Last week, we teamed up with ARK Invest (Mr Renato Leggi, client portfolio manager) for a webinar on why investing in innovation is still important despite the current inflationary environment. Rising interest rates have pressured tech and innovation stocks this year.
Here’s a recap of our discussion with ARK:
Are unprofitable high-growth companies a cause for worry?
One of the questions raised during the webinar was the outlook for high-growth but unprofitable companies.
Renato clarified that not all unprofitable innovation companies are the same. Some choose to be unprofitable as they’re spending strategically in research and development (R&D), or making targeted acquisitions that give them a competitive advantage.
Going back to his earlier Tesla example, he noted that Tesla wasn’t profitable at the start too. They invested heavily in electric vehicles (EVs) back when most people thought EVs were going to be a niche product. But today, Tesla is one of the world’s most valuable companies by market cap.
Renato reassured the audience that although many companies held in ARK’s flagship disruption innovation fund may be unprofitable at the moment, they are free cash flow positive. These companies, such as those in the genomic space, have almost two-years worth of cash and are in a strong position to dial up R&D in order to scale.
“These companies are becoming more attractive from a valuation standpoint by setting themselves up for a kind of asymmetric upside opportunity once the market shifts back into the favour of growth investing,” he declared.
What do you see as the biggest risks to ARK’s innovation strategy?
“One of the biggest risks we see out there would be the fact that [innovation] companies are [now] so cheap and they could become targets for acquisitions”, Renato answered.
He cited genomic diagnostic company Vitae as an example. Vitae, widely seen as the Amazon of genomic testing, has seen its valuation drop from $60 a share to under $3 a share.
“The risk is that they get acquired at $10 a share and [although that] may seem like we’re getting a 4x premium, that’s limiting their upside potential and we don’t want to see these companies become acquisition targets.”
To that end, ARK has been closely aligning with management teams to fend off potential acquisitions at much lower valuations.
What would the future of investing in innovation look like?
Renato noted that ARK’s valuation metric is based on a 15% hurdle rate annualised over a five-year period. Most companies in their portfolio, given the recent drawdown, are well above that in terms of ARK’s expectation over the next five years.
ARK’s innovation investing strategy is likewise shifting. They’ve started to reduce that exposure and have been consolidating companies into higher conviction names. For example, they exited Palantir but increased their stake in Zoom.
Zoom is now the top holding in ARK Innovation ETF. According to Renato, Zoom is no longer a “stay-at-home” stock. As hybrid work becomes commonplace, they’re seeing more enterprise usage.
Given that the quality of calls on Zoom is better, Zoom is also taking away market share from Microsoft and Google’s virtual communication platforms.
What is ARK most excited about?
“We’re excited about all of them,” Renato exclaimed when asked the question. The ARK team’s Big Ideas report highlights 14 technologies they’re bullish about in 2022.
Some ideas he shared were:
Artificial Intelligence (AI)
AI could automate the tasks of workers and boost productivity while significantly lowering unit labour costs.
Breakthroughs in gene editing are accelerating; ARK’s genomics team comes from top cancer research institutions and leading academic institutions.
Metaverse, blockchain and web3
Blockchain technologies enable the ownership of digital assets.
“When we think of digital asset ownership, we think of property rights essentially and as we have seen historically, as you improve property rights in countries, you improve economic stability and growth of these nations and we are doing that virtually now”, Renato explained.
Innovation solves problems
Underpinning their Big Ideas are five innovation platforms that ARK has identified. They estimate these platforms – DNA sequencing, energy storage, robotics, artificial intelligence (AI), and blockchain technology – will create over $200 trillion dollars worth of business value and wealth creation by 2030.
Renato noted that these innovation platforms served as solutions to many problems we faced during the pandemic. For instance, advances in DNA sequencing meant that the COVID-19 virus genome was sequenced in a matter of days. This enabled scientists to create a vaccine in under a year.
Likewise, robotics and automation made it faster and more efficient to do work remotely. The pandemic accelerated the adoption of such technologies, and these trends are here to stay for the long-term.
Traditional industries could be disrupted
Ultimately, Renato believes that “having an allocation to innovation is very important” in the long run. Investors in traditional benchmarks like the S&P 500 could face “a lot of risks” in the sense that companies that dominate broad-based indices today are becoming more vulnerable to disruption.
He gave the example of Tesla as a company that has upended the traditional auto industry by shrinking the demand for petrol cars.
Over the next five years, roughly half of all S&P 500 companies could be disrupted, he said.
How Syfe can help
If you see the long-term potential of investing in innovation, Syfe’s Disruptive Technology portfolio is a ready-made portfolio of innovative companies you can consider. It invests in industries like AI, robotics, cloud computing, blockchain, esports, cybersecurity and more.
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