Led by CEO and founder Cathie Wooden, ARK specializes in investments in disruptive innovations. Over the previous 12 months, the agency has seen the property underneath its seven exchange-traded funds explode by greater than tenfold, from $3.2 billion on the finish of 2019 to a whopping $34.5 billion as of December. The expansion is partially as a result of ARK funds’ robust efficiency in 2020, but in addition to surging interest from investors, who’re pouring billions of {dollars} of recent money into ARK merchandise. Solely six years because it was based, ARK is now a top-10 fund issuer within the U.S.

Whereas it’s typically a great factor when a fund is profitable in rising property, it additionally means the fund must put all that new money to work by shopping for extra shares of corporations. In some circumstances, if the fund has a concentrated portfolio or invests within the smaller corporations, it might probably shortly bump up its stake in sure shares.

That may be an issue from a liquidity and risk-management perspective. When a popular inventory stops being favored, for instance, it might be tough to shortly scale back or exit the place if there are few consumers on the opposite facet of the commerce. It may be pricey to promote, and different buyers would possibly discover the promoting and attempt to front-run the commerce and even brief the inventory, in a guess that it’s going to drop.

ARK’s Capability Problem

Following its enormous success, ARK appears to satisfy all the factors for bumping up in opposition to these challenges. Its asset dimension has grown tremendously; its actively managed ETFs have concentrated portfolios, typically holding fewer than 50 shares; and it typically invests within the smaller, up-and-coming shares for his or her progress potential. The newest money inflow has pushed ARK to buy extra of its favored shares. For some smaller corporations, ARK is now certainly one of their largest outsider shareholders.

In keeping with Barron’s evaluation, as of final Friday, ARK owns greater than 10% of the free float––shares that may be publicly traded with out restriction––in a minimum of 26 corporations, most of that are biotech or tech corporations. “Anytime you see any fund that has such vital stakes in such a lot of corporations, capability turns into a priority,” says Ben Johnson, director of world ETF analysis for Morningstar.

For

AquaBounty Technologies

(ticker: AQB), a biotech agency with a $595 million market worth, as an illustration, the

ARK Genomic Revolution

ETF (ARKG) owns practically 30% of the corporate’s free-float shares. Even at bigger corporations like

Crispr Therapeutics

(CRSP), with a market worth of $14 billion, two of the ARK funds mixed––with about 5% weight within the inventory––maintain greater than 15% of the corporate’s free-float shares.

ARK declined to remark.

The more and more giant stakes in sure corporations may additionally have an effect on the efficacy of a fund’s methods going ahead, says Johnson. “If the workforce continues so as to add the identical names which might be their finest concepts, buyers ought to ask whether or not they’re nonetheless a gorgeous place to speculate the brand new capital after costs have gone up a lot.”

An Outdated Drawback for a New Firm

To make certain, this drawback is neither distinctive to ARK, nor new to the asset administration trade. Many mutual fund giants, similar to Constancy and T. Rowe Value, have been dealing with capacity challenges for years as their fashionable merchandise grow to be too giant to handle. Many occasions they’ll merely cap a fund’s dimension and shut it to new buyers. However that isn’t an choice for ARK, since ETFs can’t be closed like mutual funds.

That’s what makes ARK’s case particular, and one of many first of its variety. Most ETFs––particularly these with enormous property underneath administration––are diversified index funds holding a whole lot, if not hundreds, of shares. Every inventory makes up a comparatively small proportion of the portfolio, and subsequently doesn’t trigger a lot of a capability drawback even because the fund attracts extra property. Some ETFs have extra concentrated holdings, however they both give attention to large-cap shares––the place liquidity is considerable––or simply don’t have sufficient property to warrant capability considerations.

ARK funds are the primary concentrated, actively managed inventory ETFs which have grown to such giant sizes. Not having the ability to curb the incoming money flows, “the ball is in ARK’s court docket to deal with this drawback as they see match,” says Todd Rosenbluth, senior director of ETF and Mutual Fund Analysis at CFRA.

Learn how to Handle Capability

What occurred in 2017 to the

VanEck Junior Gold Miners

ETF (GDXJ) may offer a good case study for what ARK can do. As buyers acquired excited over the rebound in gold costs, the fund attracted an unlimited quantity of recent cash and ended up proudly owning vital stakes in lots of small gold miners. To handle capability, the ETF began shopping for shares and funds exterior of its index constituents, and finally expanded the underlying index to permit the bigger gold miners into its portfolio.

ARK has extra flexibility, since its ETFs are actively managed and subsequently not certain by an index. The corporate can enhance the variety of holdings in its portfolios to dilute the burden in every inventory, deploying a number of the new capital to “next-best concepts” that the ARK funds don’t have already got vital stakes in but. “They will personal sure shares that aren’t their highest favored ones, however nonetheless favorable inside that funding theme,” says Rosenbluth.

As well as, the ARK funds can steadily wind down their publicity to a number of the smaller shares, whereas constructing bigger positions within the extremely liquid large-cap ones. Buying and selling information counsel the agency is already doing so.

Within the first two weeks of 2021, ARK purchased extra shares of some bigger corporations. As of Friday, it has $36 million invested in

Lockheed Martin

(LMT) and $133 million in

Bristol Myers Squibb

(BMY), and practically all of that was purchased inside the prior week. Different extremely liquid shares, similar to

Baidu

(BIDU),

Zoom Video Communications

(ZM), and

Nvidia

(NVDA), have additionally seen their share in ARK funds enhance by greater than 30% in simply two weeks.

On the similar time, ARK offered hundreds of shares in a number of the shares the place it has the very best stakes. For instance, it diminished its stake in

ExOne

(XONE) by 26%,

Organovo Holdings

(ONVO) by 12%, and

Pacific Biosciences of California

(PACB) by 6%. Nonetheless, even after the unload, ARK owns greater than 10% of those corporations’ free float as of final Friday.

Dangers and Constraints

To make certain, these buying and selling actions aren’t essentially pushed by capability considerations or liquidity wants. ARK might be shopping for just because it favors a inventory’s future return potential. The promoting, however, might be a rebalancing transfer to reap good points. ARK declined to touch upon the explanations behind its newest buying and selling.

Nonetheless, strikes like this deliver potential dangers. Following ARK’s enormous success, market contributors have been carefully watching the asset supervisor’s each transfer. Final week, when ARK filed for a new space-exploration ETF, many house shares jumped by double digits in response to the headline, despite the fact that the brand new fund’s holdings haven’t been disclosed.

“There’s this diploma of reflexivity virtually,” says Johnson. “If the ARK workforce casts its gaze on a selected title, simply by the advantage of doing so, the share costs would possibly reply. At this time they responded favorably. If that is in any manner symmetrical, the market could reply equally disfavorably in the event that they bitter on a selected inventory, particularly if buyers begin to pull their capital.”

Up to now it hasn’t been a problem. The three shares talked about above that ARK has been promoting, for instance, proceed to rise sharply as different buyers take up the baton. However additional unloading might be interpreted as a bearish sign and set off extra promoting, and that might restrict ARK’s capability to lock in a few of its good points.

Additional down the road, capability constraints additionally imply that ARK received’t be capable to purchase as lots of its favored shares because it want to. That might be a drag on efficiency, as nicely.

Write to Evie Liu at evie.liu@barrons.com