Cathie Wood Is Heating Up Wall Street’s Exotic Bond Business

Cathie Wood is lighting fires across every industry from artificial intelligence to intergalactic exploration. Another exotic business that’s booming thanks to her magic touch: structured products on Wall Street.

Big banks like JPMorgan Chase & Co. and Morgan Stanley are busy packaging up exchange-traded funds from Wood’s Ark Investment Management into equity-linked notes.

Issuance of these derivatives-powered trades has jumped from effectively nothing three months ago to $100 million today, as high net worth investors seek new ways to ride the tech bull run. While it’s tiny amount in bond-market terms, it’s a significant chunk in the market for structured notes.

In the process, banks are enjoying lucrative fees, by adding distribution expenses and structuring costs onto ETFs that are already relatively expensive by industry standards.

The lure for investors? The chance to turbocharge Ark’s performance -- among the best in the U.S. last year -- or to hedge stocks at records.

Cathie Wood Is Heating Up Wall Street’s Exotic Bond Business

“Ark is the center of the investment universe right now,” said Nate Geraci, president of the ETF Store, an advisory firm. “This is an opportunistic way for other asset managers to ride Cathie Wood’s coattails and capitalize on the insatiable demand for and marketability of the Ark ETF lineup.”

Lenders have issued about 50 structured products tied to Ark’s ETFs in the past three months, according to filings with the U.S. Securities and Exchange Commission. JPMorgan and Morgan Stanley are the most prolific with around 30 and 10 notes, respectively.

Wood is the CEO and founder of Ark, whose ETFs have attracted billions, vaulting her to celebrity and even inspiring a line of merchandise.

A spokesperson for JPMorgan declined to comment, while Morgan Stanley representatives didn’t respond to a request for comment.

Structured notes are debt securities that use derivatives to provide exposure to an underlying asset, like a basket of stocks or an ETF. While they can offer eye-popping coupons or leverage, they also charge high fees and can be difficult to exit.

Wall Street sold some $70 billion of the securities last year, according to data provider Structured Products Intelligence.

Buyers include Dan Clifford of Princeton, New Jersey, who commissioned his first $1.05 million note tied to three Ark ETFs in October.

“Ark’s holdings don’t resemble any major index and are not static,” said the senior portfolio manager at White Knight Strategic Wealth Advisors LLC. “These are the main features that attracted us to their ETFs and gives us confidence that they will continue to provide stellar returns.”

Clifford’s three-year security, which was created for him by BNP Paribas SA, works like this: On the note’s maturity date in 2023, investors receive 1.75 times the performance of the worst-performing of three Ark ETFs. But if any of the ETFs drop more than 20%, the noteholder participates fully in those losses.

Things are looking good for Clifford so far. The Ark Innovation ETF (ticker ARKK) is up 23% this year alone after a 149% gain in 2020. The Ark Genomic Revolution product (ARKG) and the Ark Next Generation Internet fund (ARKW) are both up more than 20% year-to-date.

There are concerns that Ark can’t keep this up, of course. Wood’s investments are technology-focused, and the sector is trading at historically high valuations. Her incredible popularity -- Ark assets surpassed $50 billion last week -- makes it increasingly difficult to deploy cash efficiently. The firm is also heavily exposed to volatile assets like Bitcoin and Tesla Inc.

Reflecting that, Ark funds are seeing an uptick in bearish bets. A record 1.9% of shares in ARKK were sold short last week, according to data from IHS Markit Ltd., although this has since fallen slightly.

Cathie Wood Is Heating Up Wall Street’s Exotic Bond Business

Many of the outstanding Ark-linked notes follow a similar structure to Clifford’s, but some are more defensive, offering a coupon and protection against losses in exchange for forgoing upside in the ETFs.

Clifford says he’s been “quite happy” with the performance of his notes so far, though concedes that 2020 was the perfect environment for them. He’s not in a rush to do more, and would consider buying a more defensive security.

“I am slightly concerned about the influx of new assets to Ark and their ability to continue to find new ideas with so much incoming cash,” he said.

©2021 Bloomberg L.P.

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