Investing Above the Karman Line

In light of the recent solar eclipse, I figured I’d take a look at investing in an economic sector that for at least two generations has been thought of as unreachable for mere investing mortals.

I’m talking about that (sighs) final frontier of investing, the space economy. There are basically two funds on the market that make claims to best represent the space economy. The first was launched on April 11, 2019, by Procure (Procure Space ETF – UFO), and the second on March 30, 2021, by ARK Invest (ARK Space Exploration & Innovation ETF – ARKX). I’m going to take a look at how each issuer defines a “Space Company,” what the current portfolio looks like, and what has been influencing YTD performance. Okay, here we go.

While there are a number of differences between these two funds, let’s get some of the easy stuff out of the way. The biggest and easiest to identify difference between UFO and ARKX is that UFO tracks an index (The S-Networks Space Index) which was developed by Procure while ARKX, like all of ARK Invest’s funds, is actively managed. Both issuers were smart enough to launch funds covering this strategy, and they were even smarter not to get into a fee war with each other, so both funds sport a 75 basis point (0.75%) expense ratio, meaning that $1,000 in either fund over a calendar year would result in $7.50 of fees paid for the period.

How The (Space) Sausage Gets Made

So, everyone knows (or should know) that the best way to learn everything you can about an index fund’s investment approach is to read through the index methodology or RTFM (Read The, ahem, Fund’s Index Methodology) for short. The best place I’ve found to learn about what an active manager is doing is to read through the fund prospectus as narratives end up being a little more comprehensive when they’re crafted by the legal department and not marketing.

Looking through UFO’s index methodology (p4) tells us what they are looking for in a suitable fund holding. What I like about this section is that there are clear definitions of what they feel are space economy-oriented companies. What they refer to as “Prime Manufacturers” of both satellites and launch vehicles are right at the top. Companies that manufacture components used to manufacture space-borne vehicles are included as well. The next couple of segments include companies that “operate or utilize satellites” and companies that “manufacture ground equipment dependent upon satellite systems.” At first read, I’m not in love with that language as it has the potential to justify the issuer putting a lot of pretty tangential “stuff” in the portfolio, especially when you consider that they are looking for the greater of a minimum 20% revenue exposure or $500 million of revenue in a candidate company. Still, I’ll hold off on any judgments until I get a chance to review fund holdings.

Reading through ARKX’s prospectus (p53) lets us know that analysts at ARK Invest see this economic segment as one with four distinct areas. “Orbital Aerospace Companies” launch, make, service, or operate platforms, like satellites or launch vehicles. “Suborbital Aerospace Companies” are defined the same way as their Orbital cousins but with the condition that those vehicles do not reach the velocity needed to remain in orbit. The only thing that comes to mind for me is companies like Virgin Galactic which, as it turns out, is not currently in the fund. The next segment is “Enabling Technologies”, like artificial intelligence, 3-D printing, robotics, materials, and energy storage. Finally, “Aerospace Beneficiary Companies” like agriculture companies that incorporate Global Positioning Satellite (GPS) technology into their products. Again, I’m not crazy about just how broad some of these definitions are and there is also no threshold for revenue exposure although only the “Adviser’s highest-conviction investment ideas within the theme of Space Exploration” will end up in the portfolio.

Security selection is important but also important is how those holdings are weighted in the portfolio. UFO allocates 80% of the final portfolio to the basket of eligible companies with greater than 50% revenue exposure to their respective segment and 20% of the portfolio is made up of names with less than 50% revenue exposure. Weights within each bucket are set using a modified market capitalization approach (modified for investible shares). There are some further capping rules outlined in the methodology that limit individual constituents in the 80% tranche to a 4.8% weight and the 20% tranche to a 2.4% weight. ARKX states that names in the fund are “conviction weighted.” Let’s see what kind of portfolios these processes produce.

One of These Funds is Not Like the Other…

Before we get into the nitty gritty of each portfolio, below is a quick overlap analysis of the funds. The reason both figures are so close is that both funds have about 32 holdings. I’ve also produced this matrix because overlap goes both ways meaning the exposure can be different depending on which fund you’re talking about. In this table, if I’m holding UFO then I am essentially holding 26.47% of ARKX, and holding ARKX gets me exposure to 28.13% of UFO’s holdings.

I’m going to go through holdings first and then talk about performance because understanding fund holdings helps better understand performance. Also, when you’re talking about targeted exposures like UFO and ARKX, thematic purity should be as important to investors as style purity is to asset allocators. First, the overlap names. There are a few traditional Aerospace & Defense names like Airbus AE (AIR-FR), Lockheed Martin (LMT-US), L3Harris (LHX-US), Honeywell International (HON-US), and Thales SA (HO-FR), GPS-focused companies like Garmin (GRMN-US), and Trimble (TRMB-US), and what I would consider to be pure-play names like Iridium Communications (IRDM-US), and RocketLab USA (RKLB-US).

The rest of UFO’s portfolio looks like what I would expect to see and includes a couple more traditional Aerospace names and an expanded assortment of satellite operators like Visat (VSAT-US). There are also some interesting names like moon surveyor Ispace Inc (9348-JP) and earth data provider Planet Labs (PL-US). Despite having the opportunity to pad the portfolio with names that might improve both the liquidity profile and expected returns of the fund, Procure does a great job sticking to the mission of providing exposure to the emerging space economy.

In reviewing ARKX’s remaining holdings, I see a number of names that make sense, like Mynaric Ag (MYNA-US) and even Deere & Co (DE). Where I start to scratch my head is when I see names like 3D System Corp (DDD-US), which, while a 100% 3D printing-focused company makes half of its money from medical devices and the other half from industrial applications including not just aerospace & defense, but also automotive, jewelry, motorsports, semiconductor, service bureaus, and turbomachinery. Also in the 3D printing space is ARKX’s allocation to PRNT, ARK Invest’s 3D printing ETF. Looking through that fund, there is some overlap with ARKX, like 3D Systems Corp (DDD), Markforged Holdings (MKFG-US), and Velo 3D (VLD-US) but there are also names that don’t seem to fit in a 3D printing exposure let alone a Space Economy allocation, like United Parcel Service (UPS-US), and Eastman Kodak (EMN-US). Turning back to ARKX, where I really get confused is when I run into Amazon (AMZN-US), Alphabet (GOOG-US), and Palantir (PLTR-US). Now, I’m not saying these names are bad investments but I just don’t see how they tie into a targeted exposure to the space economy.

By The Numbers?

It seems like the two numbers many ETF investors are most interested in are recent returns and the fund’s assets under management (AUM). Some will look at the bid/ask spread. The first group is looking for bigger numbers and the second, for smaller numbers. I’ll talk about AUM and returns now and save the liquidity discussion for another time.

ARKX has $241 million and UFO, despite the first-mover advantage, sits at $33 million. YTD returns as of April 8, 2024, show that ARKX is down 3.83% and UFO is down 13.29%. Given the YTD returns for PLTR (33.95%), AMZN (21.88%), and GOOG (10.79%) the return difference makes more sense given that both funds purport to invest in the Space Economy, but it seems like only one may be actually delivering that exposure.

It is reasonable for investors to get the exposure they are expecting, especially when they are investing in thematic or other targeted exposure products. As with the case here where the sector is underperforming the broad market it is tempting to go with the higher-returning product, but it will pay to do some research before dropping that ticket to make sure you’re getting the exposure you want. In this case, despite the lower AUM and worse YTD returns, if exposure to the space economy is what you’re looking for, then UFO will get you there, maybe in even under 12 parsecs.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.