NEW YORK: A series of unusual multibillion-dollar flows has rippled through the exchange-traded fund (ETF) market in the past week, suggesting major investors are using a contentious method to get exposure to the initial public offering (IPO) of SpaceX.
At least one fund manager placed temporary restrictions on its product in a bid to curb the practice.
The biggest flows were in Cathie Wood’s flagship strategy.
The US$6.9bil Ark Innovation ETF (ticker ARKK) posted a record US$4.6bil inflow late last week before recording its largest- ever outflow of US$6.2bil in the following session, Bloomberg data showed.
That activity coincided with ARKK acquiring roughly 1.7 million shares of SpaceX on the day the rocket maker listed, and echoes similar patterns seen during a number of IPOs in the past year.
The theory among ETF specialists is that such flows represent an IPO arbitrage strategy.
The tactic involves pouring cash into an ETF before an offering in which the fund is expected to receive shares, then pulling the money out once the stock begins trading.
Such a maneuver could provide indirect, or synthetic, exposure to the IPO and would profit from any post-listing gain, though it risks distorting fund performance and disadvantaging longer-term holders.
“Investors appear to be using ARKK as a piggyback vehicle for access to opportunities they may not be able to easily buy directly,” said Bloomberg Intelligence ETF analyst Athanasios Psarofagis.
“That trend has become more common in ARKK around major IPOs.”
Based on activity surrounding the SpaceX listing, it goes beyond ARKK.
The same pattern is visible in the flows of several other funds that appear to have received allocations in the IPO, including two other Ark Investment Management products, and the Baron First Principles ETF from Baron Capital.
The apparent expansion of the practice highlights the fierce competition to access major IPOs, and in particular the investor frenzy surrounding the SpaceX offering, which became the largest in history.
But it also underscores how investors are stretching the ETF structure beyond its traditional role as a low-cost investment vehicle, using it as a conduit for increasingly aggressive trading strategies, from leverage and shorting to tax avoidance.
The IPO arbitrage trade comes with risks. Success depends both on correctly identifying which funds will receive IPO allocations and on the stock performing well after listing.
But executed correctly it could offer attractive gains.
The scale of the flows suggests the strategy uses a fund’s creation-and-redemption mechanism rather than buying and selling shares on an exchange, and that one or more large institution is behind the flows.
It is hard to identify who, but the potential losers are clear: existing ETF holders will see both any gains from the offering and their stake in the newly listed company reduced.
In a bid to protect holders of the US$2.4bil ERShares Private-Public Crossover ETF (XOVR), Joel Shulman, founder and chief investment officer of ERShares, restricted primary creations for the fund ahead of the SpaceX offering and imposed a 2% redemption fee.
Investors in XOVR had indirect exposure to the company before its public debut.
“We stopped the creations the week before the IPO, and the intent was to protect our long-term loyal shareholders from dilution,” Shulman said.
“We implemented a redemption fee to cover any related costs associated with disruptive large inflows and outflows.”
Shulman estimates the firm turned away more than US$1bil of potential inflows.
Baron’s RONB saw inflows of about US$1.6bil over the last six weeks.
About US$1.5bil has been pulled out in the last two trading sessions for which data is available.
The fund held a stake in SpaceX before it went public, and added more in the IPO.
The SpaceX IPO is the third time in recent months ARKK has experienced unusually large inflows and outflows surrounding a new listing, with the pattern appearing for the debuts of X-Energy Inc in April and Cerebras Systems Inc in May. The fund owns both names. — Bloomberg
