Professional equity managers use three main kinds of tools to help them think about how to shape their portfolios. They are: research services, either in-house or bought from third parties, that provide economic information and individual stock analysis; price and data feeds that give company/industry news and real-time and historical information about the trading of individual stocks, industry groups and markets; and performance attribution reports that calculate portfolio performance vs. its benchmark and break out under/outperformance by individual stock, industry and sector.

Performance attribution reports can be a blessing or a curse. I had a colleague, for example, who had a simplified version of an attribution report rigged up on his desktop to show, second by second, how his portfolio was doing vs. the S&P 500. Instead of thinking about stocks he was watching their random trade-by-trade dance, which absorbed a lot of his time. Also, I don’t see how he wasn’t paralyzed into inaction during bad times, when he pummeling himself with how much money he was losing for clients rather than figuring out how to make things better.

But that’s just me.

Even though I think it’s a mistake for us to try to chart every little twist and turn in the market and in the stocks we hold (the academic view is that less-than-a-month stock movements are just random fluctuations), it is important to sit down, say, monthly and spend some time thinking about what went right and what went wrong. Personally, I also think that if/as one gets familiar with what normal price action is in a stock, unusual movements–that may contain information–will begin to jump out. For almost everyone, though, the effort involved is much higher than the reward.

What made me think about this today is that I was scrolling through my tablet looking at the list of stocks I follow (I use Yahoo Finance). I was looking mostly at the performance of stay-at-home stocks over the past six months. They have been, by and large, the considerable laggards I’d expected. This tends to confirm for me my thought that the market has been rotating away from them into stocks that stand to do well in a world where the pandemic is under control. (In my view, two factors are involved: the idea that the pandemic is within six months of being under control and the assessment that stay at home stocks were/are already at nosebleed high prices and would need a second catastrophe to emerge to drive them higher.)

We all can–and should–do something like this periodically. Many years of experience as a portfolio manager and a supervisor of other portfolio managers has shown me that clunkers (especially the really stupid things everyone does) in a portfolio tend to develop a cloak of invisibility that prevents their being seen and removed. The only defense is a regular position-by-position review. Getting rid of one or two can have surprisingly positive results in a portfolio.

This is really two comments. The first is about expectations:

–the flagship ARK ETF is Ark Innovation, ticker ARKK. Last year, according to my Yahoo Finance chart (I write this qualifier because my memory is the return was slightly different), ARKK gained +184%. This compares with an advance of +43% for NASDAQ and +18% for the S&P 500. The Dow, the ghost of Christmas past and kind of the inverse of ARKK, struggled to rise a tad less than 9%.

Yes, ARKK is a highly concentrated portfolio (the top ten holdings of last Friday made up 45%+ of its assets) and is focused on the most rapidly expanding parts of the world economy. On the other hand, it came close to tripling last year. It delivered something like 10x the return of the S&P and 5x that of NASDAQ. This, as the typical professionally managed portfolio struggled (as usual) to keep pace with its benchmark.

A burning question: what are the chances that ARKK can repeat its 2020 performance this year? Given my strong belief that investing (and life, for that matter) is a lot like baseball, my bet is that the business cycle-sensitive team will get a turn at bat in 2021 and may score a bunch of runs while secular growth sits on the sidelines. That’s the way the stock market always works, so why would anyone expect something different now?

I think that although some will always chase the flavor of the month, most mutual fund/ETF investors understand this and will remain with a competent manager. Also, all but the most recent purchasers will have substantial capital gains, which typically deter taxable accounts from cashing in.

So it seems to me that financial press fears of widespread redemptions in the ARK funds as/when they have a period of underperformance are way overblown.

My second thought is about redemptions from ETFs vs. mutual funds:

–if I hold shares in a mutual fund and want to sell them, I have my broker return them to the mutual fund company, which cashes the shares out at net asset value, which it calculates after the close of trading that day. The fund typically has a enough cash on hand to deal with ordinary redemptions, plus bank credit lines to use if need be.

If I hold ETF shares, on the other hand, and want to sell, my broker deals with an Authorized Participant (AP), who is basically a market maker who buys and sells the ETF’s shares during normal trading hours. The AP always knows what NAV is (from the stream of every-15-seconds exchange price updates), and makes a bid-asked spread around it. If there’s lots more selling of the ETF than the AP can find buyers for, the AP has the ability to return the excess to the ETF company in exchange for bundles of stock the ETF holds.

Strictly speaking, then, unlike a mutual fund, an ETF itself never has to sell holdings to raise cash–because it meets redemptions from APs by delivering stock the ETF holds instead. The AP, typically part of a big bank or brokerage firm, isn’t forced to sell the stocks it gets. If it does decide to sell, the AP isn’t under the same time pressure as a mutual fund. Finally, my observation is that in past times of great market stress, which is far from the condition we’re in now, the AP could easily be holding more stock than it would care to, if it bid for shares at around NAV. So the AP lowers the bid to the point where excess selling dries up. This does two things: it stops at least some selling, and it makes the reward for taking the risk of holding the ETF shares it does buy, or redeeming them for stock, more palatable.

This characteristic of ETFs has two consequences: the ETF doesn’t have to have a cash reserve to meet possible redemptions and it has less risk in running a concentrated portfolio than if it were a mutual fund.

A closing note: the financial press has advanced worries that if redemptions in concentrated ETFs/mutual funds become either high or protracted, the funds will sell their most liquid holding first, leaving “loyal” shareholders with illiquid dregs. It’s possible–in the sense of I can write a sentence describing this behavior and understand what it means–this could happen. But normal portfolio practice during a period of redemptions is to go to work immediately on selling illiquid positions, precisely to avoid the situation the press describes.

I’ve just updated my Keeping Score page for February 2021. Early signs of a recovering economy.