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John Engle
John Engle
Articles (610) 

ARK Invest: Illiquid Positions Threaten to Drown Bubbly ETFs

Catherine Wood has plunged deeper into illiquid stocks in an effort to prop up faltering positions

ARK Investment Management saw explosive growth across its high-flying, innovation-focused exchange-traded funds in 2020. Unfortunately, as I have discussed recently, it appears the wheels may be coming off ARK's proverbial wagon. In order to prop up sagging holdings across its ETFs, ARK has been forced to expand highly illiquid positions in a number of small names.

Having been buoyed by massive inflows over the past year, ARK's ETFs could rapidly deflate in the face of accelerating outflows. The mounting danger of flood turning to drought should be a warning to allocators with exposure to ARK's funds.

Illiquidity issues intensify

ARK CEO Catherine Wood (Trades, Portfolio) has insisted that nothing is amiss. On Feb. 23, for example, she argued that pullbacks in key names is actually a good thing:

"We love a wall of worry. We saw it on social media, lot of chatter, some of it just waiting for our fund in particular to take a tumble, maybe to buy and some happy to sell and short and all that."

Yet ARK's outsized position in – and exposure to – highly illiquid stocks has gotten worse on an almost daily basis since the beginning of last week. ARK has massive positions in many smaller names, with its ownership exceeding 10% in dozens of cases, including 11 in which it owns 15% or more of the total equity:

ARK Illiquid Holding ARK Percent Ownership Price Change (Feb. 16 - March 3) Price Change (YTD)
Compugen Ltd. (CGEN 21.3% -31.90% 29.10%
Stratasys Ltd. (NASDAQ:SSYS) 21.3% -45.40% 31.90%
Organovo Holdings Inc. (NASDAQ:ONVO) 20.0% -31.90% -2.60%
The ExOne Co. (NASDAQ:XONE) 19.5% -29.60% 272.60%
Invitae Corp. (NYSE:NVTA) 19.2% -20.40% -10.40%
2U Inc. (TWOU) 18.4% -32.40% -8.10%
Syros Pharmaceuticals Inc. (SYRS) 18.2% -30.60% -22.50%
Cerus Corp. (CERS) 18.0% -19.00% -9.50%
Intellia Therapeutics Inc. (NTLA) 17.7% -15.30% 1.60%
Editas Medicine Inc. (EDIT) 16.1% -23.60% -39.80%
Personalis Inc. (PSNL) 15.6% -30.50% -19.60%

ARK's efforts have increased its exposure to these illiquid names, yet they have thus far largely failed to prevent their continuing slide.

Beware the wave of outflows

ARK's recent woes have sparked concerns about allocator redemptions leading to outflows, a prospect that could intensify downward pressure both on ARK's ETFs and its struggling holdings. While flows into and out of ARK's ETFs have stabilized this week after several days of anxiety, the risk of another exodus cannot be overlooked.

ARK ETF Year-to-Date Performance Feb. 16 - March 3 Performance
ARK Innovation ETF (ARKK) 0.6% -19.3%
Autonomous Technology & Robotics ETF (ARKQ) 9.2% -15.0%
Next Generation Internet ETF (ARKW) 6.9% -16.7%
Genomic Revolution ETF (ARKG) -3.0% -13.5%
Fintech Innovation ETF (ARKF) 9.9% -14.3%

With several of ARK's ETFs having already erased most or all of their gains in 2021 to date, another downswing could trigger another wave of outflows.

From illiquid to insolvent

ARK's extreme illiquidity makes it vulnerable to attack by other market participants, as I have discussed previously. As its illiquidity increases, so too does its vulnerability.

On March 4, analyst Edwin Dorsey explained what can happen to a firm in such a position when the market turns against it:

"Copper River Capital provides an example of what large forced transactions can do to markets. In September 2008 the short-focused fund faced margin calls after Goldman deemed its cash held at Lehman Brothers invalid. The firm was forced to cover large short positions quickly and drove positions upwards of 40% against themselves within days. Part of the short-term upwards jerk was hedge funds front-running with their buying. Replace margin calls with forced selling, and you could have the same thing happen in reverse with ARK. What makes ARK's situation potentially worse is the heavy retail participation in many of its names. Retail investors may be fickler and have price drive sentiment. As a result, any declines in ARK's illiquid names may drive copycat selling by retail traders playing with momentum."

Institutional front-running and short attacks would be bad enough, but the heavy presence of retail investors in ARK's funds adds another potentially dangerous wild card into the mix. The writing may already be on the wall, given the continuing slide across ARK's once white-hot ETFs.

My verdict

ARK has put itself at risk of falling into a "liquidity death spiral" from which there may be no escape. In my opinion, the firm must be proactive if it hopes to prevent that from happening. Yet, based on its actions to date, it seems to me that ARK is still in no hurry to extricate itself from its increasingly tough position.

Ultimately, I see steering clear of these volatile ETFs as the most prudent action for investors at this stage.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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