Funds that have increased their exposure to private companies have been burned by recent post-IPO declines
There’s no shame in harbouring a “nothing ventured, nothing gained” mindset, especially if you’re a mutual fund in search of a market-beating edge. But for those that have bet big on technology start-ups, any gains they see will have to come after painful losses.
What should have been an IPO of WeWork parent We Co. turned into a disaster: its valuation got slashed from US$47 billion to US$10 billion, its founder was removed from the CEO position, and the move to go public has been delayed indefinitely.
It’s the latest in a trend of disappointing public launches this year. A recent research note from Goldman Sachs reported that this year’s IPO-stock performance relative to the broad market represents the worst showing since at least 1995. For anyone who’s seen the steep declines in share prices of newly public tech companies, including Uber, that news may not be so shocking.
But for mutual funds that have stepped up their exposure to unicorns and other stocks that don’t trade in public markets, the news has been agonizing. As reported by the Wall Street Journal, such funds owned US$6.7 billion worth of shares in We, Uber, Lift, Pinterest, and fitness start-up Peloton Interactive as of April, compared to US$2.7 billion two years earlier.
“Around six out of 10 mutual-fund companies hold private shares in their portfolios, up from about three in 10 five years ago,” the Journal said, citing a survey by Deloitte & Touche.
Funds marked up their holdings just as private-company valuations were soaring, with some companies having a bigger price tag than others. The We company was valued at US$102 per share by Fidelity Investments in July 2018; Hartford Financial Services, John Hancock Investment Management, and Principal Financial put it at US$110 a share that November.
But before We cancelled its IPO last month, its bankers were placing the offering price well below US$55 per share, people familiar with the matter told the Journal. As of March, Fidelity’s valuation of its We holdings had plunged to US$54 a share; others have been even less generous, valuing their stakes in We for as low as US$38 per share.
The rush to private markets came as active fund managers sought to differentiate themselves from index funds and earn better returns. Will Gornall, a University of British Columbia finance professor who has studied unicorn valuations, said that investments from mutual funds helped some tech start-ups by letting them defer going public and “probably pushing up their valuations.”
Unfortunately, “[m]utual funds are not experts in valuing unicorns properly,” Gornall said.
That fact isn’t lost on the US Securities and Exchange Commission (SEC), which recognizes the difficulties in valuing private stocks as it polices how asset managers do so. “We look at whether the pricing makes rational sense,” SEC Chairman told the Journal in an interview.
The challenge inherent in accurately valuing shares in private markets compared to public markets is one reason why the SEC requires mutual funds to hold no more than 15% of their net assets in private companies and other tough-to-trade investments.
Managers typically don’t go anywhere near that cap, the Journal said, but run the risk of approaching it when they suffer redemptions: managers sell public stocks to raise cash, leaving the portfolio with a bigger proportion of private investments.