In 2020, there was no investor on more of a hot streak than Cathie Wood. A longtime Wall Street investor, Wood founded her flagship Ark Innovation fund in 2014. In 2020 alone, Ark Innovation was up 152.7 percent for the year, making it the fifth-most successful exchange-traded fund (ETF) in the world at the time.
Wood’s strategy with Ark Innovation has been to make concerted bets in innovative companies that Wood and her team believe will change the world. The majority of these companies tend to trade at very high valuations, but are also unprofitable. These companies were especially popular among investors in the recent years thanks to near-zero interest rates and record amounts of investment capital seeking growth and tech investments.
Since 2020, it was hard to go a day or two without seeing an article about Wood or her opinions on the market. She had reached celebrity status in the financial world with a devoted base of followers. And yet, despite Wood’s runaway success, I had the distinct feeling I had seen this movie before.
Today, the story looks very different for Wood and Ark. The Ark Innovation fund is down a staggering 50 percent in 2022, with losses wiping out years of gains and putting the fund in the top percentage of losers for the year.
As I have watched this story unfold, a few familiar leadership principles have come to mind:
- Regression to Mean: Massive spikes or dips in performance rarely hold over the long-term—eventually, individuals, companies and markets tend to return to their average, or mean, performance. Regression to the mean has hit many of the companies that are struggling most right now; these are the businesses that rapidly scaled operations to meet unprecedented demand spikes during the pandemic, then found themselves badly overextended when demand recalibrated.
- Doubling Down: When we double down, we essentially invest more in the strategy we’re already executing, even if it hasn’t yielded success. Wood and her team have frequently doubled down on big stock bets that were not working, further exacerbating the fund’s losses. While doubling down can often be a sign of strong conviction in a vision, it also makes risky bets riskier. Sometimes, cutting your losses is the better way to go.
- Changing Opinions When Facts Change: Perhaps the largest reason Ark has struggled is Wood has been unwilling to shift her strategy or tactics, even as the underlying conditions that led to her earlier success—high investor interest in unprofitable tech companies, and low interest rates that made these companies more attractive—have dramatically reversed. Because Wood’s strategy is concentrated in this one thesis, there has been no place to hide. Wood’s strategy may well do better in the long run, but strong critical thinkers are often quick to question assumptions and fast to adapt. Sometimes, there is no long-term if you don’t survive the short-term.
Refusing to change an opinion or strategy in the face of changing facts, in its most extreme form, can cost you more than money. If there is no change in facts that will ever change your mind about a given topic, then your perspective begins to resemble fanaticism, which rarely leads to the best outcome. It’s better to have strong convictions, loosely held.
- Conflating Value and Price. Just because an investment or good has lost value doesn’t mean it is suddenly cheap and worth buying. A company can plummet from its peak valuation and still be overpriced, and a company can be at its peak valuation to date and still be a great investment.
This was perhaps best expressed by legendary investor Bill Gurley, a general partner at the Silicon Valley venture capital firm Benchmark. Last week, he shared this advice in a series of tweets:
“An entire generation of entrepreneurs & tech investors built their entire perspectives on valuation during the second half of a 13-year amazing bull market run. The “unlearning” process could be painful, surprising, & unsettling to many. I anticipate denial. Previous “all-time” highs are completely irrelevant. It’s not “cheap” because it is down 70%. Forget those prices happened.”
Whether we’re playing cards, building a company, or investing, at some point in life, we, or someone we know, will have the hot hand. It’s important to question whether that hot streak is just a temporary blip that will pass, or if it’s due to a change in circumstances that may sustain over the long-term. Too often we follow others blindly or fail to think objectively when we are the one benefitting from the hot hand, but it’s exactly at those moments where we must be most clear-headed.
Quote of The Week
“What the wise do in the beginning, fools do in the end.”