As tech continues to surge, managers at some of the biggest mutual funds are increasingly snatching up pre-IPO companies as a way to reach for more yield and amplify gains. So far the bets have paid off, but in theory such private investments could come with liquidity risks and overexposure to a tech market that some analysts believe is entering a bubble stage.
American investors may own more tech than they realize. Investment firms such as T. Rowe Price, Fidelity and BlackRock have been acquiring billions of dollars’ worth of shares in private tech companies within mutual funds held by 401(k) plans. As private tech grows faster than publicly traded companies, money managers are increasingly looking for ways to amplify gains by buying shares before they go public.
Fidelity’s Contrafund (ticker: FCNTX) owns shares in Airbnb, Pinterest and Uber, while T. Rowe Price (TROW) has at least 17 investments in private tech companies. Dabbling in private tech has so far paid off for Contrafund. Like 69 other mutual funds, it picked up Facebook shares well before the IPO. Contrafund is now the largest fund owner of Facebook with more than 47 million shares, constituting 3.2% of its holdings.
But such upside can often come with risk. Because private companies aren’t required to produce the transparent reporting that publicly traded companies do, it’s hard for investors to know what’s really going on behind the scenes. There’s the argument that investing in these private companies may be going beyond what a traditional mutual fund is set up to do.
“These investments may be more speculative, but whether or not it changes the risk profile is really dependent on the size of those investments relative to the fund’s asset base,” says Laura Lutton, editorial director of Morningstar’s Fund Research Group.
Mariann Montagne, CFA, senior investment analyst at Gradient Investments in Arden Hills, Minn., says not only is private equity less transparent, it also often can have lock-up periods of up to two years. Also, there usually isn’t any guarantee as to when investments will be cashed out to other investors in the form of an initial public offering.
Nevertheless, it’s important to keep things in perspective, as these private investments as a whole make up very small portions of a fund’s total holdings. SEC regulations say mutual funds can have no more than 15% in daily illiquidity in underlying holdings. With a net asset value of more than $112 billion, Contrafund’s holdings in companies such as Airbnb and Pinterest make up less than a 0.05% of its total holdings.