Something strange has been happening to several of ARK’s ETFs recently: Assets have been spiking like blood sugar after a pumpkin spice latte.

There has been speculation about the causes, but no one, other than the unidentified traders, knows why. One explanation is that the activity is merely heartbeat trades that were used to wash taxes. Another is that a zealous bunch of retail investors wanted exposure to a few IPOs. But the most interesting theory, from the Financial Times’ Robin Wigglesworth, is that someone gamed the creation and redemption process to ultimately pocket a cool $21 million in just a matter of days. Just before the Bullish IPO in August, someone could have borrowed shares of constituent stocks that are in the ARK Innovation ETF (ARKK) and used the holdings to create about 70 million ETF shares, Wigglesworth wrote. After ARKK bought Bullish shares in the IPO, the person or group seemingly redeemed their ETF shares for the constituents, able to then sell the Bullish stock at a premium, he said.

A twist is that the same thing appeared to have happened ahead of Klarna’s Sept. 10 IPO, “with one crucial, hilarious twist … ARKK didn’t actually invest in the Klarna IPO!” Wigglesworth noted.

I Feel Used

If the theory is correct, it would be an uncommon approach to profiting within ETFs, said Todd Sohn, senior ETF and technical strategist at Strategas Securities. Many ETFs don’t buy stocks at the time of an IPO, he said. “This activity is happening outside the fund in the primary market through the APs/market makers; they are bearing the cost of the activity.” Other ETF shareholders are insulated from the effects of such tactics, he said.

Regardless of what’s happening, it’s interesting. “It’s an incredibly unique situation,” Morningstar principal US equity strategist Robby Greengold said. “Three of ARK’s ETFs have been swept up in these violent flow patterns that don’t really happen anywhere else. This is fascinating to watch unfold, but it’s also extremely difficult to know who’s behind it.” There is a potential downside for other investors in the ARK funds, as the ETFs significantly increased their cash allocations after the share creations.

The flow activities showed dramatic changes:

• Assets in ARKK increased by more than $3.5 billion between Sept. 8 and 12, bringing the fund to over $11 billion, coinciding with Klarna’s IPO, per the FT. That followed similar activity around Bullish’s IPO in August, when assets rocketed from just over $7 billion to nearly $13 billion and then back down to about $7 billion again.
• There were also inflows and outflows from two other ARK funds: the Fintech Innovation (ARKF) and Next Generation Internet (ARKW) ETFs. As a result, ARKF’s cash allocation went from 0.2% of assets to 5%, and ARKW’s went from 0.2% to over 2%, Greengold said. The change at ARKK was smaller, at around 60 to 70 basis points, he noted.

Low Point in the Arc: As of Friday, the data didn’t show a massive exit from ARKK, and what’s happening isn’t clear. ARK did not comment on any of the recent flow activity. “Effectively, it’s dilutive to any of ARK’s pre-existing fund holders,” Greengold said of the big fluctuations that hiked cash allocations. “That post-IPO pop wasn’t felt as strongly as it otherwise would have been.”

The Federal Reserve’s recent interest-rate cut may give an extra boost to the already booming ETF industry.

Investors had been anticipating the Fed’s decision for some time, but analysts said certain sectors and strategies stand to gain from lower rates. One area to watch is the $7.4 trillion money market fund industry, which could become less attractive to investors if interest rates continue to drop through the rest of this year. A more risk-on environment is expected to drive assets out of money markets funds and into ETFs. “I think the logical landing spot, given their increasing usage and depth of strategies, is going to be the ETF market,” said Matthew Bartolini, managing director at State Street Global Advisors.

Money, Money, Money

The last time interest rates were at this level, back in late 2022, the money market industry was about $5 trillion. “It’s not going to be one for one, and it’s not going to be immediate,” Bartolini said. “I just think over the next year or so, as the Fed continues to ease policy… that’s a sizable pile of capital that could flow into ETF markets.”

Some of those outflows into ETFs could end up in the financial services sector, which tends to outperform the broader market when the Fed cuts rates. Early flows already reflect that trend, with nearly $750 million entering financial sector ETFs the day of the Fed decision, Bartolini said. The size of the money market industry has ballooned of late. According to Bloomberg:

• Since March of 2022, when the Fed began raising interest rates, money market assets have grown by more than $2.5 trillion.
• Money markets gained more than $320 billion this year alone.

The Fix Is In. Another possible winner in a post-rate cut world is fixed-income products, particularly as the yield curve steepens, said Paul Cahill, ETF national sales director at AllianzIM. The question is whether attention will go more toward short-term or long-term bonds. Rate cuts make fixed income products more attractive, but it’s easy to overestimate their benefits, even with “coupon income” back in vogue. “Traditional fixed income… is poorly priced to provide what it always has, that ballast against portfolio volatility,” Cahill said.

Taking market swings of the past five years into consideration is also crucial to preventing overreaction, said Morningstar analyst Dan Sotiroff. For investors, he advises staying the course amid a potential shift toward long-term bonds. “You would expect money to come out of the shorter end, to go more towards intermediate and longer-term stuff,” Sotiroff said. “But I’ve been surprised in the past, so I wouldn’t be surprised to see something different.”

The ETF universe may be expanding faster than the actual universe.

Last week, the US Securities and Exchange Commission approved generic listing standards for several exchanges that cover spot-price commodity and digital asset exchange-traded products. That’s a pass for exchanges (Nasdaq, Cboe BZX and NYSE Arca) to list crypto ETFs without having to get a rule change every time from the SEC. And it echoes the regulator’s 2019 ETF rule, which allowed issuers to launch products without first getting exemptions. More is better … right?

“This is a big deal, as it puts crypto ETF applications on the same level playing field as other ETF applications, which follow a set of generic listing standards,” said Don Friedman, CEO of the Digital Assets Council of Financial Professionals. The group’s founder Ric Edelman praised the policy and its likely effect on making crypto more mainstream. “We can expect an array of new investment options for both advisors and investors, arriving with greater speed to market, making it easier, cheaper, safer and more profitable for everyone to allocate to crypto,” Edelman said.

Maybe Not So Fast

The generic listing rules require commodities to be traded on a market that is a member of the Intermarket Surveillance Group (the three exchanges are) or to underlie a futures contract that has been traded for at least six months on a CFTC-regulated market. Further, ETPs can also pass if there is a similar commodities ETF in existence that meets certain criteria. “The commission is passing the buck on reviewing these proposals and making the required investor protection findings, in favor of fast tracking these new and arguably unproven products to market,” said Caroline Crenshaw, the lone Democrat on the commission, in a statement opposing the order. Crenshaw also objected because the commission’s order blurs the line between ETPs, which are 1933 Act products, and ETFs, which are 1940 Act investments.

Along with the generic listing standards order, the SEC also made several other approvals:

• The Grayscale Digital Large Cap Fund (GDLC), a ’33 Act product, was allowed to trade.
• The SEC approved certain p.m.-settled options on the Cboe Bitcoin US ETF and Mini-Cboe Bitcoin US ETF indexes.

Crypto Galore: The change seems likely to help the spot-crypto ETP realm expand beyond Bitcoin and Ethereum. Choice is a plus, said Kevin Feig, founder of Walk You To Wealth, who previously worked as head of risk at crypto exchanges Coinbase and Kraken. “Ultimately, we will move toward directly holding digital assets alongside traditional investments, without the need for an ETF,” he said. “Bottom line is that more options and lower costs for investors is something that should be celebrated.”