Record redemption in Ark ETF sparks liquidity worries

Compugen

24/02/2021 20:42

By Thyagaraju Adinarayan and Saikat Chatterjee
    LONDON, Feb 24 (Reuters) - A record half-billion dollar
redemption from Ark Invest's flagship fund in a single day has
led analysts to highlight the risks arising from the ETF's heavy
exposure to illiquid stocks if outflows pick up pace.
    A 20% pullback in Tesla  TSLA.O  shares over the past three
weeks, the biggest holding of the exchange-traded fund Ark
Innovation set up by star investor Cathie Wood has triggered a
rush among investors to sell some of their holdings.
    But according to some who watch the fund closely, a far
bigger problem could be its 15%-plus stakes in a handful of
companies whose shares are relatively illiquid and potentially
hard to exit when redemptions surge.
    These include names such as therapeutic discovery company
Compugen  CGEN.O  and three-dimensional printing firm Stratasys
 SSYS.O  whose daily share trading is tiny compared to the
overall ETF's turnover.
    "They won't find liquidity in many of these stocks," said
Ben Johnson, director of global ETF research at Morningstar. "If
there's going to be liquidity it is going to come at a price,
and it's going to be a price that, in all likelihood, would not
be favourable to fund shareholders." 
    For instance, about $100 million worth of shares change
hands on average every day in Stratasys, a stark contrast to Ark
Innovation ETF's turnover in single-digit billions and Tesla's
in tens of billions of dollars.
    Investors yanked $465 million from Ark Innovation on Monday,
according to Refinitiv data. More such redemptions would prompt
Wood's fund to sell liquid holdings to manage the squeeze in the
near-term before looking to unwind its illiquid holdings.
    That could turn nasty and rekindle memories of British money
manager Neil Woodford's flagship fund, which failed in 2019
because of its exposure to hard-to-sell stocks. That left it
unable to meet a flood of redemption requests after a phase of
disappointing performance and asset revaluations.
    "These large stakes are difficult to exit quickly. This
movie has played out before, with the leading role played by
Neil Woodford," said Neil Campling, head of technology research
at Mirabaud Securities.
    Ark Invest did not return calls seeking comment.
    The portfolio risk level of the Ark Innovation ETF, which
returned 157% last year, ranks well above average on 10 of the
11 factors in Morningstar's Global RiskModel.
    Ark Invest meanwhile shuffled its portfolio on Tuesday by
cutting its already-tiny holdings in Apple  AAPL.O , Amazon
 AMZN.O , Taiwan Semiconductor  TSM  and Google-owner Alphabet
 GOOGL.O  to beef-up its Tesla stake on Wednesday.  urn:newsml:reuters.com:*:nL8N2KU3AM
    The fund, which saw $5.5 billion inflows in 2021, traded
nearly flat on Wednesday as Tesla shares stopped falling. 
    In 2020, its assets grew nine-fold thanks to small-time
investors as actively managed ETFs focused on red-hot themes
such as major tech disruptors, space technology and pet care
took off.  urn:newsml:reuters.com:*:nL4N2KG2GQ
    Investors say Ark's ETF allows funds to invest in
specialised niche companies that other large ETFs simply don't
take stakes in.
        
    SHORT
    The pressure on the fund this week has lured in
short-sellers, with 100% of Ark Innovation shares available for
shorting out on loan as of Monday, data provider FIS Astec
Analytics estimated.
    Selling pressure can cause the ETF to trade below net asset
value (NAV), which leads to "redemptions" as ETF arbitrageurs
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 2015 stock market
crash, overseas-listed ETFs of Chinese markets traded at
significant discounts to their NAVs. 
    "ETFs can rapidly gain or lose assets based on the
sentiments of their retail investors. These changing 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 among the biggest, however, and
many others have adopted a more cautious approach.
    Global X, which has $25 billion in managed assets, uses a
concept of "modified market capitalisation" in its thematic ETFs
where no company has more than 8% weight in the portfolio, CEO
Luis Berruga says.
    "We limit the potential situation in which a company can
become a very large part of their portfolio and address some of
the potential concentration risks in our portfolios," Berruga
told Reuters.
    

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ARK, Tesla shares in the last two years    https://tmsnrt.rs/3dMGXGX
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 (Reporting by Thyagaraju Adinarayan and Saikat Chatterjee;
Editing by Sujata Rao and Hugh Lawson)
 ((thyagaraju.adinarayan@tr.com; +44 20 7542 7015; Reuters
Messaging: thyagaraju.adinarayan.thomsonreuters.com@reuters.net;
Twitter @thyagu))