds have lost ground over those that have been more cautious.

Wood still keeps her head down and continues pushing through any adversity, be it criticism or a market sell-off, as though she believes she’s fighting a righteous battle. “Truth will win out,” she repeatedly said on her firm’s monthly webinar in May.

For individual and even institutional investors, when investing in a fund, it’s important to recognize if the driving responsibility is on you, or on the manager. That is to say, don’t count on the manager taking risk-off in volatile markets, or putting risk on during bullish conditions. There are managed funds that hold completely true to their style and funds that try to create the best performance within the guidelines of their prospectus. The managed funds at ARK Invest would seem to be all in, all the time.

Take-Away

The benefit of placing money in a managed fund is you have a professional fund manager. One of the benefits of being active in selecting individual stock positions yourself is you can refine your portfolio more toward your own risk tolerance and adjust it at any time.

If you do place some of your assets in a fund, make sure you know what you’re buying. There are people who have watched the stock market take off only to realize their manager had been maxed out in cash and they missed the move and others that presume that their portfolio manager knew when the market was stormy and sidelined some riskier positions. 

It’s your money, know the driver, or be the driver.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://empirefinancialresearch.com/articles/rally-in-cathie-woods-fund-avoid-arkk-these-contrarian-indicators-suggest-the-bottom-is-in-my-35th-high-school-reunion

https://ark-invest.com/articles/market-commentary/innovation-stocks-are-not-in-a-bubble/

https://www.morningstar.co.uk/uk/

https://www.thestreet.com/technology/cathie-wood-makes-a-very-bold-prediction-about-tesla

https://www.cnbc.com/video/2022/04/29/watch-cnbcs-full-interview-with-ark-invests-cathie-wood.html

https://www.bloomberg.com/news/articles/2022-06-07/cathie-wood-s-asset-plunge-is-biggest-among-etf-issuers-in-2022

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Last Week’s Russell Inclusion List Will be Tweaked on Friday

This evening (June 10) and next Friday are days the FTSE Russell Index sets aside in their annual Russell 3000 reconstitution to check their
work. On these two Fridays, The Russell posts updates to its equity index reconstitutions that had been announced last Friday. These updates and adjustments to the original lists provided could occur for a number of reasons. The reactions to stock prices impacted could be strong as these announcements (when they occur) are less predictable and not surrounded by hundreds of other companies being added or deleted. The adjustment announcements will be after 6 pm ET on June 10 and June 17. Below are some of the reasons that FTSE Russell may adjust their newly included companies just a week or two after the initial announcement.

Possible Reasons for Adjustments from the FTSE Russell
Equity Index Guidelines:

• If an incorrect Closing Price was used, the index would determine if the index constituent still fits within the index, if not, it would replace the company.

• It is possible for them to have used an incorrect or ineligible company and added it. If discovered, the index would change out the ticker and replace it with the next in line.

• The currency used to evaluate the company’s market cap may have been incorrect. In this case, the error would have either overstated or understated the market cap. It is recalculated and Russell would re-order where the company stands in relationship to others.

• Dividend ex-dates can throw a monkey wrench into calculations if not caught. The additional two Fridays give The FTSE Russell a chance to eye any oversights and adjust the index representation.

• If there is a dividend and the incorrect amount was used to calculate, this would be backed out and recalculated. These would be redone and the company would be slotted accordingly.

• Ticker Symbol Change, Facebook, or now say Meta just had a ticker symbol change to match the name change. While this company was already included in the larger index, the ticker will be changed to reflect the new identifier.

• If there is a change in the company (ie: merged, acquired, large divestiture) prior to the third Friday in June, the combined/divided market-cap(s) will be recalculated and positioning adjusted. If both companies were included, it might make room for the inclusion of one more.

A complete list of the Russell index additions announced on June 3, 2021 with the preliminary add-ins can be found here. Many of the companies have already experienced “out of the ordinary” activity in their shares.

Take Away

The annual reconstitution is a significant driver of dramatic shifts in repositioned company stock prices as index portfolio managers have their required holdings adjusted for them. The initial list from FTSE Russell is largely accurate and has a big impact on stocks. Any revisions from there could provide opportunity.  It’s worth paying attention to.

Paul Hoffman

Managing Editor, Channelchek

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In a Declining Stock Market, SPACs Could Offer Protection

Let’s say you and a bunch of other investors pool your money and hire an acquisitions expert. This dealmaker uses the large amount of cash raised as leverage to help negotiate a great deal to acquire an existing business. The agreement with the dealmaker is, if he finds something interesting, you will all get to vote on his moving forward for you. If the vote is yes to move forward, and somehow you’re still not interested, you can individually have your money back (less expenses, plus interest earnings).

The risk is that you and the others are tying up money that may have been invested elsewhere (although you can still sell at secondary market levels). In exchange for tying up your money while the expert searches for an acquisition on the group’s behalf, if an acquisition is found you get to opt-in or out, or as mentioned, sell shares if the proposed acquisition creates a spike in share price (potential to profit). If you opt-out, or if an acquisition is not found, the agreement is you get your money back adjusted for expenses and income.

This is the essence of a Special Purpose Acquisition Company or SPAC. Participants in the original SPAC IPO may set themselves on the path to a number of decisions and opportunities along the way. In the end, they may find themselves with the question that Let’s Make a Deal players are asked by the host, “Do you want to keep the cash, or take what’s behind the curtain?” 

Keeping the Cash

As an example, two years ago the largest SPAC ever funded had an IPO at the unusual entry price of $20 per share. Typically SPAC IPOs are priced at $10 per share. There were 200 million shares at $20 sold during the IPO. The sponsor and stockholders agreed to a two-year period within which the sponsor has to target and move toward acquiring a target – or distribute to shareholders the funds held in escrow to make the purchase. 

This SPAC, Pershing Square Tontine Holdings- Class A (PSTH), is now approaching the date when it may be required to distribute the money held in escrow back to current holders of the stock. According to Part I of their Balance Sheet as of March 31, 2022 (SEC 10-Q), the Class A common stock, subject to redemption then had a value of $4,004,044,295. This is an increase from the end of the prior quarter and in excess of the $4 billion that original shareholders paid in.

If the sponsors of PSTH and Chairman and Founder of the hedge fund Pershing Square Tontine Holdings, Bill Ackman, don’t find a match in the next few weeks, they will have to distribute what is likely still over $4 billion held in escrow. This will roughly equal the $20 per share paid at the original IPO. This escrow is effectively a floor on market losses for SPAC investors that get in at the beginning and make decisions on any merger and ownership as they arise.

The money tied up for up to two years does have an opportunity cost. For example, during the duration that PSTH holders took a two-year SPAC ride and now could net almost exactly where they began, the S&P 500 rose 16%.

Behind Curtain #2 and #3

While the S&P did rise 16% since this particular stock went public, the mood of the stock market has since turned and the broader market has suffered losses of 18% so far in 2022.

Original holders of the example SPAC (Pershing Square)  may have hoped for the opportunity to one-day hold shares in stock of a world-changing company with a great future. But there are other owners as well that held it for other reasons. The stock from its first trading day rose and eventually reached a high in February 2021 of $34. For those trading the SPAC IPO, they could have beaten the market despite Pershing’s lack of success in finding an acquisition.

Since July 2021, the stock has been trading below the $20 IPO price, the capital paid in by stockholders has been earning interest in escrow, and any likely distribution may be in excess of where it has been trading for almost 12 months. This would outperform the 2022 S&P 500 returns by nearly 20%.

Take Away

Players chosen from the audience of Let’s Make a Deal are provided with an initial prize, often an envelope containing a few hundred dollars. They are then asked if they want to take a chance on something that may be bigger but could be worse. Their risk is limited in that they can always opt-out and know what they have (cash), or if they continue to take a chance, they may wind up with more than they came with.

SPACs are unique with a differing set of risks and potential rewards. A well-chosen name, trading secondarily near or under the original IPO price, limits the investors’ risk in a way other common stock purchases cannot. There is still potential upside as any talk of a merger or actual merger will move the price, but its price movements have low correlation to the overall market. This could be helpful with high volatility.

Particularly noteworthy, especially in a bear market, unlike the overall market potential, there is protection against it dropping substantially.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://pstontine.com/wp-content/uploads/2020/07/Pershing-Square-Tontine-Holdings-Ltd.-Announces-4000000000-Initial-Public-Offering-at-20.00-Per-Share.pdf

https://sec.report/Document/0001193125-22-143641/#tx317290_5

https://sec.report/Document/0001398432-20-000084/

https://www.nasdaq.com/articles/pershing-square-tontine-holdings-ltd-class-a-shares-close-in-on-52-week-low-market-mover-9

https://stockanalysis.com/stocks/psth/statistics/

https://www.businesswire.com/news/home/20220609005951/en/Pershing-Square-Holdings-Ltd.-Announces-Transactions-in-Own-Shares—9-June-2022

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Great Economic News is Spooking the Stock Market, Here’s Why

Any concern that Fed governors may have harbored that they might overtighten at an inopportune time with an already weakening economy probably ended today. The Labor Department’s employment report released Friday gave them the green light. In fact, the Fed may be even more motivated to stick to its aggressive “back-to-the-future” mindset.

Background

The BLS posted its employment report (June 3), which showed the U.S. economy created 390,000 jobs in May. The unemployment rate held steady at 3.6%. Economists had expected fewer jobs created. This provides evidence for them to work from. It confirms that demand for employees is still outpacing supply and hiring remains competitive.

We’re in a period of stock market history where good economic news is bad news for stocks and bonds and bad news provides relief for markets. In the case of this report, it likely means the Federal Reserve remains on track to raise its key interest rate by 0.50% in June, July, and possibly September.

While job growth has slowed from the 500,000-plus average pace year-over-year, the Consumer Price Index is running at over 8%. There is agreement both from the current Administration in Washington and among market pundits that soaring prices are a huge concern for the nation. President Biden went on record this week in an op-ed posted in the Wall Street Journal and a meeting he had with Fed chair Powell that price increases have caught the attention of the White House.

Good vs. Bad Definitions

Payrolls are still 822,000 below their pre-Covid 19 levels, and the overall jobless rate is only 0.1 percentage point above where it stood in March 2020. At any other time, monthly payroll gains over 200,000 would be considered a strong labor market. In addition, the latest Job Openings and Labor Turnover Survey for April, reported earlier this week, showed 1.9 job vacancies for every unemployed person. This means there are almost two jobs for every job seeker.

The markets sold off on this news. Both the Nasdaq dropped by well over 2%, the S&P by 1.5% and the small-cap Russell 2000, and large Dow Industrials by less than 1%. The reason they are selling off on economic strength is it means rising interest rates becomes more certain. The higher rates will provide better fixed income choices for investors and increase costs for many businesses that will be borrowing at the higher rates.

Other Concerns

At the same time, the Fed has begun the process of winding down its $8.5 trillion dollar balance sheet. The employment data suggests monetary tightening is only just beginning, and businesses face greater headwinds.

The reduction of the balance sheet requires the Fed to allow bonds it owns to mature without the Fed reinvesting alike amount. For June (already accomplished) and July, the Fed is letting $47.5 billion mature without reinvesting. The needs of the U.S. Treasury have changed little so it will have to find new buyers for new bonds near this amount.

Take-Away

Bad economic news is usually bad for equities. Currently, the market is looking for the Fed to have a reason not to raise rates and drain money from the economy. Today’s unemployment number may have emboldened the Fed to act aggressively. The stock and bond markets also are mindful that less money in the economy means fewer investment dollars. The price of anything is a balance of scarcity. As dollars become more scarce asset prices may also retreat.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.bls.gov/news.release/empsit.nr0.htm

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The Case Against an NFT Marketplace Employee that Allegedly was Front-Running

New markets allow new chances for manipulation, rigging, or just good old-fashioned trading on insider information. While the regulatory agencies are still trying to define where they fit in the blockchain asset explosion, some on the inside might already be exploiting what they know may have already defined their role. The Department of Justice has charged a former OpenSea employee in the first-ever NFT insider trading case on Wednesday (June 1).

The allegations concern insider trading in NFTs on the OpenSea platform, the largest online marketplace for the purchase and sale of NFTs. In violation of the employers rules and his duty of trust and confidence to customers and OpenSea, the allegations are that he exploited inside information of what NFTs would be featured on OpenSea’s homepage. The allegations also imply he did this for his own personal benefit.

The employee was in part responsible for selecting NFTs to be featured on OpenSea’s homepage. OpenSea is said to have been properly responsible by keeping confidential the identity of featured NFTs until they were featured on its homepage. After an NFT was posted on OpenSea’s homepage, the market price for that NFT, and for other NFTs created by the same artist, usually increases substantially.

From about June 2021 to at least September 2021, The employee is accused of using OpenSea’s confidential business information about what NFTs were going to be featured on its homepage. He secretly purchase dozens of NFTs shortly before they were featured. After those NFTs were featured on OpenSea, the employee sold them at profits of two- to five times his initial purchase price. Anonymous digital currency wallets were used to conceal the fraud, according to reports.

The person charged is a 31-year-old from New York City. The charges are wire fraud and money laundering, each of which carries a maximum sentence of 20 years in prison. The sentences are prescribed by Congress, however, any sentencing of the defendant will be determined by a judge.

This case is being prosecuted by the Securities and Commodities Fraud Task Force. Assistant U.S. Attorneys Thomas S. Burnett and Nicolas Roos are in charge of the prosecution.

His alleged crimes were uncovered by Twitter “sleuths” that were able to identify the owner of the anonymous accounts. The employer said in a statement that it was aware of insider trading. Opensea has since implemented new policies to prevent future insider trading among its employees.

The charges contained in the Indictment are merely accusations, and the defendant is presumed innocent unless and until proven guilty.

Paul Hoffman

Managing Editor, Channelchek

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Sources

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Firearm Stocks Spike After Mass Shootings as Investors Dismiss the Chance of Tightening Gun Laws

The day after an armed 18-year-old entered the Robb Elementary School in Uvalde, Texas, and shot dead 19 children and two teachers, the share prices of gun and weapons manufacturers jumped.

A week on, and the market rally of gun stocks following the latest mass shooting hasn’t subsided. As of the close of trading on May 31, 2022, the stock price of weapons-maker Sturm Ruger was up more than 6.6% since May 23, the day before the shooting. For Smith & Wesson, the jump was even more marked, with shares up over 12% from the stock price prior to the mass killing in Uvalde.

Source: Yahoo Finance

But that relationship – a mass shooting followed by a spike in gun industry stocks – wasn’t always the case. My colleague Anand Gopal and I studied the impact of 93 mass shootings on the stock price of publicly listed firms from 2009 to 2013. We found that, contrary to what happens now, mass shootings in that period were followed by a drop in share price for Smith & Wesson and Sturm Ruger, the two gun companies still publicly listed in the U.S.

So why has that changed? The answer may lie in how hopes of legislation over tighter restrictions on gun sales have dwindled over the last decade. The takeaway is investors no longer seem to worry so much about the chances of tightening firearms regulation when assessing the long-term viability of gun manufacturers in the aftermath of mass shootings.

Let’s look at the factors that influence the valuation of such stocks after mass shootings. First you have increasing demand for weapons. Research has shown that gun sales go up after a high-profile shooting as Americans “arm up,” both out of a perceived concern for their safety and fear of tighter restrictions.

The thinking is simple: “I better buy firearms while I still can, before legislation makes it harder for me to do so.” This increased demand would, on its own, spur the market price of gun and ammunition manufacturers by providing an unanticipated financial windfall.

But then you have the counter factor: Any talk of tighter rules on gun sales puts at risk the long-term viability of the companies by curtailing future cash flows. The business model of gun-makers, after all, is to sell increasing numbers of firearms to the public. Any ban or restrictions on what types of weapon you can purchase – or even who can buy a firearm – would limit their ability to increase profits.

In the period we looked at, investors seemed to lean into this fear of future legislation more, as seen in the reduced valuation of publicly listed firearm companies after mass shootings. Our research showed that the mass shootings from 2009 to 2013 resulted in a penalty imposed on firearms stocks over a two-, five- and 10-day window. That is to say, a mass shooting would be followed by a cumulative abnormal drop in share price over that period. The penalty worked out to around 1.25% over a five-day period.

Interestingly, even over the years we looked at, things began to change. The negative stock market response to mass shootings tapered off in the later years of our study, suggesting that the threat of any regulatory measures was not as keenly felt by investors.

Inaction over gun control at the federal level – and the loosening of regulations among some states – in the years since our work has seemingly led to a rebalancing of the two main factors at play. Yes, there is still the surge of demand for gun sales after mass shootings. But the fear over potential regulations over gun sales has seemingly abated.

The surge in the stock price of Smith & Wesson and Sturm Ruger after the Uvalde school shooting provides strong correlational evidence that firearm stocks now rise after such events. A similar effect was seen after the 2018 mass shooting at the Marjory Stoneman Douglas High School in Parkland, Florida.

But there is a problem when it comes to saying outright that there is a link. One of the things in the statistical model we used in our research no longer works. The reason: There are simply too many mass shootings in the U.S. They occur with such frequency that we can no longer implement this kind of analysis looking at the effect of isolated incidents and the stock market effect on gun companies.

In fact, according to the Gun Violence Archive, there were 18 more mass shootings in the U.S. in the seven days after the Uvalde shooting.

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