#136 - Cathie Wood: Not Another 1999

0:00Welcome to the Insightful Investor Podcast, a weekly series that seeks to share industry, investment, and market insights. Learn more about our show at insightfulinvestor.org. I'm delighted to have Cathie Wood joining us today in our podcast studio in Los Angeles. She's here in person. Cathie, as many of you know, is the founder, CEO, and CIO of ARK Investment Management. Cathie, thank you for joining us today. Thank you for having me here, Alex. Let's start high level. What experiences and turning points in your career do you feel most shaped, how you think about markets, risk, and the future, and ultimately led you to found ARC?

0:43Yes.

0:44Cathie Wood:Well, I was watching our industry, especially since the tech and telecom bust, and even more so after 08-09. Our industry started really going passive or benchmark sensitive, highly benchmark sensitive. And so I noticed that the research that investment banks and others used to do and the buy side and sell side used to do on technologically enabled innovation, that that seemed to be disappearing. Because of the global financial crisis? Yes, there were cutbacks of all kinds. And so innovation was associated with risk and being further away from benchmarks. So I figured, and even at the last firm where I was, they were going very quant.

1:41Cathie Wood:And in quantitative research, what is at the center of that? Those are benchmarks of some sort. And so I felt that there was an unmet need out there. And that's the only reason to start a business. And I also felt that it would be important, especially after 08-09, to try and bring trust back into the process, bring investors along with us. And so we made the decision to give our research away, to give it away on social media, not when it was finished, because it's never finished, but as it's evolving so that we could engage with our audience, including innovators, you know, people we would not ordinarily meet.

2:39Cathie Wood:and I felt it was an important moment of time because I had no idea we were going to be so right in the sense that I believed we were going into a technology revolution and that it was going to be pretty profound and that's where we are. Timing is everything. And also the social media part is a good way to get your name out there and get a followership, especially if it's authentic. And, you know, take a look over our shoulder, look at the research that we're doing. This is what we're seeing. And then it gets people more engaged. Yes. And it's true, not only for me, but for our analysts, each one is really evolving a reputation in our industry in a particular technology vertical.

3:30Cathie Wood:So we see 15 different technologies evolving at the same time. We have organized our research around them, not around sectors or industries. So our analysts, directors of research, chief futurists are all becoming pretty well known in their realms as well. Is there something about the traditional investment industry that you feel that it's maybe not built to fully understand how the future may transpire? Well, I think born out of especially 08-09, short-term time horizon. It seems to be getting shorter and shorter. It definitely is. And of course, the other thing that has happened is high-frequency trading, algorithmic trading.

4:17Cathie Wood:And so the market's whipping around incredibly especially during this moment, software, hardware, software, hardware, and it's just black and white. And we know the world is not quite like that. So, you know, we use that volatility to our advantage. You'll see on days when some of our stocks are down 10 or 15 percent because the companies have reported earnings and something hasn't gone right in the short term. If that stock is down and our long-term thesis has not been disturbed, we'll be a buyer. We're a liquidity provider in the market these days. Buy low, sell high. It's as simple as that.

5:10So ARC stands for active research knowledge. How do those three words still shape the way you approach investing today?

5:17Cathie Wood:So I have to tell you the genesis of ARK. As we were writing the prospectus and our attorney was getting ready to submit it, she found out that we could not use three capital letters in our name unless each one stood for something. And so literally, she came in to me, told me, and I said, okay, active research knowledge. Just like that. I did. And it's strange. I didn't expect the question. We had not named it for that reason. But active equity management, we're as active as they come. Our overlap with the indices is very low. So we're highly differentiated exposure to innovation. Research, original research centered on Wright's Law, even today, even though we've advertised Wright's Law as a really important variable to understand the cost declines associated with new technologies, we're not seeing a lot of people following us.

6:35Cathie Wood:And maybe they're following our research and they're trusting that we know what we're doing as we do this original research. But original research, very important to us. And knowledge, again, truth, knowledge, just trying to get to the truth of the matter. So the real reason I named it, do you want to know why? And I don't know why I felt so strongly about three capital letters, but I did, was I had been trying to figure out, all right, how would I like to go about fulfilling this unmet need? And this was over a number of years. And when I am soul-searching from time to time about anything, I will go to the Bible, just open it randomly and say, okay, God, talk to me.

7:27Cathie Wood:Just tell me where I'm going, what I need to do. And how many times did Ark of the Covenant come up? And I think it depends on the Bible. It's mentioned only 60 or 70 times in the Bible. Okay, so it's low probability. Low probability. I was not on the same page, rarely. And it came up so much. I said, okay, well, whatever happens, that's the name of the company. I love it. So today's AI boom is drawing a lot of parallels to the internet boom and subsequent buzz. And you lived through that period. Would you talk about what your mindset was at the time, what you were thinking at the time, what you were saying at the time, and how that relates to your views today and maybe mistakes people are making?

8:13Yes.

8:14Cathie Wood:Well, I had started a firm. It was a global hedge fund with a partner from my previous firm. And we were able to buy puts and we started loading up on them as that market seemed to go crazy out of control. and it was very interesting during that time, the lead up 1999, even though the market was soaring, we were buying puts on names that were getting hit and a lot of it was in the banking sector. We did see the financial risks and there were some cracks, but they weren't obvious until we got into the actual bust. So we were concerned and we knew we would get hit. We weren't a neutral strategy.

9:16Cathie Wood:And so we were building some protection consistently. On the other side of it, well, I made a transition as, I guess, one year after that. So we had gone through the first year and held up very well relative to traditional benchmarks and so forth. But then I moved over to Alliance Bernstein, and that was just long only. And as an economist, and that's how I started into the business, I knew that if there was a rush of capital into a narrow space, and it was narrow at the time, because sure, the internet had arrived. But the assumptions about how it was going to transform the world were wrong. The technologies weren't ready.

10:14Cathie Wood:We didn't get the cloud until 06. The two big technology breakthroughs in AI ending with transformer architecture, deep learning being the first one, until 2017. And so what I had the luxury of observing, starting in economics and thinking about capital flows was, okay, 20 years with the PC and the internet, it was a very exciting time. But we had a lot of time to analyze how much was too much capital flowing in. So when I moved to Alliance Bernstein, I inherited portfolios that had 38 % to 40 % technology. And I took it down, I would say within six months, to 11%. Now, at the time, most organizations were becoming quite benchmark sensitive.

11:15Cathie Wood:Technology was 35 % of the benchmark. So this was considered a little crazy. And yet, it worked out very well because we had, 2001, we had two more years to go in the bear market. So many people think of ARK and me as such avid technology, almost blinded by almost any technology. And that's just not true. It's not true. I went down to... You were the opposite side of it. I was on the opposite side. Too much capital, chasing too few opportunities too soon. This is kind of an economics concept. Returns will go down. Especially if the innovation isn't as real as the market is discounting. Exactly.

12:00Cathie Wood:And if the valuation is on the number of eyeballs that potentially 10 years from now, think about it. We just talked about the short-term time horizon today. Back then, in order to justify positions, there were 10-year time horizons and a lot of analysis on how many people ultimately will be using this service. and of course we know now 10 years out wasn't anything like we thought it would look like so it was an interesting time and you're right so now think about today we just talked about how short-term everything is you know the irony is investors should be much longer term in their Horizons now.

12:52Cathie Wood:They should not have been back then. The seeds for the technology revolution that is happening now, they were planted, but they were seeds in the 20 years that led up to the tech and telecom bubble. And they really have been germinating for 20, 25 years. And now they're exploding. And yet, oh my gosh, investors are scared to death, even of the hyperscalers increasing their capital spending budgets. Now, they're increasing them enormously. But you have to understand how profound this revolution is. And I think they do, in order to make the kinds of bets that they are, especially with the shareholder bases they have, The shareholders of the Mag-6, we excluded Tesla here, right?

13:50Cathie Wood:The shareholders of the Mag-6, they got used to massive cash, massive free cash flow. And yesterday, for the first time in its public history, Google reported a negative free cash flow quarter. First time. And so it's a radical shift. These companies, and I think they know what they're doing, understand how provocative and compelling this technology revolution is. Yeah. And I think it's a really important point because on the surface, you could look at 99 and today and say high tech exposure in the index. That's check the box on both sides. Great promise. Looking forward into the distant future and everything that is possible.

14:45So similar type of story. And what you focused on is let's look at the underlying technology. Let's look at the actual fundamentals, not just the earnings, which there's obviously more today than in the past. Definitely. But let's look at the fundamentals of what the story is. And is that compelling? And so that's, I think, where you draw the distinction.

15:03Cathie Wood:Yes. And a lot of the investment is being done by very well-funded and cash-rich organizations who have a shareholder base that is, as they are getting their questions on the quarterly earnings calls, this shareholder base and investor base generally is quite nervous about this. Now, as a portfolio manager, I'm very happy about this. I am happy that there is so much concern out there. Does it cause incredible volatility? Because we've got algorithms whipping around and playing on all of the sentiment. And literally, algorithms sometimes are just listening for sentiment, the kinds of questions and so forth, and playing with that.

15:51Cathie Wood:So it's kind of a wild world, I will say. This is more wild in a sense than the tech and telecom bubble was. That was just straight up. This is extremely volatile and seemingly convulsive on days, you know, when there's just so much doubt that we can't be in a world that justifies this valuation. So SpaceX,$1.75 trillion, or the trillion dollar valuations of OpenAI and Anthropic. But then you throw back and say, well, wait a minute, have you looked at what's happening to their revenue growth? And I'm not sure if you've heard, but the Anthropics annualized revenue run rate in December was$9 billion.

16:50Cathie Wood:In June, it was$47 billion. Think about that because of Claude Cowork and Claude Code. And it seemed and did surpass OpenAI. Now OpenAI has pivoted aggressively toward enterprise. And now we're seeing its developer base skyrocket. So I think that we've never seen anything like this before. There was nothing like this in the tech and telecom bubble, not this kind of, I mean, think about that. That's, you know, multiples of not just a double digit, strong double digit growth rate. And in some ways, the experience, both positive and negative of the late 90s boom and bust can help make this potentially survive and last longer because it introduces skepticism that may not be there had we not experienced that.

17:50Cathie Wood:Absolutely. I do think that we have to take a point of view on what's going to be disrupted. And that's probably a better place to put shorts because I think we are in a world full of disruption. And it'll be from all kinds of levels. Company level, if you don't get your productivity up as much as your competitors are, and they become much more efficient and therefore can price more aggressively, you're going to be in trouble. And that's true for a lot of companies. But then when you move up higher level and you look at the tech stack and say, okay, what within the tech stack, how do we handle this?

18:37Cathie Wood:We did this research two and a half years ago. The tech stack is comprised of infrastructure, so chips, data centers, power, all of that, and then platform as a service, so Palantir, OpenAI, Anthropic, XAI, we would put in there, And then applications. And we think that the old-time applications, it's becoming obvious now, SaaS, they're going to be usurped, importantly, by platform-as-a-service. SaaS is one size fits all. Platform as a service is enterprise by enterprise using proprietary data that they probably don't want others to have. So even within technology, there's disruption. And how do you distinguish between a genuinely transformative technology that generates a lot of excitement but ultimately doesn't matter as much?

19:40Cathie Wood:So the way we define an innovation platform is three ways, three characteristics. One, it follows a learning curve, a declining cost curve, and we measure that with Wright's Law. Two is that this new technology platform is going to cut across sectors. That's why we've organized by technology. So each analyst is looking at how low costs have to go before it moves into another, conquers another sector. So costs, cross-sector, and then the third is this platform becomes a launching pad for other technologies or other innovations, especially now because these technologies are converging with one another.

20:34Cathie Wood:So a good example there is robo-taxis. Robo-taxis are the convergence, or autonomous platforms are the convergence of robots. Robo-taxis or autonomous vehicles are robots. Energy storage, they will be electric, and artificial intelligence, they'll be powered by AI. So we have S-curves feeding S-curves, which means the possibility of super exponential growth, meaning very rapid growth accelerating. That is what seems to be happening in this AI age. Another example there is in the healthcare space, which we think is the most profound application of AI, combination of sequencing technologies. We have 35 to 40 trillion cells in our body, and we now have single cell sequencing, which is, you know, we're data machines, we're, you know, massive data machines.

21:32Cathie Wood:So sequencing, artificial intelligence, thanks to it, we can find what's mutating in the genes or the cells. And then CRISPR gene editing, now that we see where the mutations are, we're moving into a world where we can reprogram the genome. Mutations are the earliest manifestation of disease. Now we can find them. And as CRISPR gene editing and other gene therapies evolve, we will be able, we think, to correct them. So it's going to be transformational. And then on the other side, we have made our mistakes. 3D printing is a thing. It's a thing. But we should have, and do now, have classified it under automation, just robots, automation.

22:26Cathie Wood:We didn't. We thought it was going to evolve into something much bigger. And instead, a little bit like nanotechnology in the 90s, it's been absorbed by the companies, like the industrial companies in particular, autos and aerospace. Those are the biggest applications right now. So it didn't really become an industry of its own or a technology. We had not classified it correctly. And that's why we do have to, you know, every year as we're doing big ideas, say, okay, are these 15 technologies? So there are five major platforms. They involve 15 different technologies. Are they really distinctive enough to really become industries themselves?

23:30Cathie Wood:And in the case of 3D printing, not. And it's been very disappointing. Are there innovation platforms that you feel like are being underappreciated and maybe some that are maybe the next 3D printing type? So underappreciated is healthcare, everything healthcare. We're starting to get a bid now, but to give you a sense of how underappreciated and misunderstood, we believe, this space was, we call it the multiomics revolution. and ARKG is the ETF, that ETF was 60 % short. Think about it. And then the stocks inside the ETF were also being shorted. And this is what I mean. Everyone became so sure that these companies in the healthcare space, too regulated, too bureaucratic, too political, negative cash flow if they're investing aggressively.

24:36Cathie Wood:So there were many reasons just to keep shorting because what we've learned is a lot of the shorts are momentum driven and so they were feeding each other. We think truth wins out and this has probably been the most maligned space, the multi-omic space of all. In terms of are there others that we wonder about? No, I think we've been pretty stable at 14, 15 technologies now. But are there some that are popular? Maybe it's not within your core group that you're focused on, but others that you hear a lot about that you're more negative on? Or do you think the market generally has a right. I think the market is skeptical on anything innovation.

25:24Cathie Wood:And so we're in a good place that way, I think. Yeah, because you need a healthy dose of skepticism. If everybody's on the same side, there's a good chance it's overpriced. Yes. And there's another, this was where investment time horizon comes in. So short-term time horizon, they want a low valuation on this year's numbers. Well, really innovative companies should be investing aggressively now to capitalize on these new opportunities. These are massive industries in the making. We think, for example, the robo-taxi world altogether, global, the entire ecosystem is going to be north of a$10 trillion revenue industry within the next 5 to 10 years.

26:17Cathie Wood:Humanoid robots double that or more, maybe a little further out in terms of reaching those numbers. These are massive opportunities. And when it comes to AI, they're often winner-take-most characteristics. Certainly in the robo-taxi market, the first company to get a passenger from point A to point B, the safest, the fastest, and the least expensively is probably going to be number one. And there might be a two and three, but it's a little bit like Uber and Lyft right now. That's why it is so important. our time horizon is a five-year investment time horizon we are except for two periods in arcs history and i think in in my history at least as far as i recall our portfolios has have sold at the at a market multiple using adjusted ebitda and we do include stock-based compensation because that for all companies that was the beginning of the yen carry trade unwind in 2014 the summer and then tariff terror or turmoil uh in april of 25 we touched pretty much uh market multiple then but otherwise we we sell at a premium and our working assumption is that premium multiple is going to decay.

27:46Cathie Wood:It's going to compress during the next five years toward a market multiple. And in fact, most of our analysis has done, the market's multiple has gone up. Most of our analysis is at 18, 19 times EBITDA in the fifth year, even if we don't believe it's going to get there. We want to be conservative. So our analysts and portfolio managers have to believe that the revenue growth and margin expansion these companies are going to enjoy over the next five years is going to overwhelm that compression in multiples to deliver a minimum 15 % compound annual rate of return. So many people think, you know, we'll buy any technology, a company, no matter what.

28:33Cathie Wood:We probably are stricter in terms of valuation, but have a longer term time horizon than most. Right. To allow the technology to develop and to see the business keep up with it. See the investment that these companies are making pay off. Right. Yeah. Okay. And so let's talk about risk for a second. Obviously, there's a lot of volatility in these companies. How do you separate permanent impairment of capital versus just the market price fluctuating based on investor sentiment. So I like the way you framed the question because you didn't equate volatility and risk. We believe that those are two different things.

29:19Cathie Wood:Volatility is a function of uncertainty, and there's a lot of uncertainty now. Risk is more along the lines of, are we going to have an impaired situation here? Which is basically like the thesis does not play out. Is that fair? Yes, the thesis does not play out. One of the things we do to mitigate that risk is during corrections in the market and bear markets, we will, and we have a scoring system, which is a bottom-up scoring system. We do a lot of our work top-down to kind of understand the technologies, and we come across the companies who are making this new world happen. We have a scoring system, six metrics, what we do during a correction is concentrate our portfolios towards the highest conviction names as measured by the scores.

30:15Cathie Wood:Now, what does that do? You've probably heard the line, we love all our stocks. That's not true. It's never true. Like you love all your children. And like, yes, yes, that's not true. And in fact, very often when we're in a concentration phase, we will learn from analysts, you know, some of the doubts or uncertainties because they choose to eliminate a name. And we say, why? And, oh, there's another risk that's been tickling back here. And I'm just not sure about it. Let's just do this. I feel more confident here. so it's a great time to take risk out of the portfolio now obviously we have to be right on the one on the names left but i do think it is an important discipline for us from a risk control point of view because these you know sometimes these inklings like i wonder i wonder i wonder they're teasing but you can't verbalize them it's something that management said in the way they said it.

31:23Cathie Wood:You can't actually put it into a score, but if I have to concentrate and there are two very close in score, I'm going to remember that. And then impairment generally, you know, is this company going to fail? I'll tell you, AI has been a very important demarcation point in, we have sold stocks because as we've interrogated managements about AI and wanted to meet their AI AI talent, we could see in some companies maybe an inch deep. Right. They feel like they need to check the box that we're doing AI, but when you dig in, they're really not. Yes. And that's been true in the multi-omic space especially.

32:11So what would you say is the strongest argument against your current outlook and how would you respond to that?

32:18Cathie Wood:Okay, it would be a macro consideration informed by our research on technology. And that is inflation is going to surprise significantly on the low side of expectations, maybe even moving into deflation, but good deflation. Well, there are two sides to innovation. The disruptors enjoy these learning curves, which are cost declines if they can pass-through in price declines. They are disrupting the traditional world order, and if companies have not kept pace with innovation, they're going to have to price aggressively to compete, but their cost structures are not going to be in the right place, so they will be in harm's way.