Cathie Wood’s Growth Plays Stumbled Against Value. Here Are 6 Takeaways.

The debate took place on Sept. 22, 2021. I wrote about it and concluded that value vs. growth was the wrong topic to debate. I’ll explain in a bit.

Here is a brief summary of their arguments:

• Wood, arguing for growth, suggested disruptors like companies in genetic sequencing and artificial intelligence, where costs are declining and the technologies are converging, would lead to share outperformance. She stated that most analysts don’t realize this and the companies in this space are undervalued. Wood said her modeling shows a 30% annualized return over the next five years. 

• Arnott argued that the valuation spreads between growth and value were near record levels and would narrow because these spreads are the best predictor of future performance. He concluded that mean reversion would follow and value would outperform growth as a result. Arnott noted that companies that have disrupting technologies often get disrupted themselves. He used Palm, a 3Com spinoff, and BlackBerry as examples. Arnott told me he thought there was a 60% to 70% probability of value outperforming growth in the next year and a 90% probability over the next decade. 

While there are different definitions of value and growth, I decided to use the Russell 3000 indexes as surrogates for the U.S. stock market. I started with the closing values the day of the debate and ran the numbers using the total returns through June 24, 2024.

Growth handily outperformed value. From September 2021 through June 2024, The Russell 3000 Index returned 8.3%. The Russell 3000 Growth index returned 9.6%, and the Russell 3000 Value Index 6.5%.

This suggests that Cathie Wood should be looking pretty good so far since growth did outperform value substantially. But looks can be deceiving because neither Wood nor Arnott invest in the indexes. So I decided to compare Wood’s ARK Innovation ETF to the Invesco FTSE RAFI US 1000 ETF . The latter uses Arnott’s smart beta methodology. The results are staggering. From September 2021 through June 2024, Invesco FTSE RAFI US 1000 ETF delivered a total return (including dividend reinvestment) of 8.7% annually while Wood’s ARK Innovation ETF had a negative total return of 30.2% annually.

Although Wood has so far been right on growth outperforming value, her fund’s results to investors were dramatically worse than Arnott’s. His smart beta methodology of weighting stocks toward value actually slightly outperformed the full Russell 3000 index after covering the 0.39% annual expense ratio. Wood’s ARK Innovation fund lost more than 30% annually—a far cry from the positive 30% annualized returns she predicted during the debate. Most of the bad performance occurred within the first several months after the debate, although she underperformed over the entire period. 

Wood was brilliant in specifically pointing out the disruptions from artificial intelligence as the reason for outperformance, but she didn’t pick the right companies to buy. 

Much of the debate back in 2021 centered around the valuation of Tesla . Wood stated production costs would continue to decline on batteries so that by 2025, electric vehicles will be much cheaper to produce than combustion vehicles. She stated that $3,000 per share was a fair price though this would translate to $1,000 since Tesla had a 3-1 stock split. That means her models showed Tesla’s valuation at four times the price at the time of the debate.

Arnott said then that the current Tesla valuation implied 50% annual cash flow growth for the next 10 years, which he said was unlikely. 

What happened was Tesla stock declined 27% through June 24, 2024. Many analysts are predicting declining sales for Tesla this year as China’s BYD became the largest seller of electric vehicles. Deliveries have declined year over year for the first two quarters of 2024. Nvidia , on the other hand, gained 477% during the same period to become one the three most valuable companies on the planet due to the disruption of AI that Wood predicted. 

Lessons learned

Why am I writing about a debate that took place nearly three years ago? It isn’t because I want to award a prize to Arnott or direct attention to the billions of dollars Wood lost for investors. The purpose is to use the benefit of hindsight to illustrate some lessons for the future. Here are six:

• No one can predict whether value or growth will do better over the next year or three years. That’s why it was the wrong topic to debate. I recommend owning both. 
• Being right that growth will outperform value and insightful to realize that AI is going to disrupt and create wealth, isn’t enough. You’ve got to pick the right companies to buy. 
• Being wrong isn’t necessarily bad. Even though Arnott was wrong about value outperforming growth, his smart beta methodology of weighting stocks toward value actually slightly bested the overall Russell 3000. But don’t take this as a forecast that it will outperform going forward. The Russell 2000 small-cap index declined 1.2% annually over the period I studied and is likely the reason Arnott’s fund outperformed.
• Compelling arguments are often wrong. Though I previously wrote that Wood had the most compelling arguments during the debate, they were already known and priced into the market. The most compelling arguments tend to tug on the emotional side of our brain. Arnott, on the other hand, used statistical data, which, while often less compelling, appeals to the more logical side of our brain.
• Market concentration is dangerous. ARKK held a handful of stocks, which means you can either win or lose big. Typically, concentrated funds eventually lose big. Jason Zweig recently explained in The Wall Street Journal why hot funds have self-inflated returns.
• Money tends to pour into hot funds just at the wrong time. 

I don’t know the future, which is why I recommend total stock index funds that own both value and growth. I continue to believe overweighting one over the other adds risk to portfolios irrespective of which one happens to outperform next year. I recommend to my clients that they own every stock in proportion to its market capitalization, which takes into account the combined knowledge of millions of investors. 

Allan Roth is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He is a licensed CPA and CFP, and has an M.B.A. from Northwestern University (Kellogg), but still claims he can keep investing simple.