If there is one truth about the technology sector, it’s always changing. And in many cases, those changes have the power to disrupt the status quo, the economy, and how we work/play. Disruption is more than just a buzzword. Catching those shooting stars before they take off can lead to life-changing returns.
And with that, so-called innovation and disruption ETFs and funds are all the rage.
The question is whether or not active managers possess the ability to spot the future Amazons and NIVIDAs of the world before they happen. The data is mixed. Investors looking at actively managed innovation ETFs may want to proceed with caution.
A Surge in Assets
Disruptive technology can be thought of as game-changing technology. Innovations that have far-reaching potential can dramatically change the economy, consumerism, and how we function in society. Think about going from typewriters to personal computers and the economic/societal leap that’s had. Big data, renewable energy, artificial intelligence, and gene sequencing are just some of the current disruptive technology themes.
Innovation and disruption ETFs are all about betting on the next big thing. These funds hope to uncover the next big trend and firms at ground zero for these themes. For early investors, this can be huge in terms of returns.
A Boston Consulting survey recently looked at 1,100 venture funds. The average annual rate of return for deep and disruption tech investments clocked in at 26%. This compares to just a 21% rate of return for all venture funds. 1
With those returns in mind, investors have gone gaga for disruption ETFs. Wall Street has obliged. The changes to active ETF structures that allow for non-transparent and semi-transparent holdings have now allowed managers to keep their secret sauce and early-stage investments hidden from view until a later date.
It’s been a match made in heaven, and the number of ETFs/assets in the sector has exploded — going from just 40 innovation-focused ETFs in 2019 to more than 100 today. This chart from Morningstar highlights the growth.
Source: Morningstar
And some of these funds have grown very large. For example, the ARK Innovation ETF (ARKK) has nearly $6.7 billion in assets, while the SPDR S&P Kensho New Economies Composite ETF (KOMP) has more than $2.2 billion.
A Few Issues
The problem isn’t betting on these funds or wanting to own the potential for disruption; it’s whether or not an active manager can deliver the goods. The results have been mixed.
A prime example could be the grand-daddy of all these funds, the previously mentioned ARKK. It turns out that buying the right stocks at the right time is more complicated than expected. For example, Cathie Wood managed to guide ARKK to return a staggering 156.6% in 2020 before and during the pandemic. This market-crushing return followed a 35% return in 2019. But since then, ARKK and Wood’s returns have been just so-so.
ARKK was actually in the red up until the election, when the “Trump Bump” managed to push up the fund’s largest holding, Tesla. Were the returns based on actual skill in finding the next big thing or perhaps luck? The tech sector’s dominance of recent market trends has made disruption funds’ jobs much easier.
It’s easy to pick on Wood’s and ARKK since she’s the most outspoken and the fund is the largest. But she isn’t alone in many of these avenues. Many active managers of disruption ETFs follow a similar boom/bust pattern.
An additional worry that Morningstar notes is the false sense of diversification. Because it is hard to pick the next big thing— many analysts thought that Yahoo! would have eaten Google’s lunch during the dot-com era — the fact that disruptive firms own a variety of stocks provides some comfort to many investors. However, the volatility inherent in these types of stocks is only exacerbated when combined. Furthermore, many managers of innovation funds have very broad mandates, incorporating consumer, industrials, utilities, and other sectors alongside technology firms. This can create a highly uneven picture for portfolios and makes it more difficult to benchmark against other tech-specific indexes.
Then there is the cost to consider. Innovation funds tend to be rather “expensive” in terms of ETFs, which may not matter when a fund is up 26% yearly. But high costs do eat into returns during down years.
Attractive, But Caution Is Needed
There is nothing wrong with owning an active innovation ETF or wanting to bet on the future. But investors need to do so with a grain of salt. Perhaps the most significant data point from Boston Consulting’s venture study is that from initial funding to Series A rounds of capital growth, nearly 95% of all tech startups fail. And from A to B funding rounds, nearly 80% also give up the ghost.
That could serve as a caution for investors looking at innovation funds to build wealth and enhance their portfolios.
Perhaps the best bet might be to own the establishment. Microsoft or Apple are going to be A.I. leaders, but they have deep benches to cover any losses. And they have the cash to buy out any successful startup for long-term gains. Your standard tech index fund or ETF might be all you need.
Innovation ETFs
These funds were selected based on their exposure to disruption and exponential tech themes, covering both passive and active management styles. They are sorted by their one-year total return, which ranges from -30% to 40%. They have assets under management between $66M and $6.7B and expenses between 0.41% and 0.75%. They are currently yielding between 0% and 1.8%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| ARKK | ARK Innovation ETF | $6.03B | 41.9% | 0% | 0.75% | ETF | Yes |
| BOTZ | Global X Robotics & Artificial Intelligence ETF | $1.88B | 28% | 0.4% | 0.69% | ETF | No |
| XT | iShares Exponential Technologies ETF | $2.89B | 15.8% | 0.53% | 0.46% | ETF | No |
| ARKG | ARK Genomic Revolution ETF | $1.43B | -2.23% | 0% | 0.75% | ETF | Yes |
| LIT | Global X Lithium & Battery Tech ETF | $2.11B | -16.5% | 0.80% | 0.75% | ETF | No |
| EDOC | Global X Telemedicine & Digital Health ETF | $66.85M | -22.97% | 0% | 0.68% | ETF | No |
| ICLN | iShares Global Clean Energy ETF | $2.62B | -29.4% | 1.8% | 0.41% | ETF | No |
Overall, innovation ETFs have a lot of promise. But they also have a lot of pitfalls. Active management may not provide the skill or touch that drives long-term returns. Current results might include a hefty dose of luck. For investors, understanding these pitfalls is critical before pulling the trigger on such funds.
Bottom Line
The growth of innovation ETFs has been staggering, with plenty of new funds launching. The question is whether or not these funds can deliver lightning in a bottle. So far, the results have been mixed.
1 Boston Consulting (November 2023). An Investor’s Guide to Deep Tech
