Investors remain trapped in Emerge ETFs, unable to trade the funds as they continue their volatile performance in 2023. The fund manager, which has been ordered to wind down operations, remains silent.
The Ontario Securities Commission (OSC) placed a cease-trade order (CTO) on all 11 of Emerge Canada Inc.’s ETFs on April 6 because Emerge missed the March 31 deadline to file audited annual financial statements. Emerge’s auditor, BDO Canada LLP, had resigned the previous November and was not replaced.
The order, which has been in effect for nearly six months, represented the first time a CTO had been placed on a family of ETFs in Canada.
“When this type of continuous disclosure default occurs, the issuance of a failure-to-file CTO follows to address investor protection concerns,” said JP Vecsi, senior public affairs specialist with the OSC, in an emailed statement to Investment Executive.
On May 11, the OSC suspended Emerge Canada’s registration for capital deficiency, stating that the firm was likely deficient at some point prior to Sept. 30, 2022.
The OSC permitted Emerge to conduct an orderly wind-down of its current business, including the 11 ETFs. The regulator also allowed Emerge to arrange for another firm to assume responsibility for the ETFs.
The OSC could not provide updates on the wind-down process.
“Emerge Canada remains subject to the terms and conditions set out in the director’s decision and must wind down its current business as a registered firm before a suspension takes effect,” Vecsi said.
“We cannot provide updates about the wind down on behalf of the firm. We expect the firm, which has a statutory duty to act in the best interests of the Emerge funds, to communicate with unitholders about the status of their investments as appropriate.”
Emerge Canada Inc. declined to comment for this story. A spokesperson confirmed the firm has not sent any communications to unitholders since its May 15 news release acknowledging the OSC’s suspension.
As reported by Investment Executive in April, Emerge’s six ARK ETFs were owed more than $2.5 million in receivables from Emerge as of June 30, 2022 — an amount that had grown more than fivefold over two-and-a-half years.
The OSC’s May decision revealed that receivable had increased to $5.5 million, which represents about 5% of the assets held in the ARK ETFs as of May 10.
Vecsi said the regulator made its decision to uphold the integrity of the capital markets.
“[OSC] staff made a recommendation, which was accepted after a contested proceeding, to suspend Emerge Canada’s registration due to non-compliance with working capital requirements. As noted in the decision, registrants operating without sufficient working capital for an extended period place investors at risk and diminish public confidence in Ontario’s capital markets,” he said.
“Maintaining excess working capital is a serious regulatory obligation placed on registrants that helps protect investors from insolvency.”
Emerge ETF Trust, which managed the U.S. versions of Emerge’s five EMPWR ETFs, voluntarily liquidated those ETFs in July. The trust applied to the U.S. Securities and Exchange Commission on Sept. 15 to deregister, indicating that it’s in the process of or has completed winding up.
Performance
The CTO has prevented investors from cashing out after recent gains for some of Emerge’s ARK ETFs.
The ARK suite rebounded from significant underperformance to post returns ranging from 18.47% to 41.95% for the year to June 30. (The funds’ custodian, RBC Investor Services, continues to report a daily net asset value for each ETF during the CTO; performance figures are for the Canadian-dollar funds on a NAV basis.)
Performance has since moderated slightly. As of Sept. 30, the flagship Emerge ARK Global Disruptive Innovation ETF’s return is 23.90% for the year to date, and 2.37% over one year, according to data from Morningstar.
Year-to-date returns are still strong for four of the remaining ARK ETFs, ranging from 9.43% to 32.72%, but the genomics and biotech ETF returned -0.35% for the year to Sept. 30.
“Over the past six months, tech is the third-strongest performing sector behind energy and communication services. But it’s fallen to ninth over the past three months,” said Danielle LeClair, director of manager research with Morningstar Canada.
LeClair previously cautioned that thematic funds tend to outperform over short periods only, and that tech investors should expect volatility. The performance data as of Sept. 30 bears this out, she said: the funds are “doing what you would expect them to do.”
Examining that data also shows the Emerge ARK ETFs continue to perform at the extremes even among its peers. All but one of the five ARK ETFs with percentile data are top quartile on a year-to-date basis (to Sept. 28), according to Morningstar. But for the year ended Sept. 28, four of the five ETFs drop to bottom quartile.
What’s more, for the three years ended Sept. 28, all ARK ETFs with sufficient data were bottom quartile — with three dead last in their category.
LeClair said the ARK strategies in general — those available from ARK Investment Management LLC, the subadvisor to Emerge’s ARK suite, and from BMO Global Asset Management since November 2022 — have seen either low inflows or net outflows over the past three months.
“So you can see investors are trying to reallocate,” she said. For investors who cannot exit their positions, “you just have to look at your broader portfolio and adjust around [the Emerge holdings].”
LeClair said Emerge ARK investors could take some comfort in the fact that ARK Investment Management has expanded into Europe with its purchase of U.K.-based Rize ETFs Ltd. in September.
“I’m taking that as [evidence that] there is still broad demand for this type of strategy,” she said.
Morningstar continues to have a negative rating on the ARK Innovation ETF, the U.S. fund upon which the Emerge ARK Global Disruptive Innovation ETF is based, and a below-average rating on ARK Investment Management.
Emerge’s EMPWR ETFs, which were touted as sustainable active ETFs all managed by women, just hit their first birthday. Returns for the year ended Sept. 30 range from -6.16% to 8.89%, according to Morningstar. Over the same period, three of the five ETFs were bottom quartile, one was third quartile and one was top quartile.
As for lessons learned from the Emerge saga, LeClair reiterated the advice she’s provided since the CTO began.
The situation “highlights the level of due diligence required outside of just understanding the strategy that you’re investing in,” she said, suggesting investors also examine the fund manager. “[Does the fund manager] have the infrastructure to support the products that they’re launching? What are their resources? Do they have a history of supporting investors from a broader standpoint than just the investment side?”
In August, the Canadian Securities Administrators surprised the ETF industry when it began examining ETF regulation to assess the adequacy of the existing regime. But regulatory sources indicated the review does not stem from concerns involving specific ETFs.