It’s Emerge that needs to distance itself from ARK

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A fair amount has been said about the mysterious troubles of ETF provider Emerge Canada Inc. and how regulators slapped a cease-trade order on its funds. Not nearly enough has been said about ARK Investment Management LLC, which has caused nearly as much damage to Emerge’s customers, and to Emerge itself.

Emerge Canada wasn’t a terribly well-known fund company until it announced in early April that the Ontario Securities Commission had issued a cease-trade order because it had failed to file financial statements. That means investors can’t buy into Emerge Canada’s funds, and, importantly, investors can’t sell them.

The Toronto company, controlled by Buffalo-based parent Emerge Capital Management Inc., made its entry into Canada in 2019 by partnering with U.S. fund manager ARK. Emerge Canada launched a series of exchange-traded funds, labelled “Emerge ARK.” ARK is what’s called a sub-adviser to Emerge Capital, which in turn is a sub-adviser to Emerge Canada.

ARK founder Cathie Wood became a celebrity by riding the pandemic bull. Her funds are stuffed with things like Tesla Inc., pandemic darlings Zoom Video Communications Inc., Shopify Inc., and a host of buzzy technology and biotech stocks. The Canadian Emerge ARK funds have similar positions.

In another matter, which Emerge Capital insists is separate and unimportant, Emerge Canada owed $2.5-million to the various Emerge ARK funds as of June 30 of last year. (We don’t have a more current figure, alas, because of the failure to file financial statements.)

Emerge Canada says it had agreed to absorb startup costs for the Emerge ARK funds to keep fees charged to investors lower than they’d otherwise be. But the numbers don’t quite match: The balance of the amount owed grew faster than the absorbed expenses, suggesting they took more money from the funds than were needed to cover the fund’s costs. And the amount owed more than doubled in the first six months of 2022, for which Emerge Canada offered no explanation in the funds’ most recent financial statements, filed in August, 2022.

That is normally a problem for the fund investors: Every dollar that’s not in the fund is a dollar uninvested. Emerge Canada is accruing unpaid interest at the rate of 2.5 per cent per year – way below what any equity-fund investor expects to earn in return. And certainly less than an investor anticipated from ARK.

ARK had a winning strategy for a time of market exuberance. By February, 2021, the six Canadian Emerge ARK funds had $336-million in assets, according to data from Morningstar Direct. All were up by more than 100 per cent, less than two years from their launch.

Things change, and the market has a way of making yesterday’s wizards turn into today’s gnomes. Since that February, 2021, peak, there have been 14 months where every single Emerge ARK ETF has lost money. Three times, the monthly loss exceeded 10 per cent in every fund. In April, 2022, losses ranged from 15.95 per cent to 28.55 per cent.

All the astonishing gains are gone. As of March 31, only the Emerge ARK Autonomous Tech & Robotics ETF is in positive territory since its founding. The Global Disruptive Innovation ETF is down by more than 20 per cent.

Ms. Wood has laid the blame for the firm’s performance at the feet of the U.S. Federal Reserve and an unprecedented increase in interest rates that she says damaged her investing thesis.

So, instead of robbing Emerge ARK fundholders of opportunity, loans yielding 2.5 per cent may have been some of the funds’ best investments. The investing newspaper Barron’s says the deeply religious Ms. Wood named ARK after the Ark of the Covenant; fundholders’ experience is kind of like what happens to the Nazis in Raiders of the Lost Ark when they open the lid.

Aside from the pain for individual investors, it must be an uncomfortable situation for Emerge Canada. While the financial statements for the funds are public, the books for the management companies, Emerge Canada and parent Emerge Capital, which are privately owned, are not.

But we can do a little math based on what we know from disclosures and Morningstar data. There’s an annual management fee on the Emerge ARK funds of 0.8 per cent. At $300-million-plus in assets, the ARK funds generated more than $200,000 a month in revenue for Emerge Canada. Other expenses such as administration, legal and audit were covered by another 0.45-per-cent fee, which was bringing in about $125,000 a month.

Based on the $109-million in assets in the ARK funds at the close of March – down by more than two-thirds from the peak – management revenue is down to about $75,000 a month, with the money to cover the other expenses down to $40,000. That means total monthly revenue, too, has fallen by more than two-thirds. Clearly, Emerge Canada rode ARK to its highs and kept the faith, tumbling to its current lows.

The two firms declined to comment for this column.

In a statement after the cease-trade order, ARK said it is “not affiliated with and has no ownership or role in the management of Emerge Canada, nor its ETFs.” It said Emerge Capital “is one of many entities with whom ARK has contracts to provide non-binding advice models.” That seems to suggest ARK believes the performance of the Emerge ARK funds is more attributable to Emerge Capital, rather than ARK. (Despite the striking similarity in portfolio holdings and high correlations between the Canadian and U.S. ARK funds.)

Will things get better, and ARK look wizardly instead of gnomish? Certainly, ARK is likely to stick to its investment theories. Barron’s says Ms. Wood was a protégé of economist Arthur Laffer, who has managed to be consistently wrong about taxation and macroeconomics for nearly 50 years.

Even though ARK seemed to use its public comments to distance itself from Emerge, it should be Emerge distancing itself from ARK. As should BMO Nesbitt Burns Inc., which should know better, but inexplicably launched a new line of ARK funds last year. When the OSC lifts the cease-trade order, holders of the Emerge ARK funds will have the opportunity to disentangle themselves from ARK. It won’t be so easy for ARK’s Canadian partners.