Emerge ETFs financials show $2.5 million in receivables due from manager

As Emerge Canada Inc.’s 11 ETFs face a cease-trade order for failing to file their 2022 financial statements, previous filings show the fund manager incurring a growing financial obligation to those ETFs.

The firm’s suite of six ARK ETFs is due more than $2.5 million in receivables from Emerge, according to the funds’ June 30, 2022, interim financial statements — an amount that had grown more than fivefold over two-and-a-half years.

Financial statements show that as of Dec. 31, 2019, the five ARK ETFs trading at the time were due $486,442; by June 30, 2022, the receivable amount had ballooned to $2,539,245 across the six ARK ETFs.

In its 2019 financial statements, the ARK ETFs said the receivable “represent[ed] the amounts prepaid to the manager from the ETFs for managing the ETFs. The ETFs plan to amortize these receivables during the reporting year of 2020 against future management fees and administration costs payable to the manager.” Future financial statements noted the ETFs planned “to recover these receivables during the subsequent reporting year.”

Outstanding amounts began accruing interest at 2.5% annually in 2020, and the sum of interest as of June 30, 2022, was $39,172 across five ETFs.

The $2.5-million receivables figure represents about 2% of Emerge’s present-day assets under management: $118 million.

“From what I can see, this is distinct and different from how expense absorptions [usually] are dealt with by an ETF investment fund manager, and not in a good way,” said an ETF expert based on the West Coast. (Advisor.ca granted anonymity to sources so they could speak freely.)

Emerge declined to be interviewed but said in a statement: “Emerge absorbed certain operating expenses of the Emerge ETFs, which is a common practice in the fund industry. Absorption is not borrowing from the ETFs. The operating expenses absorbed by the manager benefited unitholders, as it reduced the [management expense ratio] and contributed positively to performance.” The statement also noted that unitholders benefited from the interest.

In each financial statement, operating expenses absorptions reported were smaller — in some cases by an order of magnitude — than receivables reported in the same fiscal year for the same ETF.

Emerge stated there are two ways for a manager to absorb operating expenses: pay them directly or reimburse the ETF for such expenses after the ETF has paid them.

“We took the latter approach, which is why we also booked a receivable to each fund as ‘due from Emerge Canada,'” it said.

A review of the financial statements of 10 other small ETF families with similar AUM to Emerge (under $500 million) found that most managers absorbed the operating expenses of their ETFs and paid the expenses directly each year. Only two of the 10 ETF families had a “receivable from investment manager” in fiscal 2021, but both were zeroed out in fiscal 2022. None of the 10 ETF families indicated they were accruing interest on receivables due.

“If [the receivable] is temporary, it’s really not newsworthy at all,” said an ETF expert in Ontario. “But if it’s not temporary, it’s a problem, because what happens if the funds are wound up and paid out?” That could result in a cash shortfall, the expert said.

In the statement, Emerge said its investment review committee (IRC) “reviewed our expense practice, the disclosures and the fund performance.” Reports filed between 2020 and 2023 from the IRC, whose mandate is to review conflicts of interest referred by the manager, did not indicate any referrals regarding the matter or discussions of the receivables.

Further, “the funds and Emerge obtained three clean audits from BDO [Canada LLP] for the financial years completed to date, including the treatment of the amounts due to the funds for reimbursement of expenses,” Emerge stated.

Emerge’s auditor, BDO, resigned on Nov. 3, 2022, and Emerge hasn’t found a new one. As a result, the company missed its March 31 deadline to file audited annual financial statements, which led the Ontario Securities Commission last week to impose a cease-trade order (CTO) on all 11 Emerge ETFs. A spokesperson for the regulator said that a CTO has never before been placed on a family of ETFs.

Amid the CTO, the ETF industry is calling on advisors to reassure investors that their assets remain in trust.

In a message to unitholders on Tuesday, Emerge founder and CEO Lisa Langley said that, while the ETFs can’t be purchased or sold because of the trading halt, the strategies are still being actively managed and all assets are held by the funds’ custodian, RBC Investor Services.

“The Emerge ETFs still exist and they have value,” Langley said.

The company is working to complete the OSC’s requirements and have the CTO removed, she said, adding that she could provide no assurances that it would be removed.

Pat Dunwoody, executive director of the Canadian ETF Association, echoed the point that investors’ money is held in trust and being managed by portfolio managers while the CTO is in effect.

“People shouldn’t be concerned that they’re going to lose their money,” she said. “It’s just … that they’re not able to access it right now.”

Dunwoody said this is the time for investors to talk with their advisors: “That’s why you pay an advisor — to give you the comfort that they are going to do the research and ensure that your money is safe.”

Emerge launched five ETFs in 2019 based on Cathie Wood’s ARK funds (plus a sixth in 2021) and five EMPOWR active ESG funds last year that are managed by women.

The Emerge ARK funds have had a whirlwind few years. Wood’s US$7.5-billion Ark Innovation ETF became famous when it caught the early pandemic rebound as interest rates were slashed to zero, posting a 153% annual return in 2020. It has since given up those gains as innovation stocks were battered in a rising interest rate environment.

As of April 6 (the last day the ETFs were traded), the six Emerge ARK funds had one-year returns of between -19.2% for the space exploration ETF and -34% for the disruptive innovation product. Only the autonomous tech and robotics ETF has a positive return (9%) since inception. All six ARK ETFs have rebounded this year, with the AI and big tech ETF leading the way with a gain of 27.6% year-to-date.

The funds have failed to gather much traction with investors. Canadian investors could already purchase the U.S. versions of the ARK ETFs directly, and BMO also began offering versions of three of the funds in November.

The main fund, the Emerge ARK Global Disruptive Innovation ETF, had roughly $73.3 million in assets under management between its Canadian- and U.S.-dollar versions as of April 12. The next highest was the genomics and biotech fund with less than $13 million, and all of the others were below $8 million in AUM.

Canadian manufacturers often consider $20 million to $50 million in AUM as the breakeven point for an ETF, with those charging higher fees able to survive at the lower end of that threshold. Emerge’s ARK ETFs, active funds usually holding between 25 and 50 names, charge a 0.8% management fee.

The five EMPWR funds launched in September 2022 have had an even harder time generating assets. As of April 12, none of the five funds had crossed the $1-million threshold between the Canadian- and U.S.-dollar versions. Performance information for the funds is not yet available.

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.

Mark Burgess

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Mark was the managing editor of Advisor.ca from 2017 to 2024.