ETFs push at SEC limit in rush to buy private stocks and debt

Exchange traded fund providers are starting to push at the limits on holdings of hard-to-trade assets as they try to give retail investors access to hot private stocks and debt.

Two US ETFs have built up exposure to Elon Musk’s unlisted rocket company SpaceX that exceeds the Securities and Exchange Commission’s 15 per cent limit on illiquid securities in such funds. An ETF run by State Street launched last year with the intention of having exposure to private capital of up to 35 per cent.

A number of other funds have loaded up on unlisted shares in Musk’s start-up xAI — which was recently bought by SpaceX — as well as AI group Anthropic, defence tech firm Anduril Industries and data analytics company Databricks.

The purchases come as fund groups race to open up private company assets — long the preserve of institutional and wealthy investors — to retail investors, who hope to access fast-growing companies that are choosing to stay private for longer.

However, that rush has sparked concerns among some commentators about a potential mismatch between illiquid holdings and ETFs’ highly tradeable structure.

“We are seeing ETFs push the boundaries on the SEC’s rules,” said Bryan Armour, director of passive strategies research for North America at Morningstar.

The Baron First Principles ETF, which launched in December and focuses on “growth businesses led by visionary, high-integrity leaders”, built a near-27 per cent exposure to SpaceX and xAI before strong inflows diluted this to 16.9 per cent.

Baron Capital believes SpaceX shares are not subject to the SEC’s 15 per cent rule because it regards the stock as “less liquid”, a separate category in the SEC’s classification system to “illiquid”, said a person familiar with the firm’s thinking.

Baron declined to comment.

Under the definition of “less liquid”, a fund must “reasonably expect to be able to sell or dispose of [a stake] in current market conditions in seven calendar days or less without the sale or disposition significantly changing the market value of the investment”.

The SEC said it “declined to comment on an individual company”.

An ETF run by ERShares has quadrupled in size to $1.5bn since December after building an exposure to SpaceX through a special purpose vehicle, which is its largest holding at 17.7 per cent of the fund currently. It also holds a stake in Anduril, the defence company run by Palmer Luckey.

Joel Shulman, the firm’s founder and chief investment officer, said of its Private-Public Crossover ETF: “The fund’s liquidity management framework is designed so that shareholder redemptions are met primarily through liquid public securities, consistent with the fund’s disclosed investment and risk-management framework.”

This comes after a State Street fund launched last year with the intention of having private capital exposure of up to 35 per cent, although so far it has not gone above the 15 per cent cap.

The SEC’s rules state that if more than 15 per cent of a fund’s assets are in illiquid investments, it cannot buy further such assets while any breach of the limit must be reported to the board along with a plan to reduce illiquids below the cap.

Armour at Morningstar said: “We are not seeing the SEC push back on this at all, so it’s not unreasonable to expect to see more ETFs pushing the envelope.”

“It’s not clear how differently the SEC is approaching this or whether fund companies just realise that there is not as much appetite to enforce rules as perhaps once thought,” he added.

The clamour for SpaceX shares comes ahead of a blockbuster initial public offering that billionaire Musk is targeting for mid-June. However, while the company remains private, there is limited secondary market trading, aside from occasional tender offers for the company’s stock, which allow employees to sell shares and selected outsiders to buy.

Among other funds snapping up private shares, the KraneShares Artificial Intelligence and Technology ETF features SpaceX and AI firm Anthropic among its top-10 holdings, while the Alger AI Enablers & Adopters ETF has stakes in software company Databricks and robotics outfit Figure AI.

Analysts have raised concerns about how private assets in ETFs are valued, given the opacity in their pricing. Even when secondary market trading does occur, this is often subject to restrictions — for instance the need to obtain permission from the company to buy or sell stock, or the business getting first refusal to buy it back. That can mean the traded price is not always a fair reflection of the group’s value.

Armour said flows into or out of an ETF could also affect its holdings of private assets. Strong inflows can dilute exposure to private assets unless the fund is able to buy more. Conversely, if there are large redemptions a manager may be forced to sell out of the more liquid public holdings, pushing the weight of the private assets ever higher.

It is “a good thing that investors can hack into some of these rapidly growing but not yet public companies using ETFs”, said Todd Rosenbluth, head of research at consultancy TMX VettaFi, but he added that, as private companies are less liquid, investors should be “mindful” of the difficulty a manager may face in selling these holdings.

Elisabeth Kashner, director of global fund analytics at FactSet, said an ETF would probably be able to offload its private holdings if necessary if there was a run on a fund but added that things could get messy.

“Everything is liquid at a price,” Kashner said. “You can always sell it, but you may not like the price.”