ARK Transparency ETF – Is the Disruptive Innovation Fund Trying to Get on the ESG Bandwagon?
Catie Wood’s ARK Invest has filed for a new index ETF. If approved by the SEC, the ARK Transparency ETF will hold up to 100 stocks with great transparency indicators. Despite leaving out some controversial industries and even banks and oil companies, the ART Transparency ETF is not too far from a classic broad ESG ETF.
ARK Invest, the famous investment fund led by Catie Wood, which focuses on disruptive innovation, has made a filing for a brand new ETF in August 2021 with the Securities Exchange Commission (SEC).
The fund to be named ARK Transparency ETF is different than most ARK actively managed funds. It is a passively managed fund that will follow the Solactive’s Transparency Index.
This new ETF from ARK Invest is being called by main the media outlets “the first ARK’s ESG ETF”. However, ARK Invest is not using the ESG term to refer to this fund. Transparency-themed is a more appropriate definition.
Let us evaluate how the ARK Transparency ETF relates to ARK Invest’s overall strategy, analyze the fund investment strategy and its potential holdings.
How sustainable are ARK funds?
ARK Invest is among the top 11 largest ETF issuers and saw its popularity soar during 2020, mainly driven by ARK Innovation ETF (ARKK), which had an astonishing return of around 150% in that year.
According to their website and quote above, ARK’s main strategy is to invest in disruptive innovation and, consequently, use technology to solve some of the world’s most challenging and persistent problems.
However, ARK Invest sees sustainability as a consequence of its focus on technology and disruptive innovation. Not the other way around. Sustainability or ESG ratings are not the main motivation for ARK Invest when selecting companies and creating ETFs.
According to ARK’s Sustainable Investing and ESG Policy, ARK seeks positive investment outcomes by focusing on five main innovation platforms:
However, when it comes to ARK’s active ETFs, despite not excluding companies or sectors from their investment universe, ARK still evaluates ESG-related components at each company.
When performing their bottom-up research, ARK scores companies based on six key metrics, and claim that at least three of them include ESG components, as below:
- Company, People and Culture (ESG component)
- Execution of Objectives
- Moat* or Barriers to Entry
- Product and Service Leadership (ESG component)
- Valuation: 5-Year Return (requires a 15% compound annual return hurdle rate)
- Thesis Risk (ESG component)
Note: The term economic moat, popularized by Warren Buffett, refers to a business’ ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms.
What is ARK Transparency ETF investment strategy?
If approved by the SEC, the ARK Transparency ETF will join the other two ARK Index ETFs: The 3D Print ETF (PRNT) and Israel Innovative Technology ETF (IZRL).
The ARK Transparency ETF tracks the Solactive Transparency Index. The index’s investment strategy follows specific volume and market cap criteria, applies industry exclusions, and considers a transparency score when selecting its almost 100 holdings.
Criteria: a company must maintain a 30-day moving average market capitalization of at least USD 1 billion and have a minimum average daily trading volume of 200,000 shares over three-months period.
Exclusions: companies operating in the following industries are excluded from the index: Alcohol, Banking, Chemicals, Confectionary, Fossil fuel transportation, Gambling, Metals, Mineral, Natural gas, Oil, Tobacco.
Pre-revenue companies are also excluded from the index.
Transparency score: the Index measures the transparency level of each company based on six KPIs:
- Transparency Standards: focus on the existence and quality of 10 different types of corporate documents, including privacy standards, customer standards, diversity standards.
- Terms and Conditions: depend on the length of a company’s terms and conditions document, with higher scores assigned to companies with documents that are shorter and simpler.
- Total Accountability: based on the company involvement in certain types of lawsuits (e.g., class action lawsuits brought by shareholders). The score depends on both the number of lawsuits involving the company, as well as the nature of the claims in those lawsuits.
- Transparent Cost: determined by whether the prices and descriptions for a company’s products or services are clearly stated on the company’s website. Companies that provide more information on their websites, such as prices, costs, and product service details, will receive higher scores than companies that provide less information on their websites. Not applicable to B2B companies.
- Truth: based on the aggregate number of lawsuits the company was involved in during the last 12 months
- Trust: based on the weighted average of multiple sources of corporate reputation rankings.
Despite not being called an ESG fund, the ARK Transparency ETF follows criteria like most broad ESG ETFs. It excludes companies in controversial industries and prioritizes companies that are transparent, accountable for their actions, and have good governance. However, like most broad ESG ETFs, ARK Invest and Solactive are not fully transparent on all the criteria and metrics used to assess the transparency of each company.
ARK Transparency ETF holdings and ESG ratings
The ARK Transparency ETF is expected to be an ETF mainly focused on US companies, but still a highly diversified ETF, with 99 holdings and allocation of less than 2% per stock (5% is the limit according to the Index rules).
Below we list all the 99 holdings of the (potential) ARK Transparency ETF and include their ESG risk ratings from Sustainalytics:
|ATLASSIAN CORPORATION PLC||TEAM||1.43%||19|
|DIGITALOCEAN HOLDINGS INC||DOCN||1.41%||NA|
|CLOUDFLARE INC - CLASS A||NET||1.29%||23.2|
|CHIPOTLE MEXICAN GRILL INC||CMG||1.28%||24.2|
|ASML HOLDING NV||ASML||1.15%||11.8|
|THERMO FISHER SCIENTIFIC INC||TMO||1.13%||14|
|COSTCO WHOLESALE CORP||COST||1.13%||23.2|
|AXON ENTERPRISE INC||AXON||1.12%||41.3|
|FULGENT GENETICS INC||FLGT||1.12%||NA|
|COINBASE GLOBAL INC -CLASS A||COIN||1.09%||NA|
|LULULEMON ATHLETICA INC||LULU||1.07%||13.8|
|CROWDSTRIKE HOLDINGS INC||CRWD||1.07%||18.4|
|TREX CO INC||TREX||1.07%||23.7|
|EATON CORPORATION PLC||ETN||1.05%||17.2|
|SONY GROUP CORP||SONY||1.04%||13.5|
|DEERE & CO||DE||1.03%||16.7|
|AIRBNB CL A ORD||ABNB||1.03%||25.2|
|SUMO LOGIC INC||SUMO||1.03%||NA|
|TWIST BIOSCIENCE CORP||TWST||1.00%||NA|
|SUZANO PAPEL E CELULOSE SA||SUZ||0.99%||20.9|
|ROPER TECHNOLOGIES INC||ROP||0.98%||20.3|
|SPOTIFY TECHNOLOGY SA||SPOT||0.98%||24|
|CANADA GOOSE HOLDINGS INC||GOOS||0.95%||16.9|
|HONEYWELL INTERNATIONAL INC||HON||0.95%||30.7|
|BEST BUY CO INC||BBY||0.94%||14.3|
|ACUSHNET HOLDINGS CORP||GOLF||0.94%||NA|
|MCCORMICK & CO-NON VTG SHRS||MKC||0.93%||28.4|
|DONALDSON CO INC||DCI||0.92%||34.5|
|CANADIAN SOLAR INC||CSIQ||0.92%||NA|
|VERIZON COMMUNICATIONS INC||VZ||0.91%||17.9|
|MOMENTIVE GLOBAL INC||MNTV||0.91%||NA|
|ROGERS COMMUNICATIONS INC||RCI.B||0.89%||21.8|
|TELADOC HEALTH INC||TDOC||0.88%||21.8|
|DELL TECHNOLOGIES INC||DELL||0.87%||16.1|
|PELOTON INTERACTIVE INC||PTON||0.85%||NA|
|FIVERR INTERNATIONAL LTD||FVRR||0.85%||NA|
|ZILLOW GROUP INC||Z||0.84%||29.4|
|PROTO LABS INC||PRLB||0.84%||NA|
|BLOOM ENERGY CORP||BE||0.83%||NA|
|NATURA & CO HOLDING SA||NTCO||0.81%||25.9|
|ZOOM VIDEO COMMUNICATIONS INC||ZM||0.77%||18.9|
|TPI COMPOSITES INC||TPIC||0.77%||NA|
|BEYOND MEAT INC||BYND||0.72%||47.5|
|CHARGEPOINT HOLDINGS INC||CHPT||0.67%||NA|
When it comes to ARK Invest it is no surprise to find small caps or not-so-well-known companies on their ETFs. However, the consequence of this is the lack of some ESG risk ratings. Out of the 99 companies, 23 do not have an ESG risk rating available from Sustainalytics.
From the remaining 76 companies, we list the ones with the best and worse ESG risk ratings.
The 5 holdings with best ESG ratings
- CDW Corp (9.1): a provider of technology products and services for business, government, and education.
- HP Inc (10.3): the famous multinational information technology company.
- Avnet (10.3): a distributor of electronic components headquartered in Phoenix, Arizona.
- Hasbro (10.4): multinational conglomerate with toys, board games, and media assets.
- Adobe (10.8): the multinational computer software company.
The 5 holdings with worst ESG ratings
- Beyond Meat (47.5): a Los Angeles-based producer of plant-based meat substitutes founded in 2009. Despite requiring fewer resources when producing its plant-based meat, Beyond Meat has not been transparent enough when disclosing its environmental and social impact
- Axon Enterprise (41.3): is an American Scottsdale that develops technology and weapons products for the military, law enforcement, and civilian. The weapons industry is not excluded from the Solactive Transparency Index, however, companies involved in this business are penalized by ESG risk rating agencies.
- Donaldson Company (34.5): a vertically integrated filtration company engaged in the production and marketing of air filters. Despite the high ESG risk rating, no major controversies were found about the Donaldson Company. Morningstar indicates a moderate controversy related to customer incidents.
- Amazon (30.9): the famous American multinational conglomerate which focuses on e-commerce, cloud computing, digital streaming, and artificial intelligence. Not surprising to see that Amazon has a high ESG risk rating. However, it is surprising to find Amazon at the ARK Transparency ETF. Amazon has had several issues related to the lack of transparency of its business
- Honeywell International (30.7): another American multinational conglomerate. It operates in aerospace, building technologies, performance materials and technologies. Honeywell is well known for its involvement with weapons and military contracting, therefore the high ESG risk rating.
Is the ARK Transparency ETF an ESG fund?
The new ARK Transparency ETF is not an ESG fund, and ARK Invest does not advertise it as such.
By excluding controversial industries and focusing on transparency, we can say that the ART Transparency ETF is equivalent to a broad ESG ETF, but with a stronger focus on the ‘G’ of Governance.
Is ARK Transparency ETF a good investment?
Considering that the ARK Transparency ETF is quite like a broad ESG ETF, it ends up having all the pros and cons of generic ESG ETFs. It avoids controversial industries and focuses on companies with good transparency and governance. However, it lacks strength when selecting companies for its highly diversified portfolio, resulting in a weak investment case.
For example, Amazon and Beyond Meat are clear cases of companies that have a long way to go when it comes to transparency.
ARK Transparency ETF does not differentiate itself enough from similar alternatives in the ETF market and could be easily replaced by other broad ESG ETFs with lower fees.
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