In the recent market downturn, investors who follow growth stocks in the tech sector have been dealing with an additional challenge. Many tech growth stocks have seen their prices fall by more than two-thirds from their 52-week high. That dismal performance stands in contrast to the Nasdaq 100, which has fallen by only 18% over the last year from its peak.
This group of investors is in desperate need of an index that more accurately reflects the state of their particular portfolios. A potential solution for investors interested in monitoring the performance of growth tech stocks is to pay closer attention to the Ark Innovation ETF (ARKK 1.24%).
The problem with the Nasdaq 100
As most investors know, investors perceive the Nasdaq 100 as the technology index. As the name implies, it is made up of 100 companies and 101 tickers (Alphabet has two tickers), and tech stocks make up the majority of the companies listed in this index. Holdings in the index can vary from large companies like Apple to smaller tech growth stocks such as DocuSign or MercadoLibre.
However, the weight of the stocks within the index is not equal, and stocks above a market cap of $100 billion hold a disproportionate influence. Apple makes up 12.6% of its holdings, while Microsoft claims 10.3%. So influential are the top 10 companies that together, they make up just over 50% of the index's value.
Moreover, in the most recent downturn, the sell-off disproportionately hit growth stocks, leaving the largest tech companies less affected. Apple stock is down about 10.5% from its 52-week high, while Microsoft is down by around 17.8%.
This pales in comparison to the 47% decline in MercadoLibre or the 68% drop in DocuSign compared with their 52-week highs. MercadoLibre makes up only 0.42% of the index, while DocuSign only makes up 0.16%. Thus, the dramatic drops in these stocks did little to influence the Nasdaq index as a whole.
How the Ark Innovation ETF can help
Despite this discrepancy, a growth tech stock index is unlikely to emerge soon. Indexes almost always focus on larger stocks, and the recent drop in smaller stocks will likely not change that.
However, the Ark Innovation ETF appears well suited to serve such investors as an index. Granted, Ark Innovation is not a formal index, nor does it own equal proportions of its holdings. Nonetheless, Cathie Wood manages this fund, and notwithstanding the challenges over the last year, Wood has built a long-term track record of beating the market. Moreover, investors still pay attention when Wood goes bargain hunting, as investors can monitor her purchases and sales for all of her funds. Such moves bring more attention to the growth stocks she follows and trades.
Her strategy has paid off over time. Between Ark Innovation's inception in October 2014 and the end of 2021, the fund generated 26% annual returns, well ahead of the 15% from the S&P 500 over the same period. Also, in the five-year period between 2017 and 2021, that annual return rises to 38%, even when accounting for the sell-off in 2021. This performance reinforces the potential of such growth stocks.
The fund also reflects many of the holdings growth tech stock investors will likely own. As of the time of this writing, Ark Innovation's top holdings were Tesla (9.3%), Teladoc Health (7%), Roku (6.8%), Zoom Video Communications (6.1%), and Coinbase Global (5.8%). Other than Tesla, the stocks above each maintain a market cap of less than $50 billion.
Also, as of the end of 2021, 62% of the fund constituted stocks with market caps between $10 billion and $100 billion, a value range often targeted by growth-oriented investors. Wood had also invested only 11% of the fund in stocks with a market cap of over $100 billion.
Finally, the cloud computing, digital media, and e-commerce industries make up a combined 34% of the fund at year's end. At the same time, big data, blockchain, IoT, and mobile each constituted about 5% of the fund's investments. Such a focus is a testament to Ark Innovation's technology focus.
Taking stock of the growth tech sector
The performance discrepancy between the largest tech stocks and the rest of the market may have left investors confused. However, the performance of the Ark Innovation ETF not only confirms that growth investors have not imagined the recent decline but also shows how the fund can serve as an index for these stockholders.
More importantly, these investors should also focus on Ark Innovation's long-term performance. If such stocks can beat the market long-term, it may give investors the needed confidence to stay the course amid recent declines.