The SpaceX IPO is already on course to break records left, right and centre. Now it has led to a first in ETF Land, with a fund intentionally turning away money in order to protect existing investors.
The ERShares Private-Public Crossover ETF, popularly known by its ticker XOVR, is an ETF promising public market access to pre-IPO SpaceX. However, it has decided that too much demand from the public market might not be a good thing.
XOVR’s largest holding is a 13.2 per cent position in Elon Musk’s AI-to-rockets empire held via a special purpose vehicle. With speculation of the stock enjoying a “pop” in Friday’s wildly anticipated IPO, there was the possibility of a flood of money gushing into XOVR this week.
This in turn would dilute any gains for XOVR’s pre-existing investors if the ETF had to put this new money to work by buying more of the listed stocks that form the bulk of its portfolio, such as Nvidia and Alphabet.
Moreover, this hot money might then exit soon after the SpaceX float, limiting any benefit for ERShares, which would see the short-term pop in its own fee income rapidly deflate.
Indeed, that is exactly what has happened before. As Alphaville has reported, Cathie Wood’s flagship ARK Innovation ETF saw huge spikes in its share count around the flotations last year of two of its holdings, Bullish and Klarna, only for the money to disappear again straight after.
XOVR itself saw a similar surge in its market cap in December, seemingly driven by arbitrageurs seeking to benefit from a revaluation of its SpaceX stake, with the hot money heading for the exit two months later.
In order to combat “potentially disruptive short-term trading activity” around the SpaceX IPO, XOVR has therefore now implemented a “shareholder protection plan”. Alphaville’s emphasis below:
The Fund expects to use tools described in the fund’s prospectus to mitigate potential adverse harm to the fund.
These tools include the ability to reject certain Creation Units where acceptance may have an adverse effect on the Fund or on the rights of the Fund’s beneficial owners, which has already gone into effect.
Beginning on the day of the SpaceX IPO, a variable redemption/transaction fee, payable to the Fund, of up to a maximum of 2% may be imposed on redemptions.
To be clear, these measures apply to primary market trading in XOVR, the market where new shares in the ETF are created or redeemed by specialist market makers known as “authorised participants”. They do not apply to the secondary market used by regular punters, meaning trading can continue in that market.
However, as the creation/redemption process is the arbitrage mechanism ETFs use to keep their share price in line with the value of their assets, XOVR’s share price can become untethered from its NAV.
And yes, as ETF pop-pickers would have predicted, XOVR’s share price has already swung to a notable premium to its NAV, of 1.1 per cent at pixel time, as demand exceeds supply. However, it could potentially fall to a discount, or at least trade on an unusually wide bid-offer spread, when the redemption fee is applied.
As Joel Shulman, founder and CIO of ERShares told Alphaville:
We have stopped receiving new money. I think we are the first to do this. Fund managers don’t wake up in the morning and say ‘we won’t take the money’. We decided we would rather turn down the money and we can protect ourselves and try not to dilute our loyal long-term shareholders.
We might be turning down billions, $2bn-3bn of hot money. We have already turned down $450mn.
There is a strong likelihood that SpaceX will trade up on the opening bell on Friday. There is a strong likelihood that it will end up 20-30 per cent on day one.
It should be noted, though, that the temporary bar on new creation units was only instituted after XOVR’s market cap surged from $1bn in late April to $2.27bn (in the process bringing its SpaceX exposure down from a whopping 44 per cent), largely due to strong inflows in the run-up to SpaceX’s float.
This run-up in assets — and the resultant dilution — has not been wildly out of line with that of the Baron First Principles ETF (RONB), another with SpaceX exposure, although it has been outstripped by the rush of money into the Tema Space Innovators ETF (NASA), another SpaceX botherer, which has rocketed to $2.7bn despite only launching in late March.
Jeffrey Ptak, a managing director at Morningstar who has been following the saga, was somewhat unconvinced of ERShares’ professed concern for its investors’ wellbeing, telling Alphaville:
I’m tempted to call it the ERShares Protection Plan. It’s largely about protecting their own commercial interests and less the shareholders.
It’s a Goldilocks scenario. They want the [SpaceX] position to be big enough to make a difference prior to the IPO pop but then they don’t want to end up with a gargantuan position because so much of their investor base risks redeeming.
[The redemption fee] is a way to retain the assets that have flooded into the ETF in recent weeks. It’s mainly to deter this money from bolting when the [SpaceX] shares become tradeable.
It will express itself in the bid-ask spread and the secondary market trades. There is the potential for unintended consequences.
Ultimately, the proof of these highly unusual ETF trading restrictions will come out in the pudding. It will be instructive to see how much investors in RONB and NASA are further diluted this week, given that they do not have any restrictions in place.
And to be fair to ERShares, XOVR would have been likely to see larger inflows than its rivals, given that its 13.2 per cent exposure to SpaceX outstrips NASA’s 6.44 per cent and RONB’s 2.25 per cent (down from a high of almost 27 per cent).
Let’s give the final word to Ptak, though:
One hopes that [ERShares] succeed in doing what they are trying to do. What this really boils down to, though, is the risk of tying yourself, as they have, to a single security. It was a relatively obscure ETF with an undistinguished record that managed to procure SpaceX shares. They [the investors] are there for SpaceX.
