(Repeat item first presented on Wednesday)
By Thyagaraju Adinarayan and Saikat Chatterjee
LONDON, Feb. 25 (Reuters) – A record single-day release of Ark Invest’s flagship fund has led analysts to highlight the risks posed by the ETF’s heavy exposure to illiquid stocks if the outflow fits.
A 20% decline in Tesla shares over the past three weeks, the bulk of the exchange-traded fund Ark Innovation set up by star investor Cathie Wood, has caused a rush among investors to sell some of their shares.
According to some people watching the fund closely, a much bigger problem could be that it has a 15% stake in a handful of companies whose shares are relatively illiquid and potentially difficult to trade as redemptions increase.
These include names such as the therapeutic discovery company Compugen and the three-dimensional printing company Stratasys, whose daily trading of shares is small compared to the total 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 is liquidity, it will cost a price, and it will be a price that in all likelihood will not be favorable to fund shareholders.”
For example, about $ 100 million worth of shares fluctuate on average each day in Stratasys, a stark contrast to Ark Innovation ETF’s single-digit million turnover and Tesla’s ten-million dollar dollars.
According to Refinitiv, Ark Investation withdrew $ 465 million from Ark Innovation on Monday. More such redemptions will lead Wood’s fund to sell liquid shares to manage the short-term shortfall before it wants to withdraw the illiquid assets.
It can be nasty and ignite the memories of British money manager Neil Woodford’s flagship fund, which failed in 2019 due to its exposure to hard-to-sell shares. This has not enabled him to meet a flood of redemption requests after a phase of disappointing performance and revaluations of assets.
“These big interests are hard to leave quickly. This film has played out before, starring Neil Woodford,” said Neil Campling, chief technology officer at Mirabaud Securities.
Ark Invest did not return calls for comment.
The Ark Innovation ETF’s portfolio risk level, which returned 157% last year, is well above average on ten of the 11 factors in Morningstar’s Global RiskModel.
Ark Invest shook up its portfolio on Tuesday by reducing its already small shares in Apple, Amazon, Taiwan Semiconductor and Google owner Alphabet to increase its stake in Tesla on Wednesday.
The fund, which flowed $ 5.5 billion in 2021, traded almost evenly on Wednesday when Tesla shares stopped falling.
In 2020, its assets grew ninefold thanks to small-scale investors, as actively managed ETFs focused on red-hot themes such as major technology disruptions, space technology and pet care.
Investors believe that Ark’s ETFs allow funds to invest in specialized niche companies in which other large ETFs simply do not take interest.
SHORT
The pressure on the fund this week has attracted short sellers, with 100% of Ark Innovation shares available for lending on Monday, data provider FIS Astec Analytics estimated.
Sales pressure can cause the ETF to trade below the net asset value (NAV), leading to ‘redemptions’ because ETF arbitrators exchange the underlying asset fund and then sell the underlying asset, exacerbating the sales pressure on these ETFs.
In a similar episode, during China’s stock market crash in 2015, ETFs traded overseas in Chinese markets at significant discounts on their net asset value.
“ETFs can quickly gain or lose assets based on the sentiment of their retail investors. This changing flow could serve as a self-fulfilling prophecy for ARK,” Campling added.
Of course, Ark is not the only fund that has invested heavily in a very small number of companies. However, this is one of the largest, and many others have taken a more cautious approach.
Global X, which has $ 25 billion in managed assets, uses a concept of ‘modified market capitalization’ in its thematic ETFs where no company has more than 8% in the portfolio, says CEO Luis Berruga.
“We are limiting the potential situation in which a company could become a very large part of their portfolio and could address some potential concentration risks in our portfolios,” Berruga told Reuters.
(Reporting by Thyagaraju Adinarayan and Saikat Chatterjee; Editing by Sujata Rao and Hugh Lawson)