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(Repeats item that first aired on Wednesday)
By Thyagaraju Adinarayan and Saikat Chatterjee
LONDON, Feb. 25 (Reuters) – A record half-billion dollar takeover of flagship Ark Invest in a single day has led analysts to highlight risks stemming from the ETF’s heavy exposure to illiquid stocks if exits accelerated.
A 20% drop in Tesla shares in the past three weeks, the largest stake in exchange-traded fund Ark Innovation set up by star investor Cathie Wood, has sparked a rush among investors to sell some of their holdings .
But according to some who are watching the fund closely, a far bigger problem could be its 15% and larger holdings in a handful of companies whose stocks are relatively illiquid and potentially difficult to exit when redemptions increase.
These include names like therapeutic discovery company Compugen and three-dimensional printing company Stratasys, whose daily transactions are minimal compared to the overall ETF turnover.
“They won’t find liquidity in many of these stocks,” said Ben Johnson, director of global ETF research at Morningstar. “If there is liquidity, it will come at a price, and it will be a price which in all likelihood would not be favorable to the shareholders of the fund.”
For example, about $ 100 million of stocks change hands on average every day at Stratasys, a stark contrast to Ark Innovation ETF’s turnover in billions of single digits and Tesla’s in tens of billions of dollars. .
Investors withdrew $ 465 million from Ark Innovation on Monday, according to data from Refinitiv. A greater number of such buyouts would prompt Wood’s fund to sell liquid holdings to manage the short-term squeeze before seeking to liquidate its illiquid holdings.
It could get unpleasant and rekindle memories of UK portfolio manager Neil Woodford’s flagship fund, which failed in 2019 due to its exposure to hard-to-sell stocks. This left it unable to respond to a flood of redemption requests after a phase of disappointing performance and asset revaluations.
“These big stakes are hard to get out of quickly. This movie has played 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 rating of the Ark Innovation ETF’s portfolio, which returned 157% last year, ranks well above the 10-factor average of the 11 factors in Morningstar’s Global RiskModel.
Ark Invest meanwhile reorganized its portfolio Tuesday by cutting its already tiny positions in Apple, Amazon, Taiwan Semiconductor and Alphabet, owner of Google, to strengthen its stake in Tesla on Wednesday.
The fund, which posted $ 5.5 billion in inflows in 2021, traded almost flat on Wednesday as Tesla shares stopped falling.
In 2020, its assets grew nine-fold thanks to small investors, as actively managed ETFs focused on hot topics such as major tech disruptors, space technology and pet care took off.
Investors claim that Ark’s ETF allows funds to invest in niche, niche companies that other large ETFs simply don’t take a stake in.
SHORT
Pressure on the fund this week has drawn in short sellers, with 100% of Ark Innovation’s shares available for short sale on loan from Monday, FIS data provider Astec Analytics estimated.
The pressure to sell can cause the ETF to trade below the NAV, which leads to “redemptions” as ETF arbitrageurs swap the fund for the underlying securities and then sell the securities. underlying, exacerbating the selling pressure on these ETFs.
In a similar episode, during the 2015 Chinese stock market crash, overseas listed ETFs in Chinese markets traded at significant discounts to their net asset value.
“ETFs can quickly gain or lose assets depending on the sentiments of their particular investors. These shifting flows can act as a self-fulfilling prophecy for ARK,” Campling added.
Of course, Ark is not the only fund to bet heavily on a very small number of companies. It is, however, one of the most important and many others have taken a more cautious approach.
Global X, which has $ 25 billion in assets under management, uses a concept of “modified market capitalization” 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 large part of its portfolio and address 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)
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