Cathie Wood is no Buffett – With insights from The Wall Street Journal

Investment guru Steve Eisman who was immortalised in The Big Short book and movie, warned in August 2018 that Tesla's bubble was about to burst. I put together a podcast on his scathing views. Back then, at the other end of the spectrum was Cathie Wood of ARK Innovation who said Tesla was massively undervalued. Eisman stopped betting against Elon Musk in February last year, closing out his shorts because "everyone has a pain threshold….when a stock becomes unmoored from valuation…and has cult-like aspects to it, you just have to walk away." Eisman's decision was costly – but as Tesla's share price has quadrupled since, it was one of the better calls of his career. On the other hand, ARK's Cathie Wood is still riding the Tesla wave, and as a result of huge outperformance there have been massive inflows into her supercharged Exchange Traded Fund. Should you join her fan club? Here's the analysis from our partners at The Wall Street Journal. – Alec Hogg.Use Spotify? Access BizNews podcasts here..Use Apple Podcasts? Access BizNews podcasts here..___STEADY_PAYWALL___.Warren Buffett's latest challenger will fizzle like the rest.Cathie Wood has ridden stocks like Tesla to stardom, but funds like ARK Innovation ETF are best avoided after they get hot.By Spencer Jakab of The Wall Street Journal.Jan. 9, 2021 10:03 am ET."Move Over, Warren Buffett : This Is the Star Investor You Should Be Following.".So read the headline on a year-end article from retail investing advice site Motley Fool touting the performance of fund manager Cathie Wood. Variations on the "Buffett is done" theme have been around since at least the tech bubble, while the cult of star mutual-fund managers goes back to the 1960s. Such commentators have eventually eaten their words..Not that Ms. Wood's performance is anything to sneeze at. Her largest exchange-traded fund, the ARK Innovation ETF, ARKK -2.99% surged by almost 160% last year, growing assets 10-fold—unprecedented inflows for an active fund of that type. She made concentrated bets on hot stocks such as Tesla, Roku, Square and biotechs boosted by the Covid-19 pandemic. An ARK Invest spokesperson wouldn't elaborate, but Ms. Wood told an interviewer last month that she expects to nearly triple unit holders' money over the next five years.That is unlikely. In fact, similar star managers' performance has tended not only to be mean-reverting but actually worse-than-average after their runs end. Bill Miller, who famously beat the S&P 500 from 1991 through 2005, drawing huge inflows into Legg Mason Value Trust, spent the next few years as one of the worst fund managers in the country.Comeuppances are especially harsh when a manager has ridden a hot category as Ms. Wood's firm has done. The fate of mutual-fund firm Janus is instructive: Between the end of 1998 and the end of March 2000, it went from being the 20th largest mutual-fund firm to the fifth largest—an incredibly rapid ascent. It bet big on tech highfliers such as Cisco Systems and AOL. As the bubble burst, some of its funds lost two-thirds or more of their value.Fund managers are often compared with dart-throwing monkeys. That might be too flattering for those who get the most attention. Hot funds' performance is often worse than random on the downside. A regularly updated study on the persistence of investor performance from S&P Dow Jones Indices shows that just 0.18% of domestic equity funds in the top quartile of performance in 2015 maintained that through each of the next four years—less than half what one would have expected by pure chance. And of course most actively managed funds lag behind the index to which they are benchmarked because of fees and taxes.This explains the amazing rise of index funds. It is mainly the supposed existence of stars such as Ms. Wood that has staved off an even bigger exodus from actively managed funds. Studies have shown, though, that actual stock-picking skill is very rare and is only provable after decades—the sort of record that Mr. Buffett has established. An academic study by Jerry Parwada and Eric Tan that examined the Morningstar Fund Managers of the Year between 1995 and 2012 showed that winners got big inflows but that their future performance was unremarkable. Indeed, one fund manager who later stumbled blamed the difficulty of deploying the extra cash for his poor results.That makes sense. If one looks at Mr. Buffett, his results when he ran a modest partnership in the 1960s were far better than those of his huge, diversified conglomerate recently. But, unlike a share of Berkshire Hathaway, BRK.B -0.26% the dollar-weighted returns of a growing fund are worse than the stated results because more people are around for the stumble than the ascent.Hot funds can burn you.Write to Spencer Jakab at spencer.jakab@wsj.comCopyright ©2020 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8Appeared in the January 11, 2021, print edition as 'Challenger To Buffett Is Likely To Fizzle.'WSJ opens select articles to reader conversation to promote thoughtful dialogue. See the 'Join the Conversation' area to the right for stories open to conversation. For more information, please reference our community guidelines. Email feedback and questions to moderator@wsj.com.

Cathie Wood is no Buffett – With insights from The Wall Street Journal

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