Cathie Wood explains why she (almost) completely missed the AI ​​wave, and the easiest way to avoid making the same mistake again

Cathie Wood's ARK Invest has been gaining attention for its unprofitable growth stock boom in 2020 and 2021. Tesla (Nasdaq: TSLA) In 2020, it recorded a staggering 743% increase.

But over the past five years, all of ARK's major exchange-traded funds (ETFs) have S&P 500 And that Nasdaq Composite IndexHere we explain how Ark Invest lost its market edge, why the fund missed a big opportunity in artificial intelligence (AI), and how to avoid making the same mistake.

ARK’s Strategy

Every year, ARK publishes a 100+ page research report on its best and biggest ideas and the companies to invest in to take advantage of those trends. ARK caught our attention because it assigns a high weighting to smaller companies and excludes most mega-cap stocks (except Tesla).

ARK owns six actively managed ETFs. ARK Space Exploration Innovation ETF (NYSE:MKT:ARKX) We won't be covering it in this article because the fund was founded a few years ago and has only $236 million in net assets.

• ARK Innovation ETF (NYSE: MKT: ARKK)

• ARK Next Generation Internet ETF (NYSE:MKT:ARKW)

• ARK Fintech Innovation ETF (NYSE:MKT:ARKF)

• ARK Autonomous Technology & Robotics ETF (NYSE: ARKQ)

• ARK Genome Revolution ETF (NYSE:MKT:ARKG)

Below are the top 10 holdings in each of the other five actively managed ETFs.

Data source: ARK Invest.

There are several stocks with overlapping holdings across multiple funds: UiPath, for example, is in four of the five funds, while Tesla, Robinhood, Block, and Coinbase are in three of the five funds. There is a lot of overlap between the ARK Innovation ETF, Next Generation Internet ETF, and Fintech Innovation ETF.

The story continues

ARK's underperformance is due to its concentration of a small number of niche companies across its ETFs, and many of these stocks have cooled since their meteoric rise in 2020 and 2021 and are well off their highs.

of Invesco QQQ Trust (Nasdaq: QQQ) Reflects the performance of Nasdaq 100 –It includes the top 100 non-financial companies in the Nasdaq Composite Index. Given its high growth nature, we'll use this as a benchmark instead of the S&P 500 to see how these funds perform.

Year to date, the Invesco QQQ is up 12%, while the best-performing ARK ETF, the Next Generation Internet ETF, is up just 2%. Over a three-year period, the gap is even wider, with the Invesco QQQ up more than 40% while the five major ARK ETFs are down more than 28%. Looking back over the past five years, during which many of ARK's top holdings soared in 2020, all five ETFs still It was below Invesco QQQ and compared with the gains in top growth stocks, indicating stronger selling pressure in many of ARK's favorite companies.

The Dangers of Underweight Market Leaders

ARK's underperformance is highlighted by two big disappointments over the past few years. First, and most important, large-cap stocks, not small-cap stocks, have led the market to new heights in most sectors. Because ARK's active ETFs don't focus on large stocks, they've missed out on this trend. The one large-cap stock that ARK has strong faith in, namely Tesla, is down about 24% since the start of 2021.

The second, and more notable, mistake was that ARK did not have enough exposure to AI led by mega-cap growth companies. NVIDIA Other semiconductor stocks, Microsoft, alphabet, Amazon, Meta PlatformThe firm also has small investments in AI-focused and big tech companies, but not enough to move the ETF's index.

Index funds and sector-based ETFs are market cap weighted to include high exposure to these giant companies. But ARK's allocation is based on its best ideas, not market cap. And unfortunately, these ideas haven't been very good in the medium term. They could still work out, but for now, the flaws in ARK's strategy are fully exposed.

There is no perfect formula for ensuring you have “enough” mega-cap growth stocks in your portfolio, but there are certain criteria to be aware of. The technology sector makes up 29.2% of the S&P 500. The “Magnificent Seven” — Microsoft, Apple, Nvidia, Amazon, Alphabet, Meta Platform, and Tesla — make up 31.4% of the S&P 500, but there are many other mega-cap growth stocks that are highly weighted in the index outside of these stocks. It's also worth mentioning that Amazon and Tesla are in the consumer discretionary sector, not the technology sector, and Alphabet and Meta Platform are in the communications sector.

Overall, a portfolio with less than 40% to 50% in mega-cap growth stocks has likely underperformed the major indexes in recent years. If you're primarily invested in companies other than mega-cap growth stocks and have the risk tolerance to approach the space but aren't sure where to start, the following ideas might be a good idea. Vanguard Mega Cap Growth ETF (NYSE: MKT: MGK).

The ETF has dominated the Nasdaq Composite and S&P 500 in recent years, with heavy exposure to the technology and consumer discretionary sectors, with Microsoft making up 55% of the ETF. appleIt invests in big companies like , Nvidia, Alphabet, Amazon, Meta Platforms, and more. It also charges just 0.07% annual fees, or $7 for every $10,000 invested.

Because the fund is concentrated in a small number of stocks and themes, it can be quite volatile depending on major company earnings results and investor sentiment, but it's a great way to fill holes in your portfolio if you're not already exposed to some of the biggest and most important companies in the market.

Making the most of ETFs

In the stock market, anything can go up in the short term, and often for the wrong reasons, but in the long term, fundamentals win.

ARK Invest became popular because its strategy was perfectly in line with the trends of the time, and because it backed Tesla at a time when there was widespread doubt whether the company could scale to the mass market. ARK deserves a lot of credit for taking bold decisions with Tesla, but that doesn't mean it's worth replicating every move made by Cathie Wood and her team.

As an individual, you can choose which funds and big-name investors to respect while also understanding their weaknesses and the state of their holdings. The joy of investing in individual stocks comes from knowing a company well and trusting it for the long term. And if there's a particular sector or theme you want to invest in but don't have a high-conviction idea, ETFs are a good way to fill that void and provide diversification at the same time.

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John Mackey, former CEO of Amazon subsidiary Whole Foods Market, serves on The Motley Fool's board of directors. Randi Zuckerberg, former director of market development and public relations at Facebook and sister of Meta Platforms CEO Mark Zuckerberg, serves on The Motley Fool's board of directors. Suzanne Frey, an Alphabet executive, serves on The Motley Fool's board of directors. Daniel Folber has no position in any of the stocks mentioned. The Motley Fool owns shares in and recommends Adyen, AeroVironment, Alphabet, Amazon, Apple, Beam Therapeutics, Block, CRISPR Therapeutics, Coinbase Global, Intellia Therapeutics, Ionis Pharmaceuticals, Meta Platforms, Microsoft, Nvidia, Palantir Technologies, Pinterest, Roblox, Roku, Shopify, Taiwan Semiconductor Manufacturing, Tesla, Toast, Twist Bioscience, UiPath, Unity Software, and Zoom Video Communications. The Motley Fool recommends Deere & Company, Moderna, Teradyne, and Trimble and recommends long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.

How Cathie Wood (almost) completely missed the boat on artificial intelligence (AI) and the easiest way to avoid making the same mistake again was originally published by The Motley Fool.