ARK Innovation, the flagship ETF from Cathie Wood’s Ark Investments, is down more than 15% so far in 2022, and underperformed Invesco QQQ Trust by 65 percentage points in 2021, details an article in The Wall Street Journal by Jason Zweig. In explaining the rise and fall of ARK, Zweig points to the fatal flaw of ETFs: they have the potential to get too big too fast, and no one can stop that trajectory.

ETFs are usually much cheaper and more tax-efficient than mutual funds, and investors have been flooding into them for the last decade. But where mutual funds can close themselves off to new investors, effectively damming up a flood, ETFs generally don’t shut new investors out. But it’s that limitless potential for growth that can be its undoing: the better the performance of the ETF, “the bigger it will get, and the more likely it is to end up doing worse,” Zweig writes.

In the case of ARK, the firm’s growth was so fast that it wound up owning a large portion of a lot of its holdings. Owning too much of itself reduces their ability to trade those holdings without negatively affecting the price; prices inflate when the fund buys, and fall when they sell. Then those actions damage returns.

ARK declined to comment for the Journal article, but they’ve said in the past that their funds can “scale exponentially” as their favored sectors grow. But that trajectory could still result in devastating losses for their investors. Looking back, ARK gained less than 2% over its first years of existence. At the end of 2016, it only had $12 million in assets so ts huge 87% gain in 2017 was only earned by a small number of investors. When investors began buying in en masse in 2020, they deluged the ETF with $13 billion in new money, and right away performance peaked. The fund lost 23% in 2021, and there were too many investors at that point to capture any of its biggest gains.

The problem, Zweig writes in conclusion, with this cycle is that an ETF is constantly chasing past performance, but it won’t ever catch it as new money pours in. And though ARK has gained an average of more than 31% annualized over the last 5 years, it’s estimated that as a whole its investors have lost money since its launch in 2014.