The Ark Innovation ETF (ARKK, Financial) is Catherine Wood (Trades, Portfolio)'s famous technology ETF that seeks companies adhering to the lump of labor theory, which says that innovation will cause deflation as it will reduce the burden of human wages. Invesco's PowerShares QQQ Trust Ser 1 ETF (ETF) is a similar ETF with a significant weighting on technology stocks, but instead of following the lump of labor theory, it simply mimics the Nasdaq 100.
The QQQ ETF is also passively managed, as opposed the the ARKK ETF, which is actively managed with a specific economic theme in mind. Thus, while these technology-focused ETFs may seem similar at first glance, and indeed their performance has been correlated in the past, they are actually very different.
In this article, we will go over the similarities and differences of these two ETFs, what you can expect by investing in either or both of these securities, and why I believe their performances could diverge in the future.
Statistical measures
The rolling correlation shows that these two ETFs have always correlated closely and that the correlation statistic is currently in its upper quantile. Furthermore, they have similar Betas, with the ARKK ETF's beta of 1.56 and the QQQ ETF's Beta of 1.02. The higher the Beta, the more volatile the asset is, so the ARKK ETF is slightly more volatile than the QQQ ETF.
Source: Portfolio Visualizer
However, many will be surprised to know that the ARKK ETF actually holds a Sharpe ratio of 2.42, which exceeds that of the QQQ ETF at 2.278. The Sharpe Ratio is a measure of a stock's excess return over the risk-free rate relative to overall market volatility. It's rather surprising to me to see that the ARKK ETF has a better risk-return profile than QQQ.
Fundamentals
Fundamentally speaking, the ARKK ETF is actively managed based on financial modeling, while the QQQ ETF aims to track a broader index in the Nasdaq. By eyeballing it, one would predict that the ARKK ETF's scope is smaller due to its thematic nature, and you'd thus see excess downside potential with possible lower long-term returns.
If we examine the respective top holdings, it's certainly evident that the QQQ ETF is invested in more established tech firms with higher market share, whereas the ARKK ETF is invested in growth prospects.
This could explain the ARKK ETF's better Sharpe ratio as much of its holdings performed better during the pandemic than Invesco's; however, with rising interest rates may come struggles in the tech sector, which could cause outsized negative returns for the ARKK ETF's holdings due to their growth nature, whereas the QQQ ETF's holdings may fare better due to their more mature nature.
Below are some screenshots of the top holdings of both the QQQ ETF (top image) and the ARKK ETF (bottom image).
Source: Invesco
Source: ARK Invest
Final word
I believe the ARKK ETF will be a rollercoaster and a long-term hold. However, there's still much doubt surrounding the sustainability of its returns; sure, it did well during the pandemic with several thematic shifts and overflowing easy-money policies in the broader market, but it's unlikely that it will outperform the market in a higher interest rate environment.
Invesco's QQQ ETF has correlated with the ARKK ETF in the past, but it is a lower-risk investment with more mature holdings that will likely sustain better returns throughout a variety of different market environments.
