Won’t Somebody Please Think of the ARK Structured Notes?

Noah’s Ark was a biblical port in the storm, providing shelter as a vengeful God wreaked havoc with devastating floods.

Today’s ARK is not only sinking in the face of higher interest rates, it may also end up being the proximate cause of a structured product storm.

That’s because big investment banks from JP Morgan Chase & Co. to Goldman Sachs Group Inc. have been issuing structured notes tied to the value of Cathie Wood’s famous ARK family of exchange-traded funds.

The notes offer highly leveraged exposure for anyone not content with the paltry return of almost 150% earned by the ARK Innovation ETF over the course of 2020, with most of the notes launching just in the past couple years in an attempt to key off Wood’s success.

Banks that launch the products get big fees and a slice of Wood’s magic so long as ARK keeps going up. Once the magic evaporates however, the notes can turn into liabilities as investors watch their principal evaporate too. One Bloomberg estimate counted at least 50 ARK-related structured notes as of early last year, worth at least $100 million and issued by banks including Morgan Stanley, Citigroup Inc., BNP Paribas SA and more.

The notes use derivatives to provide exposure to ARK’s performance, giving investors a chance to make supersized bets on investment superstars like Wood. The downside is that the notes can be difficult to exit and, because of their leverage, investors can also be exposed to supersized losses.

You can see the dynamic in the below excerpt from the prospectus for JPMorgan’s delightfully-titled “Uncapped Accelerated Barrier Notes” linked to three of the hottest funds in the ARK family: the ARK Innovation ETF ($ARKK), the ARK Genomic Revolution ETF ($ARKG) and the ARK Next Generation Internet ETF ($ARKW).

The notes provide 1.4 times the performance of the least performing of the trio of funds at maturity, which in this case is Jan. 5, 2027. You can see how the payoff structure is supposed to work in the chart below:

Investors stand to lose a chunk or potentially even all of their principal if the share price of the least-performing fund is less than a pre-agreed barrier amount. That barrier amount is 65% of each ETF’s value at the pricing date of the notes, which is $82.62 for $ARKK, $62.43 for $ARKG and $95.95 for $ARKW.

Now there’s clearly still a while to go until the notes mature, but if we were to go off the basis of yesterday’s closing prices (after the ARK empire was once again slammed as part of a heavy tech sell-off in the face of potentially higher interest rates), then $ARKG would be the least-performing of the three funds and would already have broken through the 65% barrier outlined in the prospectus after dropping down to $55.95.