Surging SpaceX stake raises doubts over private assets in ETFs

Fund issuers have been racing to find ways to add unlisted assets into ETFs to give investors easy access to private marketsAuthor of the article:You can save this article by registering for free here. Or sign-in if you have an account.A modest investment in SpaceX that thrust a niche fund into the limelight in recent months has morphed into a monster position, testing the very capacity of exchange-traded funds to hold unlisted assets.Subscribe now to read the latest news in your city and across Canada.Subscribe now to read the latest news in your city and across Canada.Create an account or sign in to continue with your reading experience.Create an account or sign in to continue with your reading experience.Around 37 per cent of the ERShares Private-Public Crossover ETF is now invested in Elon Musk’s rocket ship maker, a figure that has climbed well above 40 per cent in recent days, according to data compiled by Bloomberg.It’s practically unheard of for a private firm to account for so much of a single ETF, since the United States Securities and Exchange Commission limits open-ended vehicles to investing just 15 per cent of their assets in illiquid securities. That rule is intended to ensure they can meet redemptions, particularly at times of stress.Canada's best source for investing news, analysis and insight.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Investor will soon be in your inbox.We encountered an issue signing you up. Please try againInterested in more newsletters? Browse here.The shift reflects the mechanics of managing a daily-traded fund that owns hard-to-sell assets. The SpaceX stake grew during a period of heavy inflows and a jump in the private company’s valuation. As investors later pulled money out, the fund met redemptions largely by selling liquid public stocks rather than the SpaceX holding, which isn’t easily traded. That left the portfolio increasingly dominated by the private investment.The rapid shift in the composition of XOVR, as the fund is known, threatens to re-energize a debate about whether the hyper-liquid ETF structure can safely contain private assets, as well as what classifies as illiquid and how such investments get valued.“It makes me more dubious about the proposition of stuffing hard-to-trade assets into daily-liquidity vehicles like ETFs,” said Jeffrey Ptak, managing director at industry data provider Morningstar Inc., who wrote a report criticizing the fund last week. “The ETF is saddled with a huge concentration in a hard-to-trade-and-value security.”In the past two years, fund issuers have been racing to find ways to add unlisted assets into ETFs to give retail investors easy access to private markets. The major sticking point has been the liquidity mismatch: ETF shares change hands all day in the cash market, in extended trading and increasingly even overnight. Private assets are infamous for barely trading at all.XOVR is among just a handful of ETFs that have added private securities to their portfolios. The SpaceX stake, currently valued at US$205 million, is held via a special-purpose vehicle for which exact details are unavailable.Joel Shulman, founder and chief investment officer of ERShares, said the firm has a plan for managing the SpaceX position, but declined to provide details.“There is robust investor demand, which should support liquidity and facilitate orderly sales if needed in a relatively short period of time,” Shulman said. “However, we have high conviction for this investment and would prefer to maintain the investment for the benefit of our shareholders.”The SEC declined to comment on XOVR’s SpaceX exposure.Even with a holding in one of the world’s most coveted private companies, XOVR has struggled to keep pace with broader technology stocks. The fund returned 12 per cent last year, as the Invesco QQQ Trust Series 1, which tracks the Nasdaq 100 Index, returned 21 per cent.XOVR is now on track to post a fourth consecutive week of outflows, with its total assets more than halving to under US$600 million from a peak of US$1.8 billion last month.As part of a regulatory update this week, ERShares beefed-up the risk warnings in XOVR’s prospectus. This included the section on risks related to privately offered securities. Within the added language, it says: “There cannot be any guarantee an SPV or other private fund will be successful.”Shulman said that as the ETF has expanded its exposure to privately offered securities through SPVs, “it is appropriate to ensure that the prospectus clearly describes the associated risks.”“The disclosure language should not be interpreted as reflecting any change in the structure or quality of the underlying investment,” he said.The total operating expenses of the fund were also increased to reflect costs related to the SpaceX holding. Shulman said those expenses apply to the last reporting period and a previous structure of the SPV, and “does not reflect the economics of the restructured vehicle going forward.”The majority of cash in the us$14 trillion U.S. ETF market is tied up in index funds, but the industry has been pushing into more complicated and niche corners of the investment world like cryptocurrencies and derivatives strategies. In a survey of institutional investors, almost all of the 325 respondents said they were willing to access private markets through an ETF wrapper, Brown Brothers Harriman said this week.XOVR is demonstrating some of the practical problems of such an approach, but it’s not alone.

The Baron First Principles ETF (RONB), which directly invests in SpaceX shares, has also seen its stake in the rocket company exceed the SEC’s illiquidity threshold at times. But issuer Baron Capital has classified the holding as “less liquid” with the regulator, a category which has no percentage limits.Under SEC liquidity rules, fund managers have some discretion in classifying holdings based on how quickly they believe the assets can be sold without significantly affecting their value.XOVR garnered attention in 2024 when it first added exposure to Musk’s firm. Interest intensified in December after Bloomberg News reported SpaceX was targeting a potential 2026 listing at a valuation of roughly us$1.5 trillion. As the only U.S.-listed ETF offering exposure to the company at the time, XOVR drew significant inflows.Critics pointed out that as assets poured in, the fund’s SpaceX stake became increasingly diluted, potentially limiting the upside for investors. Morningstar’s Ptak has also noted inconsistencies with how ERShares values its SpaceX stake. ERShares responded by issuing a memo titled, in part, “Transparency Reset.”The figure of US$205 million for XOVR’s SpaceX stake is based on a valuation of around US$1 trillion for the rocket maker, according to Shulman.Should the company go public above that, “any corresponding increase in value would be reflected in the fund’s NAV and therefore directly benefit XOVR shareholders, without additional management fees or carried interest at the SPV level,” he said.Bloomberg.comPostmedia is committed to maintaining a lively but civil forum for discussion. Please keep comments relevant and respectful. Comments may take up to an hour to appear on the site. You will receive an email if there is a reply to your comment, an update to a thread you follow or if a user you follow comments. Visit our Community Guidelines for more information.