(Repeats the item that ran for the first time on Wednesday)
By Thyagaraju Adinarayan and Saikat Chatterjee
LONDON, Feb.25 (Reuters) – A record $ 500 million bailout of Ark Invest’s flagship fund in a single day has prompted analysts to highlight the risks that arise from the ETF’s heavy exposure to illiquid stocks if they are departures are sped up.
A 20% decline in Tesla shares in the past three weeks, the largest stake in the Ark Innovation exchange-traded fund created by star investor Cathie Wood, has prompted a rush among investors to sell some of their 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.
These include names like the therapeutic discovery company Compugen and the three-dimensional printing firm Stratasys, whose daily stock trading is small compared to total ETF turnover.
“They will not find liquidity in many of these stocks,” said Ben Johnson, Morningstar’s global ETF research director. “If there is going to be liquidity, it will have a price, and it will be a price that, in all probability, would not be favorable to the fund’s shareholders.”
For example, roughly $ 100 million worth of stock changes hands on average every day at Stratasys, a stark contrast to Ark Innovation ETF’s turnover in the single-digit billions and Tesla’s in tens of billions of dollars. .
Investors took $ 465 million out of Ark Innovation on Monday, according to Refinitiv data. More such redemptions would lead Wood’s fund to sell liquid holdings to manage the short-term contraction before looking to divest its illiquid holdings.
That could get nasty and rekindle memories of British money manager Neil Woodford’s flagship fund, which went bankrupt in 2019 due to its exposure to hard-to-sell stocks. That left it unable to meet a flood of redemption requests after a disappointing performance phase and asset appreciations.
“It’s hard to get out of these big bets quickly. This movie has been developed before, with the lead 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, ranks well above average for 10 of the 11 factors in Morningstar’s global risk model.
Meanwhile, Ark Invest reorganized its portfolio on Tuesday by cutting its already small stakes in Apple, Amazon, Taiwan Semiconductor and Alphabet, which owns Google, to bolster its stake in Tesla on Wednesday.
The fund, which posted inflows of $ 5.5 billion in 2021, traded almost unchanged Wednesday when Tesla shares stopped falling.
In 2020, its assets grew ninefold thanks to small investors as actively managed ETFs focused on hot topics like top tech disruptors, space technology and pet care took off.
Investors say that the Ark ETF allows funds to invest in specialized niche companies that other large ETFs simply do not participate in.
Pressure on the fund this week has attracted short sellers, with 100% of Ark Innovation shares available for short lending as of Monday, FIS data provider Astec Analytics estimated.
Selling pressure can cause the ETF to trade below the Net Asset Value (NAV), leading to “redemptions” as ETF arbitrageurs trade the fund for the underlying holdings and then sell the underlying holdings, exacerbating selling pressure on these ETFs.
In a similar episode, during the Chinese stock market crash in 2015, overseas-listed Chinese market ETFs traded at significant discounts to their NAVs.
“ETFs can quickly gain or lose assets based on the sentiments of their retail investors. These shifting flows can act as a self-fulfilling prophecy for ARK,” Campling added.
Of course, Ark is not the only fund that is strongly committed to a very small number of companies. However, it is among the most important and many others have taken a more cautious approach.
Global X, which has $ 25 billion in assets under management, uses a “modified market capitalization” concept in its thematic ETFs where no company has more than 8% weight in the portfolio, says CEO Luis Berruga.
“We limit the potential situation in which a company can become a very important part of your portfolio and we address some of the possible concentration risks in our portfolios,” Berruga told Reuters.
(Information from Thyagaraju Adinarayan and Saikat Chatterjee; editing by Sujata Rao and Hugh Lawson)