The Breakdown - An Interview With Cathie Wood on Bitcoin, Tesla and Innovation Investing

Episode Date: April 2, 2021

This episode is a replay of NLW’s conversation with Cathie Wood from October 2020. In it, they discuss:   Why she had conviction in Tesla before the market caught up  Why her fund offered the first bitcoin investment opportunities to Wall Street Why it doesn’t hire traditional Wall Street analysts  Why it gives away all research for free Why it shares the trades made in a completely open-source way ARK’s recent Bitcoin Investment Thesis white paper What the prospects are for innovation in 2021  Find our guest online: Twitter: @CathieDWood Web: ark-invest.com   This episode is a replay of NLW’s conversation with Cathie Wood from October 2020. In it, they discuss:   Why she had conviction in Tesla before the market caught up  Why her fund offered the first bitcoin investment opportunities to Wall Street Why it doesn’t hire traditional Wall Street analysts  Why it gives away all research for free Why it shares the trades made in a completely open-source way ARK’s recent Bitcoin Investment Thesis white paper What the prospects are for innovation in 2021  Find our guest online: Twitter: @CathieDWood Web: ark-invest.com

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. This episode of The Breakdown is originally aired on the 9th of October 2020. What's going on, guys? Today I am so excited to share with you a conversation with Kathy Wood. Many of you will be familiar with Kathy, but for those who are not, she is the chief executive officer. and the chief investment officer for ARC Invest. In a recent cover story, Forbes called Kathy Wood the newest superstar investor,

saying that she had, quote, leveraged a zealous belief in innovation into a $29 billion in assets firm and a $250 million net worth. In case you need some more statistics, ARC's flagship $8.6 billion ARC innovation fund is up 75% in 2020 and is returned an annual average of 36% over the last five years, which is nearly triple that of the S&P 500. ARC is an asset management firm focused solely on innovation, investing in areas from genomics to cryptocurrency to autonomous vehicles. They're perhaps best known in the last couple years for their at times highly controversial and always high conviction bet on Tesla, but they were also one of the earliest, in fact,

maybe the earliest Wall Street firm to offer Bitcoin as an investable asset. In this conversation, we talk about everything from specific domain theses to how Ark works differently, to how Kathy sees the world changing in the year to come. So without any further ado, let's dive in. All right. We are back with Kathy Wood. Kathy, thank you so much for spending some time with us today. Oh, I'm happy to be here, Nathaniel. Thank you for inviting me. You bet. So there's so much to dig into. I'm really excited to talk about. I just gave a little bit of an introduction before this to you and your background and Arc. But I'd love if you could just, in your own words, for people who are not familiar, describe yourself and Arc, really, what you guys are out of the world doing.

Right. Well, I founded Ark InVest. in 2014 for two reasons. The first was to focus exclusively on disruptive innovation. I felt that it was a huge unmet need in the market because after the tech and telecom bust and then 0809, so over those 10 years and even longer, we saw risk aversion rise in the market, and what did that mean?

It meant to move towards indexed or passive strategies. And at the same time, we saw the search for innovation or getting exposure to innovation moving into the private markets. And yet there were some amazing companies in the public markets and they were being neglected, both from a research point of view. They weren't big parts of indexes, if they were in the index at all, and from a valuation point of view. So there was a lot of low-hanging fruit.

We saw companies in the private market. trading for 10 or 20 or 30 times the valuations in the public markets. So that was the first reason and really addressing what I believe is the most massive misallocation of capital that has happened ever. This move towards indexation. More than half of the ownership in stocks today in the United States is in passive wrappers like ETFs and mutual funds. And so we wanted to actually become a hedge against the value traps that are populating those indices

increasingly over time. So that was the first run. The second reason I started ARC was to evolve an open research architecture and patterning it after open source software. You know, there are a lot of contributors to open source software, and they are not paid directly for contributing, but they may be elevating their status in the community. They may be helping their consulting practices. They may be trying to solve a problem in their own businesses, and so open source software has helped them. In the same way, I feel that there's so much innovation taking place at the same time now. I mean, we've never seen anything like this, and we can go into that in a moment, that it's not possible for one research house to be able to research these ideas effectively. And in fact, I think research departments in our business, the asset management business, are going to have to restructure entirely in order to understand how innovation is going to evolve in the world. So right now, most of the traditional asset management world is very siloed, very specialized, very short-term in its focus.

What we have now are innovation platforms that are cutting across economic sectors. That's not how the world is set up in traditional asset management. And yet that is how it will have to be set up if companies want to capitalize on the exponential growth curves and trajectories that are, our five platforms and 14 different technologies are offering today. So there's so much to unpack there. And I want to get into all of it. I would love to talk more about the rise of passive and index investing. And that's something that it's amazing because it's such a frogs boiling in the pot type of scenario where everyone has been living through it.

But it's still this vanguard of conversation in terms of understanding or trying to really understand the true implications of it. So that's something I definitely want to get into. But maybe let's start actually going back. I think one of the things that makes you guys such an interesting phenomenon, really, is that there was this 10-year period where Silicon Valley, I mean, maybe longer, but certainly at least a decade where Silicon Valley got farther and farther away from public markets. And there's a lot of reasons for that. Just the influx of capital moving to the private sector was part of it.

But net net, what you had was this big information gap, this big space, almost a hostility to both sides looking at each other. And in a lot of ways, you guys kind of came in and were like, you blew apart the distinction in some ways between startups and tech, which is sitting over here at just public markets, which is now converging again. I mean, is that, you must have felt a little bit like just kind of wandering off in the wilderness for a while, though, there. Yes. So I funded the firm for three years by myself, and I obviously thought that we were going to take off a lot sooner than we actually did. And part of the problem that evolved was our first wrapper was the ETF. And my question to the marketplace and to anyone who would listen to me is, wait a minute, this is a really good wrapper for. the end investor. It is cheaper, more cost effective. It's more tax efficient. It's more liquid. And probably most of all, most important of all, according to how our clients have received us, is more transparent than the traditional world. And I was saying, okay, that's great. Why can't active do this? Why is this only a passive wrapper? And so just doing that, I thought,

that my sort of network in the traditional financial world would help me with this idea. But what I learned very quickly is, wait a minute, you're in a different world. You know, the passive world and the active world, that infrastructure, those people don't talk to each other. And they also don't trust each other. And so, you know, at one point, probably two years in, I was saying, oh, my goodness, wow. And so we had to pivot and do separately managed accounts and so forth. And that's what really got us going, getting an institutional account. I think we were somewhere in the $20 to $30 million in assets under management and we had been stuck there for a long time when one of my former clients, an institutional fund, a state pension fund, gave us $200 million. So that really put us on the map. I don't think we would have survived. if that had not happened. And it happened, you know, seren, there was a lot of serendipity involved,

if I can say so. So, yes, we were in a foreign land. I didn't realize that before I entered it, but it was foreign and there was more hostility than I had expected. I thought we would be welcome because this would be the next big wave for the ETFs, for the ETF industry's growth. So, yes, we were kind of, I won't say twisting in the wind, I will say, I didn't understand why there wasn't more acceptance of what we had to offer, which was so differentiated. And as it turns out, after that drought and after we got our first few separately managed accounts, In 2017, the combination of bringing in distribution, so we struck agreements with two companies, they have minority interest in ARC, and they became our distributors, both here and in Asia PAC.

And so we started to take off because in 2017, the market started, the public equity market started recognizing innovation in the public space, not just in the private space. Some, I'm sure, public private players like Fidelity and T. Roe were saying, wait a minute, there's a huge arbitrage opportunity here between the public markets and the private markets. Let's start making that happen. I'm not sure if that's what happened, but in 2017, that is what was beginning to happen. And then since then, I think most Many portfolio managers or advisors realize that the world is shifting around them or the ground is shifting underneath them and they don't have enough exposure to it. They're seeing it in their lives, their children's lives, or grandchildren's lives,

and they don't have enough exposure. And so we are, again, solving an unmet need out there because a lot of our companies either are not in indexes or they're very small positions relative to ours. I mean, Tesla is the poster child there. It's shocking. You know, that at 400 billion-ish in market cap, it's still not in an index. It's kind of crazy. It's nuts.

So, but we are filling a void. And the way we were selling ourselves is, hey, you, traditional or advisor with many traditional strategies in your asset allocation, you are. missing us. You are missing disruptive innovation. And oh, by the way, our companies are probably going to give your companies a very difficult time. And we think they're going to either disintermediate or disrupt your companies or bankrupt them. So we did get a little of attention around that, but I do think the 2017 market, the swish there, helped. The other thing that did help. The other thing that did help us, and this was even earlier on, and maybe more relevant to your audience here, was in

September 2015, we were the first public asset managers to gain exposure to Bitcoin. Now, when we did that, there was such hostility out there, if I might say, that the ETF journalists out there were saying, this is just a marketing gimmick. This is just a gimmick. They didn't read our white papers clearly because we had done a lot of research on Bitcoin. And so we were still, though, in that period of who are you and what the heck are you doing here. So there was still that going on and probably writing on and putting Bitcoin into our portfolio or GBT into our portfolio, aggravated that point of view. So 2017, we had some breakthroughs. And now I think most people understand they must have exposure to innovation because if they don't,

they're not doing, they're not doing justice to their clients. Well, innovation is one of these things that people have a tendency to ignore it for as long as humanly possible. And usually that's at least a little bit too long, right? If you're coming from, especially if you're a market incumbent. And it sounds to me just like watching kind of your trajectory that you, actually were trying to do almost like three innovative things all at the same time. You were trying to invest in a different type of asset with a different type of process with a different type of structure,

you know, which is like all of these things made a ton of sense. And frankly, how are you going to invest in innovation without thinking about whether the structure of researching, learning, making those decisions, and then implementing in the market also needs to go through a process of innovation. However, I can see how you come to market and all of a sudden people are like, wait, what? You know, but I think it's... Who are you? Yeah. Who are you? No, it's really, it's really fascinating. So I guess I'm interested in, I guess was another

challenge for you that you kind of reference this at the beginning, but part of the difficulty is that these categories often get changed in the process of being innovated, right? So things don't fit comfortably in, I mean, even just the lexicon that we still use, the idea that tech has performed well this year, but other categories want or haven't. It's like, well, that's sort of true, you know, the broadest brushstrokes kind of way. But what do we mean when we say tech? You know, where do we draw those lines? Well, we believe that tech is permeating every sector, every sector, including industrial utilities, every sector. And the, that analysts who are not comfortable, and you find this especially in health care,

analysts who are not comfortable with technology, because it's either moving too fast or there's a lot of, there are a lot of dislocations, and because the cadence of their own industry is so slow, and regulators often get involved, you find a lot of, you know, a lot of dismissal. You know, there's a, there is a, I often say you've got the old guard and they're in the indexes and they're big parts of the indexes. And then you've got the new guard. The new guard has completely different DNA. And they're nipping at the heels of the old guard. And the old guard basically is saying, off with your heads, you know, we're going to destroy you.

This is our installed base. It happens all the time. And this also influences analysts. So if you think about how the sell side is set up, so the brokers are set up, these analysts have been following their companies often for 20, 30 years. And some, even 40, the business really took off in the 80s. And there are a lot of analysts who have hung on for the ride. And they know the old guard really well.

And the old guard was good to them over the years. The old guard once was the new guard, right? And they were good to them over the years. But now, because of all of these platforms, the five platforms, 14 different technologies evolving at the same time, they have no idea that essentially these companies are the equivalent of Wiley Coyote. You know, they're already off the cliff and they don't know it and they're going to, they're going to collapse. And we certainly think a really good example of that right now. I used to marvel at how the big television broadcasters had just held on to their $70 billion in advertising revenue as their audience were shrinking. Well, guess what?

The coronavirus. And typically a crisis accelerates the shift to new technologies, new ways of doing things. Why? Because consumers and businesses both are scared and they're willing to change the way they do things. So certainly the cord cutting during the crisis accelerated. And now the advertising is following. And we think that after years of holding steady around that 70 billion mark within the next five years, they'll be cut in half. And we see many, many trajectories like that during the next five years, you know, talk about test. the entire auto industry is at risk, right? So it's been, I think the move to passive went to an extreme and opened up this opportunity for us. If passive had not happened, the markets would

have been pricing innovation correctly or more correctly than they have been. And now I think now that the writing is on the wall, there is this. there is this sort of step function shift to, wait, wait a minute, I need more exposure here. One of my favorite mental models is the idea of punctuated equilibrium, which is an evolutionary biology concept that basically Stephen Jay Gould came out with this. And we had kind of viewed evolution as the steady line up, right? And he said, that's not how it happens. There's these long periods where it feels very kind of samey, right? And then there's these moments of explosive change that happen and they settle to a new equilibrium. And once you start to adopt that mental

model, you see it absolutely everywhere. And I think it's interesting because, so, I mean, it seems like your analysis of passive is that it's almost enabled that sort of punctuated equilibrium moment where had active managers still been kind of doing their thing, perhaps the movement over into some of these innovation spaces would have followed that steady line. You know, each year a little bit more would have proven itself and so on and so forth. But instead, there's going to be this race to catch up moment. I mean, is that how you see it? Absolutely. Absolutely. Think about what I said. More than half of all equities in the United States are in passive portfolios. And that does not even include benchmark sensitive. So what happened with active management is after the tech and telecom bust and

0809, you had a stream of quantitative analysts move into our business. And what does that mean? What quant means is they're worshipping at the holy index, you know, which I would call an idol. And basically, the indexes are backwards looking. The companies at the top in these various indices are there because of what has happened in the last 40 years. If there's this, if disruptive innovation is going to be as pervasive as we think it's going to be, Most of those companies are going to be sidelined at best. There's going to be huge consolidation. They're going to be bankruptcies, restructurings, and so forth.

And so the irony here is the traditional benchmarks may not deliver interesting returns because of that. It's been a setup for that unless they move much more quickly towards putting innovative companies in there. There's one company from an index point of view, and again, consider the source, but MSCI has put together a number of innovation indexes because they realized this was a problem in the marketplace. And they, I think, you know, the strategists over there were thinking for a long time, how do we do this? because they were watching ETFs being, you know, birthed, you know, it's sort of spaghetti throwing against the wall just to see which ones would hit. And they knew there was going to be, and there should be a more thoughtful way of thinking about innovation in the public equity markets.

And so, and here's when I'll say, again, consider the source. They were watching our research, and I'll get into our research and exactly what open source means. but they, like many others, because we give our research away for free, they were watching our research and they came to us and said, if we would like to collaborate with you, and all we need as an index provider are the keywords that you think are important in guiding us towards where the world is going. And so they use artificial intelligence and they go scour the world for these keywords. So they're going to have very broad-based portfolios, very, maybe 400, 500 stocks per portfolio, whereas we have 40-ish stock. So we're very concentrated.

We're rifle-shot. They'll be scatter-shot. But in terms of solving one of the reasons I started the firm, and that is helping the markets move away from this massive misallocation of capital towards, something much better, I think MSCI has the right idea. And the way they're thinking about this is in the day, in the 1980s, emerging markets were considered exotic, much in the way that innovation is today, believe it or not. And so companies, asset managers, used to, you know, tiptoe into Brazil or Malaysia or Vietnam and it's at a time. But each of those countries has

idiosyncratic risks. Putting them all together in something called an allocation towards emerging markets helped solve that problem. We've had a much more efficient allocation of capital towards emerging markets because that became a category, both active and passive, right? We think the same thing is going to happen to innovation. Going back to, I guess, the state of affairs as it is now, do you worry that so much of the wealth in this country and the world is wrapped up in these passive vehicles? I don't worry. I think it's a great opportunity for active managers. There are two forces that are going to be very helpful, I think, to equities going forward. One is the shift from passive. We think the pendulum has swung way too far. And when you include benchmark sensitive,

which is practical the same thing, that's probably 80, 90 percent of how equities are managed today, which is kind of crazy. That's the misallocation of capital. We think the pendulum is going to start swinging in the other direction as companies see that, wait a minute, there's some companies out there growing exponentially, exponential growth rates, and the companies in these benchmarks are growing at maybe 4%. That's not very interesting. So I think that aha moment is upon us just because innovation strategies have pulled away from the pack. And there's nothing like success to garner the attention of the traditional world. So that's the first force. The second force that I think is the pendulum has swung in one direction for 40 years, and that is fixed income. I believe that

fixed income, which is still seeing, believe it or not, massive inflows as equities are experiencing outflows, if you look at ETFs and mutual funds, we think that pendulum will swing as well as we move out of harm's way. And as these innovation platforms with their very strong growth characteristics, I'm talking about 25, 30, 45, 50 percent growth rates, their base, their base is going to grow large enough that they are going to make a big difference in GDP growth as these other companies are being disrupted. So as that becomes obvious, we think interest rates will start rising and that there will be a shift away from fixed income back into equities. Now, a lot of people, when they hear that, they think, that's kind of crazy.

Look at what's happened to the equity market since 2009 and even since the bottom of the coronavirus. Look at how equities have done and they've done very well. But we think that now we're going into a different phase where the market is going to be more discerning is going to look for more growth, which is scarce in the world that we're analyzing, at least. And I think we're going to, I think equities, again, more risk-taking is going to see the beneficiary of the move from passive to active and from fixed income to equities. That's a very optimistic scenario, I think, in a way that's great to hear, because there's so

much doom and gloom, I think, about these forces being off the rails. And you're basically making an argument or a market-based argument for a shift back that once these things start proving themselves, you open up the doors, that becomes kind of self-correcting, which I think would be wonderful. So I wanted to dig into maybe more of some of the specific theses, but I think that would be a good time before we do that to talk about that kind of difference that you guys have in terms of how you research, how you design the firm. You know, I mean, everything from who you hire to to how you do research, to how you make it available is different. So let's talk a little bit about that.

Sure. So we're focused on first principles-based research. Now, many people say, yeah, so are we. But if you look at the traditional asset management world, it's very bottom up in its focus, you know, company by company and so forth. And in fact, for a long time, macro or big picture thinking was out of style. You know, consultants didn't want to hear about it and so forth.

Interestingly, though, it's that having a perspective that is top down as a starting point is extremely important in the world we are now entering. And so what does first principles research mean? And this is not being done in the traditional asset management world. insofar as we can see it. And I've been around a long time. So first principles research is, first of all, first and foremost, not using an index as a screen for stock selection. It is using our research as the screen. Now, this is how I started in the business in the late 70s when I was in college. I was a capital group. We used research as our screen. In fact,

indexes, they weren't even around. We provided them as a courtesy occasionally for our clients, you know. And now, and now you can see how different the world is. So first principles research, autonomous vehicles. Now, in 2014, nobody was talking about autonomous vehicles. Today, more people are talking about autonomous vehicles, even though they don't know they are. Drones are autonomous vehicles. And we believe we're going to see electric vehicles that move on to autonomous taxi networks. We believe we're going to see autonomous truck platoons. But Tasha Kinney, she was the first analyst we hired.

And we basically sent her out and said, okay, what's going to go inside an autonomous vehicle? What is this? And as she started interviewing companies trying to figure out where to look, and started reading academic research, she found out pretty quickly and she brought into our brainstorm, it looks like the brains of an autonomous vehicle are going to be GPUs. And at the time, we were in a period where PCs were dropping at a double-digit rate, so personal computers. And Invidia, which was

the GPU, it had the lion's share of the GPU market, 80%. It was considered nothing but a PC proxy because it was a PC gaming chip company, right? And so it was being thrown out because PCs were dropping at a double digit rate.

And here's Tasha coming in and saying, yeah, it looks like this is These are the brains or the central nervous system. I remember saying, are you sure? Are you sure? I've never heard that. The market does not know that. The market does that.

And then later on, James Wang, who joined us from Nvidia, said, well, of course, you know, a GPU is going to be the brains of an autonomous system. That's because GPUs are used primarily in the artificial intelligence world for, training. They probably have 80, 90% of that market. And I said, I didn't know that. And I've been around a long time, and I've owned Nvidia for a long time, but I didn't know that. Let's size this market. Autonomous vehicles, that's one use case for artificial intelligence. How big is artificial intelligence going to be? Well, this week, Nvidia came out and basically said, this market is going to be a $100 billion opportunity, a hundred billion revenue opportunity. That's not stocks. You multiply that by 10 or 20. You've got a trillion to $2 trillion in market cap there. And so we went from not

even pricing anything for AI into Nvidia in 2014 to now, it is the most important company in that world. So doing the research that early on saying, okay, this is going to happen. And why is it going to happen now? Because battery costs are down low enough, one. Two, deep learning, which was ignited in 2012, is a thing. We're taking the human programmer out of artificial intelligence and just letting machines teach themselves. And we've got this explosion of data all around us, which finally computing power and storage can begin to catch up with. So those forces have come together and are now giving us this great opportunity

to invest in artificial intelligence, autonomous vehicles, and the market doesn't even know it. So that was 2014-15. So it seems like one of the things that you guys do as a matter of course that is so different, it is almost structurally forced out of category conversations is instead of thinking, okay, we're thinking about the category of X or Y, you take a technology building block. So in this case, what this sort of chip can do and say, what is this likely to do when it intersects with the market and where things are headed? And that opens up a whole different set of possibilities where if you viewed this chipmaker in the context of its previous framework, that you wouldn't have even walked down those paths, much less come to the conclusions that you had.

We're also illustrating the convergence of the platforms that are taking place. If you think about autonomous vehicles, so there are five major platforms evolving at the same time. And we have not seen this ever in the history of innovation. You go back to the early 1900s, you see three, telephone, electricity, automobile. But we've never seen five. And we have a paper on our site called disruptive innovation, why now? And it shows a timeline of innovation. And if you look at what we believe, and this is Brett Winton, our director of research,

did this study, with the help of some academic research, the productivity uplift and the wealth creation that we expect from these five platforms and the 14 technologies that are involved in them is going to dwarf anything that we've seen in the history of the world in terms of innovation. And it was a pretty rigorous study, and I think it's fairly conservative if you take a look at it. So yes, the convergence is among three of them. Robotics, autonomous vehicles are robots, whether they're electric vehicles, drones, trucks, even airplanes ultimately. And they will be powered with batteries. Battery technology is becoming so good.

It's dropped low enough in price. And with the innovations, thanks to Elon and team, it is moving forward faster now than it hasn't quite some time. So, again, every time you see technologically enabled innovation, you see increased access. It enables access around the world in ways that would not have been possible before. And artificial intelligence. Autonomous vehicles are going to teach themselves how to get from point A to point B. safely and quickly. And so research departments are not set up this way.

In fact, what you see in research departments, or what you would see is, and you probably do see when it comes to Tesla, is Tesla you have auto manufacturers, I mean auto analysts following them, right? Absolutely the wrong analyst. You need robotics analysts. You need energy storage analysts. You need artificial intelligence. analyst. You need software as a service analyst over the air software updates. You need all of those.

The auto analysts are not equipped to analyze Tesla. And yet, I don't know this for sure, but my guess is they are fighting to keep control of Tesla. You know, it's a big stock. It's a big market cap now. They can't pull the trigger and put a buy on it, but they want to cover it. But they can't cover it. And they're very good at what they do. It's just that Tesla, and EVs, autonomous EVs, are not what they do. So you see the disconnect in the market and why the inefficiencies in terms of valuations are so large, it's because of that dynamic. This is, I mean, this is a perfect segue into Tesla, which certainly is one of the things

that you guys are absolutely best known for, both good and bad if you could go back far enough, right, in terms of where people's perceptions was. But this is something you've had high conviction of for a long time. And it seems to me that part of that core conviction that has been durable throughout is this breaking it out of the auto category and looking at it as a technology convergence category. And also being, I think, sophisticated enough to separate the, oh, this is tech so it should have a premium type of thinking, which is kind of replete in certain analyst circles, from actually understanding the underlying. But I mean, I guess let's maybe ask it as a question. Where did this conviction start to come from? What has reinforced it over time?

So you asked, and I did not answer completely, the analyst question, how we put our research out there. So our analysts have, they have domain expertise for the most part in the new, new world, one foot in the new world. Why? Because they've just been educated in CRISPR gene editing and have experimented with it themselves. themselves, or they've worked in the industry. I mentioned James Wang coming from NVIDIA. Well, NVIDIA is the AI chip company. James already had a wide network in that space. It has grown even wider because of how we do our research. First principles is, okay, what is an autonomous vehicle? That Tasha, Sam Khoris, who follows battery technology

and robotics, Tasha, and James Wang, who follows artificial intelligence, the three of them work on that model together. So think about that. Very collaborative, no turf, no turf fights. In fact, we're all trying to seek the truth. That's our mission. We are also trying to engage with the communities we are researching. We want to become a part of those communities. And in many ways, we have become a part because we are willing to give our research away. We are, I often call ARC, one of the first sharing economy companies in the asset management space when it comes to research. We are giving our research away. We are putting our Tesla model up on GitHub. We just put our square model up on GitHub. Whenever we feel there's a glaring inefficiency in the way that a

company is being analyzed, we are going to put it on our models on GitHub, just so other analysts and other people just interested in the space can experiment with them and scenario test them. We leave the variables open so others can battle test our assumptions. And so we have become a part of those communities. And we're getting information. It is not, this is very important from a compliance point of view. The information we're getting is not material non-publican information. It is simply trying to understand how the world's evolving generally.

And those who are doing the innovating have a really good idea of how it's evolving. What we have to offer for them is we are trying to size the markets they're going. after. We're trying to figure out where the unit economics are going to be. Where is the profit margin in this particular space going to land and which parts of this space will be commoditized? So in the case of Tesla, we think battery cells are commoditized. But we do not think that about battery pack systems, which is what Tesla does and what Tesla is going to build into the the floor of its cars. Talk about vertical integration. So we are helping those innovators say, hey, this is how we're thinking about the world. Where could we be wrong? Well, they want to understand

where their world is going from a financial point of view as much as we do. And so they want to help us do our work. And so it's a win-win situation. And as you can see, it's transparent. We're putting, we're tweeting with these researchers or, you know, about them or with them. And, and we're on this journey together. And we want our clients to the extent they want to be on the journey in terms of in the weeds and understanding why we're doing what we're doing. We're happy to have them join us, enough so that we post our trades at the end of every day. And we get, I can't believe how popular that has become. Many people might be using our trades for their own, you know, personal accounts.

That's fine. But what you'll find, many in the ETF world didn't think that a fully transparent active equity ETF was possible. And the reason they didn't is because many growth managers are momentum driven. We are not. we are, some people would say we're aggressively patient. Certainly you can see from the moment we started ARC 2014 to its breakout point last year, we were in a huge trading range and everybody saw our trades. They're beginning to understand that we are lying in wait for misperception and controversy to visit a stock. And we will buy. So we are a liquidity provider in the

marketplace. That's why we don't mind being transparent with disclosing our stocks at the end of every day or our holdings and our trades at the end of every day. Because if a stock is getting beaten up by some short-term thinking, we are usually there picking it up. And we don't mind company when it's down 20, 30 percent, you know. And on the other side, we don't mind company. if the stock is hyperventilating, you know, analysts have decided that invidia is there, check the box for artificial intelligence. We are quite happy to see invidia going up, and we're quite happy to take profits as it does. One of the things that I think is very clear listening to that perspective is how you fit well

with the Bitcoin community. One of the things you'll see constantly is when people who are thinking short term, And maybe that's because their mandate leave the space. The hodlers flood in and say basically, thank you for the sats. You know, I mean, and the thing that's interesting is that you see kind of a rising price floor each cycle because of that. But before we get into Bitcoin, I want to just stay on Tesla for just a minute. I guess actually it's a broader question than Tesla.

But one of the things that I tend to see when it comes to, you know, I came out of a Silicon Valley perspective, and now I pay more attention to kind of traditional markets. And I think that there's this perception of innovation as a venture capitalist thing, right, where you're winner picking almost exclusively. And so I guess, you know, how does your research process differentiate you from the work of, say, a late stage venture capitalist who maybe is starting from a similar macro place as you, but isn't thinking in terms of day-to-day trades? Right. The biggest surprise to me in doing the research we've been doing and sharing is that when we engage with innovators, let's say, and they may have VC owners, the venture capitalists are not doing the kind of research we're doing this first principles based. You know, I mean, when you think about it, our autonomous vehicle, autonomous truck drone models, they started in 2014, 2015, and they are evolving. We're going, as

the technology progresses and the cost drop, our models are becoming even more useful to us. And why is that? Because the venture capital world, they will only go so far, and then they want a liquidity event. The world we're looking at, and we call ourselves the closest you'll find to a venture capital firm in the public equity markets, we believe that these opportunities, the platforms, technologies are all, the seeds for all of them were planted in the tech and telecom bubble. We weren't ready for prime time back then, and it ended badly back then. But 15 to 20 years of gestation of these new technologies, they are ready for prime time now. It's interesting that many people are nervous about the volatility now that they're ready to take off, but they didn't mind the volatility during the tech and telecom.

bubble. But whereas VCs will be looking for that liquidity event and they're out, we think they're leaving so much on the table because these exponential growth opportunities have just begun. They've just begun. And you actually need the public equity markets to fund the kind of trajectories possible here. And the, and you know, it's interesting. I am very happy when I see one of our companies saying, uh, we're doing a deal. We're doing an offering. And why am I happy? Because we want our companies to invest aggressively now. The more they invest now, the better shot they have of capturing the lion's share of whatever market they're going after. Because so many of these exponential growth opportunities are powered by artificial intelligence and the companies with the largest

amount of data and the best data and the best understanding of how to label the data are going to win, are going to win. And so these are winner take most. And if we're on the right horse, as I think we are, just to go back to your Tesla or our Tesla, I think there is. I think they're in the poll position for the autonomous taxi network in the United States. And we're even surprised in China at how well they're competing against the Chinese incumbents. And we're trying to figure out, wow, could they get a piece of that autonomous action as well? That would be, that would multiply the opportunity manyfold where we are right now. I actually want to come back to the geopolitics of innovation. I think it's a really interesting question for you. But

But one more kind of piece that connects to what we were just discussing. How do your models or do your models take into account or intentionally ignore when there is momentum, when there is narrative, right? So obviously this year has seen a large narrative around the retail day trader set rising, right? Is that something that you guys kind of just, it's too short for your time scale or is it something that, you know, doesn't really change your long-term conviction, but you're still going to pay attention to? Right. So our investment time horizon is five years. And the minimum hurdle rate of return for any stock to get into our portfolio is a compound annual return of 15%. So that's a doubling over five years. That's our minimum hurdle. So when we see short term trading, if you watch our trading, you'll see we are, as I said before, a liquidity. provider will be very opportunistic around it. And just to give you an idea of how productive that can be, if you look at just Tesla, let's just take Tesla in 2018, which was a down year for the market, take away Tesla's performance, which actually was up for the year, but take that

away, and just look at the contribution to return that are trading account of. for in 2018 it was 175 basis points in a down market. And I believe in 2019, it was roughly 200 basis points. Right. So in a market where many think we're, and as we're seeing from the S&P 500, we're up five, six percent for the year in the S&P 500, if you can get one stock like a Tesla, and we do this for all of our stocks to deliver, you know, 170, to 200 basis points just because of wild trading, you know, that's, that's, that's, that's, that's, that's, that's, that's, that's, that's, our generation, right? If alpha is a portfolio that does not trade around opportunities compared to one that does trade around opportunities. So we use the volatility to our advantage. But, you know,

it's not going to change our short, our, our, our, our, our, our, our, our, our, our, our, our, company is going. You know, one of the exercises we do every Monday during stock meetings, okay, which of our stocks has dropped below a 15% compound annual return expectation for the next five years? And, you know, those are, we will take profits from those stocks because we have a lot of ideas trying to get into these portfolios. Makes sense. So I want to shift because I know there are a lot of people who will be chomping at the bit

for this. So let's talk Bitcoin for a minute and the disruption of financial services writ large, maybe. So first, I guess, let's talk about when you started to get interested in Bitcoin and how it evolved for you guys as a firm. So Brett Winton and I have worked together for more than a dozen years. Brett was at Alliance Bernstein when I was there as well. And I remember Brett coming into one of our brainstorm meetings. we have a brainstorm. We had one there every Friday as we do still. And I remember he was talking about this crazy thing called Bitcoin and we were just trying to get our, just that would

have been probably, I'm going to say that was 2011. And it was interesting, but it was so esoteric at that time. When we started the firm, we did not break out blockchain technology as one of the five platforms. Today, the five platforms are DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology. But we didn't break it out then. We simply included it in what we used to call next generation internet. And we've broken that out into artificial intelligence and blockchain technology because we think both of them are going to be so profound. Now, I remember, so Chris Berniske did our original research on Bitcoin, and he'll tell you, he's now one of the partners at Placeholder, he'll tell you he was following next generation

internet and was given this task, and he just fell down that rabbit hole and didn't want to cover anything else anymore, period. He knew. And I brought Art Laffer. I don't know if you're familiar with Art Laffer, the Laffer Curve Supply Side Economics. He was my mentor at USC, University of Southern California, and he's a very well-known economist, Austrian school. He's been a wonderful mentor. I asked him, he's on our board of advisors, and I asked him, would he review this paper and say that he collaborated with us? on it. And he had had had a lot of offers like this because his mentor is Robert Mandel, who won a Nobel Prize for monetary theory. And so he is a global monetary expert as well. And so he said,

okay, I'm not going to tell you yes until I read the paper. And the paper was so long, he said, okay, I'll say yes to that part, but no to that part. The yes part was Bitcoin. The no part was network security because he just didn't understand it, was too tech-oriented. The Bitcoin, though, what he said was, wow, he said, this is, this is rules-based monetary policy. And he had been yearning for that ever since, really, 1971, when the U.S. went off the gold exchange standard under Richard Nixon. He happened to be in that administration. And he knew that was a mistake, but he was so young, he had no influence over it. And ever since then, he's been looking for a rules-based monetary policy. We kind of had it with Volker when he was trying to crush inflation.

We moved into a money supply price rule. Money supply could only go up so much each week. And boy, every Thursday, just waiting at, believe it or not, the teletype machine for that money number to come over to see what the market was going to do the next week. It was every Thursday at 4 o'clock, 415. So that was good and it did squeeze inflation out of the system. But as you might imagine, he believes, I believe, that monetary policy today is unhinged. And fiat money, we don't know what the ramifications of this experiment are going to be. I think a lot of people are complacent now because we were all worried after 0809 when the monetary base went up, I think it was, to $4.5 trillion here in the U.S. And, you know, we thought, what's going to happen here? You know, we're going to have an inflation explosion, which we didn't. And we didn't because the velocity of money started falling and started falling at an accelerated rate with 0809 accelerating the downward trend and velocity. So what that meant was all of the reserves that the Fed had put out there were on the central bank's balance sheets and it had not had not been able to enter. the real world because there was so much caution and fear out there. Okay, so now we are that much further beyond. And I should say the velocity of money has come down. It's been, I guess I

didn't contradict myself. It accelerated during 0809, but it had been falling. And now everyone's betting it will continue to fall. But I'm not so sure that's a good bet. I think, and you can see it in the housing market. Housing has taken off in this crisis. This is 100% different from 0809. It's the other side of it. So why aren't we going to see the other side of a lot of other trends versus 0809? And why won't velocity turn around? You see Walmart giving wage increases of 11%. 11% wage. I remember starting in the business in the late 70s and hearing this phrase, we have an inflation problem because of wage push. Well, is Walmart starting another wage push? I don't know. Here is what I do think is going to happen. I think for the next three years, the innovation

that we're seeing explode right now is going to drive productivity growth to a significant extent. And that's a potent anti-inflationary force. So this complacency that we're talking about will probably continue. And I remember stories about the 60s when I forget who it was. There was an economist who basically said, you know, the business cycle is dead. This was the 60s. We were basically working into one of the worst recessions we've ever seen. That was because of the quadrupling of oil prices. And that That's because of the complacency, you know, and that's one reason we went off the gold exchange standard. So I think after all these years with inflation not taking root, we're probably got another few years, thanks to productivity growth. But if we get velocity turning around to any great extent, then what you see as kindling on the bank's balance sheet right now, that is going to turn into a fire. It'll be loan growth and it will be inflation. So for those of your listeners who own Bitcoin as an insurance policy, we think that's a really good bet.

So much there. I think that, I mean, speaking of punctuated equilibrium models, right, too, it's the same thing. It's not a problem until you realize it is. And usually it's too late. And that contributes to the whole rapid sort of catch up, you know. I guess, you know, for people who are interested in what you guys are looking at, looking at either, you know, so you tend, it seems, from what we've been talking about before, to not just say, okay, here's an asset, you know, or here's a stock and we're interested in it.

What's the set of things around Bitcoin, around this ecosystem that you're paying attention to? And it can be also, we can expand it to financial services kind of more broadly, too. Well, now, Yassine Elmandra is our analyst, handpicked by Chris Berniske. and he's doing an amazing job. It's super, super sharp. Yeah, running with the ball here. We've just published Yassine's authorship two papers, one of them with coin metrics. And so you can read all about it there.

Those are on our website. One of them, the one with coin metrics, is really trying to help institutions understand. Are we ready for prime time and turn time? of institutional involvement in the space. So many people ask, are institutions ready for Bitcoin? We did the opposite. Is Bitcoin ready for institutions? And he did, Yassin did a terrific job at framing, you know, the liquidity profile of Bitcoin in the market. I mean, you can look at it. I mean, the summary is, you know, it's trading like one of the large fang stocks right now. sure, institutions can get involved, but they'll have to move in slowly and then scale with it as time moves on.

So that's that one. The first one was, you know, the use cases and the insurance policy. I think confiscation of wealth in emerging markets, that's a risk everyone understands, Venezuela's, Zimbabwe and so forth. But I think, you know, even with our own election here, or if you looked in the Middle East, when MBS basically confiscated his own cousin's wealth, I bet a few of them wish they had, you know, some big wine and the private key, you know, memorized. So I think more and more people are thinking, okay, we do need an insurance policy. what Yassine did that in that paper is said, okay, if 5% of all of the people in the world with more than $1 million in net worth, I think that's roughly it, we're to take out an insurance policy and try assuming that there's a 5% chance their wealth will be confiscated, if they put 5%, that would be a trillion dollar opportunity for Bitcoin just there, two-day,

present valuing it to today. We also took a look at demonetization. So again, that can happen in a number of ways. It can happen because of hyperinflation and, you know, currencies becoming worthless as corrupt regimes, you know, basically lose control. And so I think that opportunity, he characterized it using monetary measures from emerging markets or markets other than the developed world, that was another trillion dollar opportunity. And, oh, I'm blanking on the third one. But those two use cases alone, $2 trillion were starting from, and that's present valuing them, right? This is going to scale with time from 200-ish billion, right?

now for Bitcoin, those two alone, we think, are going to be the most important use cases. Now, one of the refinements of our thinking about Bitcoin is the first paper we wrote, Chris wrote in collaboration with Art Lafter, basically was titled something like, could Bitcoin serve as the three roles of money? So means of exchange, store of value, unit of account. And I think we've morphed our view a bit. And out of recognition that the means of exchange role for Bitcoin is really, on its network, on the Bitcoin blockchain, on the base layer, is for

very high value transfers, right? Anything small, like a cup of coffee or a pizza or however you, no, too expensive, takes too long, it's not set up for that. Lightning Network is making progress. That's interesting. What's also interesting, though, and raises a lot of questions that come up at our brainstorm is the fact that Bitcoin is, the transactions in Bitcoin are more on the Ethereum network, or larger, than on the Bitcoin network, is really interesting. That's really interesting. Now, store of value, we believe that's a case, mathematically metered. Unit of account still, most of the crypto world is quoted in terms of business.

Bitcoin. But means of exchange, what does this mean that more is trading? Is it truly that Bitcoin is the reserve currency? We do believe it is. And this is another manifestation of it, that transaction activity taking place on Ethereum is higher than on the Bitcoin blockchain itself. And does this mean that the velocity of Ethereum or of Ether is going to speed up if Bitcoin is fulfilling some of the transaction roles? Maybe. So we're going back and forth on that because this concept, as you know from Chris's original work, this concept of velocity increasing or decreasing is a very important one to figure out who's going to be left standing in terms of crypto. We think it's only three or four potentially, and we're specifically interested in

ARC is in cryptocurrencies, because we do think it's going to be win or take most. It's like a lot of our other innovation platforms, you know, the most secure network or the most robust network, the first one there gets the lion's share of the market. but there has been this refinement of our thinking in terms of means of exchange. Super interesting. We could dig so much deeper into that, but I'll make sure to share in the show notes the papers that you referenced just so if people haven't had a chance to look at them yet, they can. I want to be respectful of your time. I could talk to you for hours, but I want to kind of round out with maybe zooming back out at the highest level. And I'll kind of ask two questions

and you can figure out how to kind of take them on. The first, which is a I wanted to get into is where China and just geopolitical competition in general have to fit in an innovation portfolio construction. How do you think and, you know, take that seriously? How do you figure out what's worth paying attention to and how do you factor in the political dimension of this? And I guess maybe we can kind of broaden that out to what are you expecting from, from next year or the coming years. You know, we're coming off of what was a totally unpredictable 2020, how have your kind of broad picture feces changed or not or been reaffirmed? So, you know, I'll kind of ask them together and let you figure out how to tackle them.

So China, we pay a lot of attention to China. I was presenting at a World Economic Forum event in China on an innovation platform when ARC had barely started. I was so grateful to be up there. And up there with me was China's Minister of Innovation. And I think it was also Malaysia's Minister of Innovation. China's taking innovation very seriously. And they want to dominate.

And personally, I think that's great. I think that's great because there's nothing like competition to stir animal spirits here in this country. That's our DNA. And so I don't look at it as a bad thing. I do wonder, you know, we were looking just this week at the autonomous taxi platform in China. China's really trying to catapult that forward. Now, we just had an analyst join us. He's our Asian innovation analyst.

And he's able to, he's from Chen Zhen. And he's able to translate some of the papers out there that, you know, we would never have translated. We probably couldn't even find them. And he found that 11 ministries in China are working on this autonomous taxi network. Now, when I hear that, I say, okay, they're going to get all caught up in their knitting, bureaucracy, competition, power plays, and so forth. If I'm wrong, it will be because the Shiji Ping himself says, no, we're doing this and we're going to be number one. And off with your heads, you're in the way. That, you know, command and control. So if I had any pause about China's ability to, to catapult itself into number one on innovation, it would be these ministries

and the kind of tension there is between the Chinese provinces and the national government. So we'll see what happens. That's the pause I have. I think on, chip technology. I was in China when Smick went public. And that was going to be their China. So this was maybe 10, 15 years ago. And this was going to be their marquee play. Well, it didn't work. It didn't work. So there's something about the DNA in the United States when it comes to semiconductors that gets us over the hurdles, but has not. not help them get over the hurdles. And I'm really surprised about that because I think they've even imported talent from Taiwan Semiconductor, which is the most advanced out there. That said, when it

comes to artificial intelligence, because the country is so surveillance oriented, and because their population does not expect any privacy at all, they can do more of what they want in terms of AI than we can and even more so relative to Europe, given all the privacy concerns, legislation, politics and so forth. So their population, 1.4 billion, is going to produce enough data to be very meaningful for artificial intelligence, which is determined by the most data and the highest quality data. No one will have better data on China than China will. And we're seeing their chip companies started to, starting to move up the league tables, especially those focused on AI chips. So again, we want to make sure we're looking behind our shoulder and not

dismissing the possibility. This is not another Japan, we think. I remember in Japan, everyone thought in 1989, Japan would rule the world, and it has not. And they were able to get so far, but then something stopped them. And that's why I mentioned those 11 ministries and the tension between the provinces and the national. In terms of the way our government is treating technology and China, I actually think that in hindsight, when history is written, that we will look at this as a very important moment for leveling the playing field. And so we are seeing some success. I think one of the reasons Tesla was allowed in without any local partner is because the pressure our government was putting on it. So I don't think China wants to blow it this time. I think they're going to

try and find a way to continue to push, push, push. But we don't, just the way there, the way we're dancing around each other, we're both going to be, we're going, are going to be advocating for our own countries. It's going to be no more from the U.S., China, come on in, world trade organization. We're going to give you most favored nation. And that's done. That's done. And the playing field will be more level. As far as 2021, well, you know, we obviously are looking at the election like everyone here is. And on a purely economic, just from a an economic point of view. It is clear that there's black and white, or I won't, maybe I shouldn't say it anything like that. These two administrations will be very different. A Trump administration,

we know what they'll do. They'll continue to cut taxes, meaning probably a flatter tax for individuals, a capital gains tax cut, more corporate tax reform, a state tax reform, and more deregulate. That we know. That is extremely capital-friendly. That is why innovation stocks, I believe, have taken off. Remember I said 2017? 2017 was the beginning. I believe that was because of corporate tax reform. And what that does is it improves our terms of trade. Our dollar goes up. Capital seeks to come into the United States. We are a friendly place for capital. I'm not saying that for crypto because we've been unfriendly with our chaotic regulatory regime. And I realize that some funds in the rest of the world will not allow U.S. investors in. So not perfect, but certainly in the crypto world, but much better than otherwise would have been the case. A Biden administration has been very clear.

It will increase marginal tax rates, especially at the high end. It will increase corporate tax rates and it will probably increase capital gains tax rates, and it will re-regulate. So to have said that since 2017, that's what's really helped innovation here in the United States, I have to be honest on the other side, that will hurt innovation in this country. However, I do believe the five platforms, 14 technologies around which we have centered our research, they are all ready for prime time. They've been germinating for the past 15, 20 years.

They are unstoppable now. And we will see exponential growth. What will happen is these platforms in the United States will not serve as much as a long, launching pad or launching pads for more innovation. I think innovation will move to other countries. We know, we've seen it. You look at drone regulation, for example, the reason our FAA has finally gotten off its duff and is moving a little more quickly to allow drone manufacturers to test in this country and they're beginning to play ball with them is because Australia, Hong Kong, China's way ahead of us on drones, the UK, many India, many other countries

are vying for our innovators to come and innovate where they are. Better regulatory, better pay, better tax incentives, and so forth. And so I believe that future innovation will be in harm's way. I don't think I'm speaking out of both sides of my mouth. We've spent 15, 20 years in the United States working on these technologies. And now the costs have dropped to a low enough point where they're just going to take off. And in fact, if we do, if Biden is elected, then as costs go up for corporations, they're going to seek more productivity gains and more ways to cut costs and maybe more ways to create products and services. from the technologies that are evolving. And so they'll perhaps gain even more traction than might otherwise have been the case. Well, we'll have to come back

and circle back on that exact question. I think it'll be fascinating to see. Kathy, thank you so much for spending so much time with us today. Like I said, we could talk about this for a lot longer. But until the next time, just thank you. And I'll make sure to include all of your details and all these papers so people can follow along if they're interested. Thank you, Nathaniel. It's been my pleasure.

It's wild to me reflecting on that conversation, just how under-indexed innovation is as an investment strategy for so many firms. I think what makes it seem so crazy is that all of us every day live inside the byproducts of these innovations. So why haven't our investment strategies change to match. I wonder to what extent it has to do with the inertia of the actual firm structure and the way people think. I joked in that conversation that Kathy kind of tried to change what people were investing in, how they were investing, and how they were making those decisions all at once, but I think that that's kind of the way that it has to be. We are, I believe, in a moment of punctuated equilibrium across so many domains. It only makes sense to me that firms are

going to follow suit and are going to have to adapt to take advantage, capture the upside, and bring new people into that moment. I think arc's story, their trajectory up, is just beginning, and it was an absolute delight to have Kathy on the show. For all of you listening, thank you for making it this far. I appreciate it. I appreciate your listening. I appreciate your ratings and reviews. And until tomorrow, be safe and take care of each other. Peace.