Cathie Wood’s ARK stands for test when Tech Rally is Cools

Known as “Mamma Cathie” by individual investors on Reddit’s WallStreetBets forum, Ms. Wood, in videos and podcasts, praises her strategy of investing in what she calls disruptive companies – companies she claims are destined to change the world and to grow enormously. Her bets range from investors’ favorites such as Apple Inc.

and Tesla Inc.

for pandemic winners like Roku Inc.

and square Inc.

to the unknown 3D printing company Stratasys Ltd.

and Israeli therapeutic company Compugen Ltd.

CGEN 1.65%

Those gambling paid off quite a bit last year, as Tesla jumped over 700%, added Square 325% and Roku was up nearly 150%, more than doubling ARK’s ETFs. Ms. Wood garnered acclaim as the most popular stock picker on Wall Street, but her star has fallen over the past two weeks when long-term interest rates suddenly spiked and investors stopped growth trading en masse.

Tom Staudt, ARK’s Chief Operating Officer, said Thursday that the company is not overly concerned about the recent downturn, seeing it as a short-term market trend rather than the start of a permanent shift. He added that the ETFs have performed as expected and the company’s portfolio managers are using the volatility to buy stocks that fit their philosophy and appear to be oversold.

One factor exacerbating ARK’s pain is a series of highly concentrated holdings, including small companies in which Ms. Wood’s firm owns a significant portion of the stock. Bearish investors are also taking short positions to bet that ARK’s funds and some of its holdings will continue to decline.

The following graphs illustrate this dynamic:

Of the 164 stocks held in the five ARK funds, 139 have fallen in the past month, according to daily holdings data compiled by Dow Jones Market Data. That’s much worse than the S&P 500. Less than half of the constituents have declined over the same period.

ARK held significant positions with many companies that were seen as winners during much of the Covid-19 pandemic last year. But a number of ARK’s stock generate little or no profit, including Roku and Teladoc Health Services Inc., as well as electric vehicle manufacturer Workhorse Group. Inc.

and Stratasys.

Analysts including those from Goldman Sachs Group Inc.

have noted that stocks of unprofitable companies have been most affected by the recent sell-off and have recommended investors limit their exposure to such stocks. Due to the declines so far, the shares of ARK’s flagship fund have fallen to their lowest level since the end of November.

Tesla counts as ARK’s largest holding in three of its funds, accounting for approximately 10% of those ETFs’ assets. ARK has a soft cap of 10% on positions within its funds. Tesla accounts for 7% of assets across all five ETFs. Square, Roku, Teladoc and the cryptocurrency bitcoin are among some of the other largest holdings.

Michael Purves, CEO of Tallbacken Capital Advisors, said he has warned investors against investing in the innovation fund’s individual holdings as they are much smaller stocks that can be sensitive to large swings.

“You don’t have to be in ARKK to be hurt by the ARKK situation,” said Mr. Purves of the innovation fund.

Of ARK’s five funds, 26 holdings are in companies in which the company owns more than 10% of all outstanding shares, according to data from companies FactSet and Dow Jones Markets Data.

Most of these holdings are in small companies with a market value of less than $ 5 billion and fewer shares are available for trading in the open market.

“You have to think about the market impact you have with small caps,” said Elisabeth Kashner, director of fund research at FactSet. “Where the market prices of some of these less liquid securities have been inflated quite quickly, they can then be reduced at the same rate as the outflow of funds.”

Investors are also turning bearish on ARK’s funds, creating a knock-on effect across the portfolio, said William Kartholl, director and head of ETF trading at Cowen. Inc.

Short-term interest rates as a percentage of ARK’s innovation fund total raft rose to about 11% on Thursday, its highest level ever, according to S3 Partners. Investors are also increasingly bearish of ARK’s Genomic Revolution ETF, with short-term interest rates reaching 8% of the total float from less than 3% late last year.

When investors go short on an ETF, shares are created exclusively by specialist investment firms known as authorized participants, solely for the purpose of lending. That process involves authorized participants shorting the underlying stocks of the fund, which could add to the short-term interest rates in some of ARK’s holdings, Mr. Kartholl said. That could lead to greater volatility of the individual stocks, he added.

Among ARK’s significant short-term holdings are Workhorse Group and biotech company Beam Therapeutics

RAY -1.21%

both at about 20%, according to S3 data. Shares of Workhorse, which was briefly targeted by Reddit’s day traders during the GameStop Corp.

GME 4.07%

saga, are down 66% in the past month, while Beam is down 38%.

—Ken Jimenez and Gunjan Banerji contributed to this article.

Write to Michael Wursthorn at [email protected]