Morningstar - Q2 2021 - 20

Dispatches

Changes for the Better

TRENDS

ARK Pushes Capacity Limits of ETFs
ARK ETF Trust's asset growth is unprecedented
among the upper ranks of the asset-management
industry. During the 12 months ended
January 2021, ARK's U.S. exchange-traded fund
lineup grew by 886%-dramatically faster
than the largest growth rates posted by any of
the other current 15 largest U.S. fund families
over a one-year period.
ETFs can't close to new investors, so new
assets will inevitably diminish the
team's ability to buy its best ideas at compelling
valuations. As assets swelled, ARK began
deploying cash in more-established large-cap
companies. At the end of February, only
14% of the assets in flagship fund ARK Innovation
ETF ARKK were in stocks with a market
cap under $5 billion, down from 33% a few
months earlier. ARK still maintains a
sizable ownership stake in many of its smaller

AMERICAS

Canada

holdings, but that raises another issue: Its
trading activity can have a material impact on
stock prices.
ARK's U.S. ETFs must disclose their portfolios
to the market each day-with watchers at
times copying its every move. By simply
initiating a position, ARK can send a stock's
price soaring. This can work in reverse,
too, and record redemptions for ARK in February
were a reminder of the risks. The ETF
wrapper comes with lower costs and greater
tax efficiency than mutual funds, but the
drawbacks may outweigh the benefits
for an active strategy with capacity constraints.
Ben Johnson, CFA, is director of global exchangetraded fund research at Morningstar Research
Services LLC. He is a member of the editorial board of
Morningstar magazine.

ARK's One-Year Growth Rate Sets a Record
Fund Family

12-Month Organic Growth Rate
250
End Date 0%

ARK ETF Trust

01/31/21

Metropolitan West Funds

04/30/15

Janus Henderson

07/31/00

SPDR State Street Global Advisors

02/28/09

Schwab ETFs

07/31/18

Pimco

06/30/10

IShares

11/30/17

American Funds

09/30/04

Dodge & Cox

03/31/15

Invesco

12/31/00

T. Rowe Price

08/31/07

JPMorgan

01/31/21

Vanguard

10/31/17

Dimensional Fund Advisors

01/31/18

Fidelity Investments

12/31/19

750

1000

Morningstar's conversations with market
participants, regulators, and self-regulatory
organizations suggest that the know-your-product
requirements will have the most impact on
wealth-management firms. As part of this
requirement, firms are required to assess, approve,
and monitor a set list of securities from which
advisors can make recommendations. For firms that
have not closely monitored their offerings,
this will present a challenge-both in terms of
the due-diligence requirement and ensuring they
offer a range of investment products wide
enough for advisors to be able to put together an
appropriate asset allocation for clients.
Despite stricter firm oversight, advisors are
not absolved of their own due-diligence
responsibilities. For example, to make a suitable
recommendation, advisors must demonstrate that
they've considered a reasonable range
of alternatives, a welcome requirement from
Morningstar's perspective.

$0B
Source: Morningstar Direct.

500

Against the backdrop of regulatory changes
across the globe, the Canadian Securities
Administrators has set out to improve the minimum
standard of conduct for advisors with the
goal of improving the experience for retail investors.
The sweeping set of changes, known collectively
as the Client Focused Reforms, targets six
categories: know your client, know your product,
suitability, conflicts of interest, relationship
disclosures, and misleading communications. For
the most part, the changes are principles-based,
putting the onus on firms and advisors to both
interpret the requirements and shore up processes
to ensure they're met. These reforms are
reminiscent of the SEC Regulation Best Interest in
the United States, but the changes in Canada
represent a much larger step for the market rather
than small changes along the way.

Net Flows

100

200

300

400

Canada is a vertically integrated market, where
many fund companies own their own distribution
channel, so advisors are often working with

Morningstar - Q2 2021

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