ARKchegos Looming

For months, we have been watching ARK Funds closely, noting on more than one occasion that Cathie Wood’s “investing” style of selling big tech names to add speculative illiquid names to her flagship ARKK ETF had caught our eye. Now, we’re watching even closer.

That’s because ARKK is “in the midst of its worst stretch since 2018”, according to Bloomberg, as the NASDAQ teeters back and forth, trying to decide how to react to what appears to be the end of an 18 month gamma squeeze, coupled with the widely accepted consensus that significant inflation is on its way. 

Key components in Wood’s flagship ARKK fund – names like Twilio, Zoom and Roku, have all bucked a larger trend in the NASDAQ as it tried to rally for the first time this week, Bloomberg notes. That may not bode well for Wood when the NASDAQ eventually turns red again.

As one trader simply noted…

This is beyond ugly – $ARKK pic.twitter.com/PqBoY5g6cG

— Andrew Fisher (@acpandy) May 6, 2021

The bucking of the NASDAQ trend appears to mark the decoupling between real rates and riskier tech names. As real rates fell over the last week, NASDAQ names have not responded in the manner with which they had over the last 18 months, where stooping real rates would put a bid under risky names.

The change could be due to rising concerns about inflation. Matt Miskin, co-chief investment strategist at John Hancock Investment Management, told Bloomberg: “Even though the bond market is suggesting that tech should be doing better, commodities are what the equity market is listening to and that is causing less of a bid for technology. Commodities are whispering in the ear of the equity market and saying inflation is coming.”

This could fare terribly for Cathie Wood’s strategy, which has outperformed for years on the relationship between real rates and risky tech names.

This has also led to $785 million in outflows for ARKK over the last 6 days, according to Bloomberg. Hedge funds, during the same time, have cut their exposure to technology to the lowest since December, the report notes. High flying names like PLUG and XPEN fell 9% and 6.4% respectively on Thursday, after sizeable surges throughout all of 2020. PLUG, for example, gained 973% over the course of last year. 

Dan Suzuki, Richard Bernstein Advisors LLC’s deputy chief investment officer, said: “With the data continuing to suggest a faster than expected recovery, the recovery/reflation trade is winning and expensive growth becomes a source of funds. The rising inflation expectations indicate that people’s confidence in the reflation trade is picking up.”

And we literally just noted – moments ago – that prime brokers had begun to slash leverage as a result of the Archegos blowup. As momentum charged higher last year, riding a sea of liquidity, every stock market ‘guru’ bought the junkiest junk…

Source: Bloomberg

…with the most leverage.

As a result, hedge fund leverage – both gross and net – hit record highs in late April, according to Goldman’s Prime Brokerage. And that has now prompted prime brokers to slash available leverage for their hedge fund clients:

…managers of small hedge funds who lack the negotiating clout of trading whales are grousing. For the little guy especially, the saga will make it harder to borrow money from banks to finance bets.

While specific measures will vary by bank and client – and in many cases are still being ironed out – the talks and tensions point to greater pressure on clients to reveal their biggest wagers, stricter margin limits on those positions, more frequent collateral adjustments and more rigorous audits. The deliberations were described by executives close to prime brokerage desks and money managers.

At its most extreme, Credit Suisse, which was the hardest hit among Archegos’ primes, drastically adjusted risk tolerances and practices, slashing lending to hedge funds by a third.

And so the analogues to Bill Hwang are tough to not notice. In April, we pointed out the tie between Hwang, who had recently blown up, and Wood, noting that Wood could also be on the precipice of her own “Jesus Take The Wheel” style moment. We knew at the time that Bill Hwang was a mentor to Cathie Wood and that both investors had a penchant for bringing religion into their investing methodology, as we noted in a report we published earlier in April. 

In that report, we shone light as to how close Wood and Hwang were in the investing world. A Bloomberg report released in April said Hwang was “on the same trajectory” as Wood. For example, in 2016, Hwang was invited to a weekend retreat put on by Princeton Theological Seminary that was set up to “connect Christians in finance”. The Saturday keynote dinner that weekend featured Wood, who was then a startup manager and and an adviser to the ministry.

After then, Hwang became an investor in Wood’s firms, and “Archegos and ARK collaborated on industry research,” the report noted. Hwang was/is “a backer” of Wood’s. Wood, like Hwang, holds Bible study meetings in her office. 

And Wood’s risk management – like Hwang’s – might eventually be called into question. About a month prior, in March, we also noted when ARK Funds filed to allow for larger concentrations in names, including overseas ADRs.

ARK funds filed an amendment to its prospectuses for its ETFs in March, making some little recognized changes that were caught by @syouth1 on Twitter at the time.

First screencap shows language that was removed re ownership of ADRs, warrants, etc. (in red). Second shows language removed re limits on investing 30%+ of assets in a single firm and investing in 20+% of firm’s shares (also encircled in red). Source: https://t.co/yDVAHJTf6Y pic.twitter.com/ZJUlRSxQ5n

— Jeffrey Ptak (@syouth1) March 26, 2021

As the tweet noted, the ARK SEC filing did several things. First, on a perfunctory note, it specified risks related to investing in SPACs, noting that they are “subject to a variety of risks beyond those associated with other equity securities”. 

But then the filing got very interesting – language was removed that allowed ARK funds to take even larger concentrations in names – in addition to over-the-counter traded ADRs, which are notoriously riskier products than normal equity. 

The amendment removed ARK’s limit to invest 10% of its total assets in any active fund in ADRs that are traded over-the-counter. 

The amended prospectus also removed language that formerly limited ARK to investing no more than 30% of a fund’s total assets into securities issued by a single company.

Another “rule” removed was language preventing ARK from investing in more than 20% of a company’s total outstanding shares.

The amendments portended ARK piling further into concentrated, high-risk names that dominated their respective funds, we noted at the time.

Now, it could be time to pay the piper. As we wrote in April:

Obviously, if a pin is finally going to prick the NASDAQ gamma bubble that has blown up over the last 12 months, the higher Wood’s concentration in speculative names, the more spectacular a crash would be for ARK funds.