Innovative disruption: balancing disbelief with unlimited upside

Catherine Wood called the 2020 Tesla (TSLA) bull run, and her conviction in disruptive innovation remains strong still. The founder, CEO and CIO of ARK Investment Management isn’t interested in gradual change, but in technology that revolutionises societies during one of the most transformative periods in human history. And while technology permeates every sector and industry of the global economy, Wood feels healthcare will be next in the spotlight.

Wood tips the battle for artificial intelligence ascendancy as the fiercest fight between the US and China, as the latter collects massive amounts of data on its own population. But the US tends to thrive on competition, and will likely ramp up innovation in seeking to maintain an edge. In the long run, this competition should benefit all five of the innovation platforms in which ARK invests.

The ARK philosophy maintains that “innovation should displace industry incumbents, increase efficiencies, and gain majority market share”. Where have you seen the biggest changes during the COVID-19 pandemic?

COVID-19 appears to have accelerated all of the disruptive innovations. For example, many companies that serve the digital workplace didn’t expect customer numbers to hit current levels for another three to five years. Due to COVID, there’s been a rush into the new world. The other side of disruptive innovation is creative destruction. Many companies are being disintermediated by these new platforms – not surprisingly, in financials, energy, and industrials tied to the internal combustion engine. We believe many companies are in harm’s way.

Disruption occurs because we underestimate the effect innovation will have on our lives. Who are the less obvious beneficiaries in this current market?

We believe genomics is the most inefficiently priced and underappreciated part of the market, and the most misunderstood is health care. Technology is an important part of every sector and is blurring the lines between and among sectors. We believe healthcare will see the convergence of DNA sequencing, artificial intelligence, and CRISPR (Clustered Regularly Interspaced Short Palindromic Repeats) gene editing – all new technologies that have fallen enough in cost and price and are ready for prime time now. We learned from the coronavirus that there were weak links in the supply chain in terms of tests and vaccines.

But what we have this year – very unusual – is cover for the healthcare space. No one in Congress wants to vote against budgets to help get us all back to work. We think we’re headed into another golden age for healthcare. 

American biotech firm Genentech launched the biotech revolution in the 80s, and we had 20 years of rising returns on investments in healthcare. They became super stocks. I believe that’s about to happen again.

Against the backdrop of huge technological change in 2020, many governments around the world have quite a dire outlook. Is there a chance that the macro instability could stifle the innovation runway moving forward?

The tensions between the US and China have caused macroeconomic concerns around how it could stifle innovation going forward. It appears that China is doubling down on innovation with the desire to be the world’s leader in technology, which we believe is a positive for our investment universe. We believe that we will see government policy focused on developing new technologies similar to what we saw with DARPA in the 1990s. This should create a pipeline for further innovation and competition between the US and China. Technology is permeating into every sector and industry of the economy and China seems to be taking advantage of the opportunity as quickly as possible. One example where China is leading the way is in fintech, specifically, digital wallets, mobile payments, and peer-to-peer transactions and lending.

China was able to move on this opportunity earlier than the US because its financial infrastructure was less developed. When China launched WeChat Pay and Alipay roughly 10 years ago, it had more opportunity and space to scale because there were no legacy infrastructure or services to overcome. After witnessing the benefits of fintech in China, it appears the US is following suit. And China can achieve scale because of its enormous population, whie the US doesn’t have this ability. The US would have to cover several other continents – for example, South America and Europe) to match China’s size. In the short-run, US-China tensions may stunt China’s growth, but new innovations can still thrive because they have a population of 1.4 billion on which to practice and learn.

We believe the fiercest fight between the US and China is on the artificial intelligence front. China hasn’t previously broken into the semiconductor chip space, but now has a shot. China is collecting massive amounts of data on its own population, and we believe its store of data on ex-China populations may also be greater than many nations realise. If China has orders of magnitude more high-quality data, it could catch up to the US. That said, the US responds well when faced with competition and it likely will continue to innovate in trying to stay ahead of China.

In the long run, this competition should benefit all five of the innovation platforms we are investing in and further accelerate the adoption of the underlying transformational technologies. 

In fact, we recently hired an Asian Innovation analyst to focus specifically on China and innovative companies that are evolving in the region.

In February 2016, you predicted Netflix would grow its user base to more than 175 million by 2020, from 75 million at the time. With 193 million subscribers now, what gave you such early confidence? And is there a similar company today for which you predict such stratospheric customer expansion?

We looked at Netflix initially because it was, and still appears to be, the poster child for subscription video on demand. Many at the time thought that streaming video services would be a US-centric story. But we believed that it would be adopted globally, given that it is relatively cheaper than alternative entertainment formats. As the leader in the space, Netflix would have first-mover advantages to scale at a global level.

Today, a similar company that we have our eye on is Roku, which provides an affordably-priced line of hardware products to help consumers stream entertainment. Roku is the only company with a purpose-built operating system for TVs, and is now in more than 43 million households. Roku TV models, produced and sold by its TV OEM partners, account for more than one-in-three smart TVs sold in the US. Again, we believe this is an international story, while many see it only as a domestic opportunity.

Many IPOs have launched in recent years, but questions have been raised around the earning potential for some of these businesses. With so many options, how do you approach the investment case for IPOs within the innovation space?

We believe companies that are staying private for so long are spending too much time getting ready for their liquidity event, prettying things up, and they’re losing strategic focus.

Good cases in point are Uber and Lyft. By all rights, they should have the autonomous taxi network opportunity; they should be in pole position. But they’re nowhere close to that. In fact, their stocks have been cut almost in half since the IPO – even before the coronavirus.

If they had started outfitting the cars of their drivers, they could have much more data today than Tesla. 

Data is the name of the game in the autonomous world – what really matters is who has the largest volume of real-world driving data, and the highest quality data, along with the best AI expertise. 

Uber and Lyft don’t, because they weren’t thinking about this. But they should have been.

A year ago, it seemed you were constantly having to defend ARK’s positioning on Tesla, with many investors failing to understand the growth possibilities of the company. Fast forward a year and Tesla’s share price is up 535%, having recently gone above $2,000 a share. What is your thesis for Tesla from here?

We believe Tesla is going to launch a ride-hailing network to compete against Uber and Lyft. If it does that successfully, it will be able to provide drivers with cars. The total cost of ownership and operating will be about one-third less than a Toyota Camry. It’s going to be a win-win situation – drivers can pay USD5,000 down and work the rest of the car off by driving it, while Tesla gets the data that the driver delivers every day for its artificial intelligence engine.

When the world goes autonomous – unlike drivers who were working for Uber and Lyft, who will be left out of the party – Tesla’s ride-hailing network of drivers will likely own an autonomous car that will work for them. They will be entrepreneurs.

If Tesla pulls this off, it will be so much more profitable than just building cars. Electric-vehicle margins are in the 20% range; ride-hailing is probably in the 40s; and software-as-a-service and autonomous vehicles will be in the 80s. This is a margin structure that most auto analysts have never seen.

What does Tesla’s stock split mean for the company, and can you take us through how you approach a stock split scenario?

Tesla’s stock split did not have any impact on our long-term thesis for Tesla. Given market capitalisation biases, multi-quarter profitability requirements, and one-year stock listing minimums, traditional index methodologies can sometimes disqualify the stocks of innovative companies that are sacrificing short-term earnings and investing aggressively to capitalise on exponential growth opportunities.

We believe Tesla is one of these stocks. We believe the stock split made it more accessible to the retail investor and should also make it easier for individual stock ownership by retail investors through retirement accounts that don’t traditionally allow for fractional share ownership.

From what I can see, ARK invests with a minimum five-year time horizon. You started the company in 2014, six years ago. How did 2020 stack up with your projections from 2014, and what does the next half-decade have in store?

Generally, our projections from 2014 were in-line with our expectations for 2020 because we centre our research around Wright’s Law and forecasting cost declines. We have identified 14 transformative technologies that are approaching tipping points as costs drop, unleashing demand across sectors and geographies and spawning more innovation.

Because the lines between and among different platforms sometimes blur, particularly in this age of convergence, we have bucketed the candidate technologies into five major platforms:

1. artificial intelligence
2. DNA sequencing
3. robotics
4. energy storage
5. blockchain technology.

In 2020, the COVID-19 pandemic had a profound positive impact on innovation because innovation tends to take relative share during uncertain times.

Many of these disruptive technologies experienced an acceleration in adoption as business and consumers turned to innovative solutions during the pandemic. As a result, we pulled forward adoption curves and increased total addressable markets for most disruptive innovations. Some examples include:

• digital wallets
• electric vehicles
• genomics sequencing and genetic diagnostic research
• drone delivery
• robotic logistics
• 3D printing.

According to our estimates, the five technology platforms should generate more than USD50 trillion in business value and wealth creation over the next 10-15 years. Today, they are in their infancy and account for less than $6 trillion in global equity market capitalisation, giving investors an opportunity to capitalize by almost 10-fold if they have positioned their portfolios on the right side of innovation. We will be releasing our Big Ideas 2021 in early January that will highlight the breakthrough technologies that we believe will advance significantly over the coming year.

Finally, ARK’s Big Ideas Summit will be coming out to Australia through Nikko AM, your strategic partner, and exclusively through Livewire, in mid-November. What can investors expect from your presentation?

The event seeks to educate investors and the general public on current market dynamics, as well as innovations that we believe have gained traction during the pandemic and will continue to have a significant impact on our world. Highlighted most recently by the COVID-19 pandemic, during times of fear, uncertainty, and doubt, businesses and consumers are willing to change their behaviour and seek innovative products and services that are more productive, cheaper, faster, and creative. As a result, innovation typically takes root and gains significant market share during and after tumultuous times. We seek to be on the right side of change.

Not everyone sees the next big thing coming

Click to visit the Nikko AM ARK Global Disruptive Innovation Fund Profile to learn more about the Fund, fees and performance.

Click to visit the Catherine Wood Contributor Profile, to discover her investment philosophy and content.

Register now for Big Ideas

ARK’s Big Ideas Q&A on 17th November seeks to educate retail, adviser and institutional investors on innovations that it believes are gaining traction and will have a significant impact on our world over the next five to ten years: drones, streaming media, and the digital economy. To register for the event, please click here