The Case for Innovation ETFS as an Important Diversifier

ByDylan Callaghan Published On:

It’s simple. Innovation has the potential to create higher productivity – the same input generates higher output. As productivity increases, more goods and services are produced, and the company or the overall economy grows.

Innovative companies, in turn, will displace industry incumbents as they see an increase in efficiencies and productivity, leading them to gain market share. The long-term exponential growth potential of these innovative companies is what investors in this space are after.

Technology is advancing at a rapid pace

In the late nineteenth century, the introduction of the telephone, automobile, and electricity changed how we communicated, travelled, transported, and powered our economy. The world’s productivity went through the roof as costs dropped, creating demand across multiple sectors.

The global economy is undergoing the next significant technological transformation that will shape the future. Innovations in areas such as artificial intelligence, robotics, DNA sequencing, energy storage and blockchain technologies are evolving rapidly and seeing cost declines that are expected to lead this growth further.  

For Canadians, however, getting into these types of technologies is very difficult unless you own USD and buy USD-domiciled ETFs or stocks.

Introducing BMO’s ARK ETFs

ARK Invest and Cathie Wood, two names synonymous with innovation investing, have partnered with BMO Global Asset Management to offer three ETF series focusing on disruptive innovations that trade in Canadian dollars.

Now, before you write off ARK funds because of their returns the last few years, let me at least explain their overall philosophy.

ARK’s investing philosophy

ARK believes innovations should meet three criteria and invests accordingly in these unconstrained, high-conviction portfolios.

3 Criteria for Innovations

  1. Dramatic cost declines
  2. Cuts across sectors and geographies
  3. Serves as a platform for additional innovations

DNA sequencing innovations aim to cure cancer and other diseases (not just treat them). Blockchain technology is shaping the future of the internet (web 3.0) and solving problems around data security. 

Innovation touches all sectors, not just technology and healthcare, as some would think. While technology inherently fuels innovation, innovative companies cut across industries. It also reaches across geographies, and the companies that are not adapting will fall behind.

An example of recent innovations

Within the tech industry, Microsoft’s upgrade to its Bing search engine, including an AI chat feature powered by OpenAI, is causing investors to wonder about the future of Google. While many analysts think the goal is to capture a meaningful share of the search market, it may be that Microsoft aims not only to lower Google’s search margins but also to dissuade Alphabet from running Google Cloud and other businesses at a loss.

What’s clear is that the pace of change is accelerating alongside cost declines, so while it took the telephone close to a century to take hold, innovations today are taking place and being adopted at a record pace.

How to use Innovation ETFs in a Portfolio

Did investors possibly get a bit too optimistic and euphoric on innovation ETFs during the pandemic? Likely. However, Innovation ETFs can serve as a complement or a growth sleeve in a traditional diversified portfolio.

These innovation ETFs are for investors with a longer time horizon. They can serve as an effective complement to Canadian-focused portfolios that are typically less exposed to technology.

Investing in these disruptive innovations can help you hedge against the risk that many of the tech leaders we see today could be displaced. Below is an outline of two simple strategies you could realistically deploy for portfolio construction using BMO’s ARK ETF Series.

Core Satellite Approach: Asset Allocation ETF & High Growth ARK ETFs

  • For the core portfolio, you can build your own or select an appropriate Asset Allocation ETF.
  • You can add a satellite position in an ARK ETF to add higher growth potential over the long term.

Barbell Approach: Low Volatility & High Growth ARK ETFs

  • Pair a low-volatility ETF such as BMO Low Volatility US Equity ETF (ZLU) with an ARK ETF to balance the higher-risk growth solution with a lower-volatility solution

To those visionaries who believe in the power of innovation to change the way we live, BMO’s partnership with ARK brings investors in Canada the option to invest in these game-changers in Canadian dollars. We have our share of problems in the world today, but innovation solves problems.

To learn more, Click Here

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