(Repeats the item that was first executed on Wednesday)
By Thyagaraju Adinarayan and Saikat Chatterjee
LONDON, February 25 (Reuters) – A record $ half a billion bailout of Ark Invest’s main fund in a single day has led analysts to highlight the risks stemming from the ETF’s strong exposure to illiquid stocks if outgoing flows increase.
A 20% decline in Tesla shares in the past three weeks, the largest share of the Ark Innovation exchange-traded fund, created by investor Cathie Wood, has sparked a rush among investors to sell some of its holdings.
But, according to some who watch the fund closely, a much bigger problem could be its more than 15% stake in a handful of companies whose shares are relatively illiquid and potentially difficult to exit when redemptions increase.
This includes names like the therapeutic discovery company Compugen and the three-dimensional printing company Stratasys, whose daily stock trading is small compared to the overall turnover of the ETF.
“They will not find liquidity in many of these stocks,” said Ben Johnson, director of global ETF research at Morningstar. “If there will be liquidity, it will have a price, and it will be a price that, in all likelihood, would not be favorable to the fund’s shareholders.”
For example, about $ 100 million in stock changes hands on average every day at Stratasys, a stark contrast to Ark Innovation ETF billions in single-digit billions and Tesla’s billions in tens of billions of dollars.
Investors took $ 465 million from Ark Innovation on Monday, according to data from Refinitiv. More such redemptions would cause Wood’s fund to sell its net holdings to manage the tightening in the short term, before attempting to undo its illiquid holdings.
That could make it unpleasant and rekindle the memories of the main fund of British fund manager Neil Woodford, who went bankrupt in 2019 because of his exposure to hard-to-sell stocks. This left her unable to cope with a flurry of redemption requests after a phase of disappointing performance and asset revaluations.
“It’s hard to get out of those big bets quickly. This film has been shown before, with the main role played by Neil Woodford,” said Neil Campling, head of technology research at Mirabaud Securities.
Ark Invest did not return calls seeking comment.
The risk level of the Ark Innovation ETF portfolio, which returned 157% last year, is well above the average for 10 of the 11 factors in Morningstar’s Global RiskModel.
Meanwhile, Ark Invest changed its portfolio on Tuesday, cutting its already small stakes in Apple, Amazon, Taiwan Semiconductor and Alphabet, owner of Google, to increase its stake in Tesla on Wednesday.
The fund, which had inflows of $ 5.5 billion in 2021, was traded almost flat on Wednesday when Tesla’s shares stopped falling.
In 2020, its assets grew nine times thanks to small investors, as ETFs actively managed focused on hot topics, such as big technology switches, space technology and pet care took off.
Investors say Ark’s ETF allows funds to invest in specialized niche companies that other large ETFs simply don’t participate in.
LOW
The pressure on the fund this week attracted short sellers, with 100% of Ark Innovation’s shares available for short sale on loan starting on Monday, estimated data provider FIS Astec Analytics.
Selling pressure can cause the ETF to trade below the net asset value (NAV), which leads to “redemptions” as ETF arbitrators exchange the fund for the underlying holdings and then sell the underlying holdings, exacerbating the selling pressure on these ETFs.
In a similar episode, during China’s stock market crash in 2015, ETFs listed outside Chinese markets were traded at significant discounts on their NAVs.
“ETFs can gain or lose assets quickly based on the feelings of their retail investors. These variable flows can act as a self-fulfilling prophecy for ARK,” added Campling.
Of course, Ark is not the only fund to bet heavily on a very small number of companies. He is among the largest, however, and many others have taken a more cautious approach.
Global X, which has $ 25 billion in managed assets, uses a “modified market capitalization” concept in its themed ETFs, where no company has more than 8% of its portfolio, said CEO Luis Berruga.
“We limit the potential situation in which a company can become a large part of its portfolio and deal with some of the potential concentration risks in our portfolios,” Berruga told Reuters.
(Reporting by Thyagaraju Adinarayan and Saikat Chatterjee; Editing by Sujata Rao and Hugh Lawson)