Over the past couple of months, a significant performance gap has developed between shares of Warren Buffett (Trades, Portfolio)'s conglomerate Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and Ark Invest's flagship exchange-traded fund strategy ARK Innovation (ARKK, Financial).
Berkshire has returned 38% over the past two years compared to ARK's 30%. In the interest of full disclosure, I should note that ARK is still outperforming over the past five years. Shares in Catherine Wood (Trades, Portfolio)'s ETF are up 255% since 2016 compared to 140% for Berkshire.
These performance figures are not really extensive enough to judge ARK performance, nor are they extensive enough to justify the ETF provider's strategy. Still, the recent developments illustrate one of the main challenges investors face over the long term. That is maintaining and growing wealth without suffering significant drawdowns and booking losses.
Growing wealth
Buffett's Berkshire is built around the principle of growing and protecting wealth. ARK's strategy is designed to achieve outright growth. This strategy is bound to come with a high level of risk. Picking tomorrow's winners rather than buying proven and established operators (the strategy preferred by Buffett ) is going to entail a level of speculation and guess work. It is impossible to tell the future; therefore, one has to make an educated guess.
There is nothing inherently wrong with the strategy. Some of the most successful hedge funds of all time have grown by investing in future winners. Tiger Global is a great example. However, such a strategy is incredibly difficult to replicate over the long term and it requires a huge amount of money, time and resources to pursue successfully.
Only time will tell if ARK's investment strategy will pay off. But over the past couple of years, one thing that has become clear is that the strategy is highly volatile and perhaps not best suited for all investors, especially those investors with a low level of risk tolerance.
On the other hand, Buffett's approach has continued to churn out returns for his investors, building wealth and generating cash flow year after year.
True, the returns have been nowhere near as impressive for Berkshire over the past five years compared to the growth investor, but investing is a marathon, not a sprint.
There's no point making 100% in one year and then losing 50% of it the next.
As well as the monetary gains and losses, there is also a psychological element to consider.
Riding out peaks and troughs is very psychologically difficult. Investing is hard enough as it is. Investors should try to simplify and streamline the process, not add an additional layer of psychological difficulty. Avoiding highly volatile growth stocks, which require guesswork to analyze, is one way to reduce the potential workload.
That being said, I need to make it clear that there is no right or wrong way to succeed as an investor. Buffett's Berkshire has outperformed ARK in the past two years. It might go on to outperform over the next decade, or ARK could rally back. Some investors might be more comfortable holding ARK than Berkshire. They may be willing to deal with the higher levels of volatility.
The challenges we face
Nevertheless, this case study perfectly illustrates the challenges investors face when looking for an investment style that works not just for the next year or few months, but for the next decade and beyond.
Finding the next growth stock is always going to be a challenge. The more growth stocks one needs to find for a portfolio, the higher the chances are an investor will make a mistake.
At the same time, holding growth stocks through the bad times can be psychologically tough, and it is not something all investors will be comfortable with.
However, buying good businesses and holding them is a strategy that requires its own set of skills. What's more, it also requires a great deal of patience.
For investors, the challenge of deciding which strategy they should follow could be just as hard as picking the stocks themselves.
