Fund Giants’ Unicorn Dreams Gored

If you’ve been reading financial news recently you couldn’t escape the tumultuous drama of office space-sharing company WeWork. In a matter of weeks the company filed for an IPO, withdrew it, fired its once-visionary CEO, nearly went bankrupt and was finally rescued by an emergency multi-billion-dollar bailout from its largest shareholder, SoftBank. While former CEO Adam Neumann bailed out via a $1.7-billion golden parachute, thousands of its employees are facing layoffs, and the company’s valuation tumbled from an expected $47 billion to just $8 billion—a drop of over 80%.

While WeWork’s ride has been exceptionally wild, it’s not the only private company whose huge multi-billion-dollar valuation took a hit once it faced public market scrutiny. Fellow “unicorns” like Uber and Lyft successfully launched IPOs earlier this year but have done poorly since, declining in value from their initial offering prices by around 35% to 45%, respectively.

Why should you care about this debacle? Usually mutual funds stick to investing in public stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company., so WeWork shouldn’t impact investors like us—right?

Wrong.

It’s true that the bulk of mutual funds holdings are publicly traded, but they have a bit of wiggle room to hold some “non-liquid” securities. Up to 15% of a fund’s holdings can be illiquid, according to SEC regulations. And in recent years, a number of funds, including some from Vanguard and Fidelity, have been taking advantage of that flexibility to own pieces of private companies. In the case of WeWork, Vanguard’s U.S. Growth has owned shares of the now-beleaguered company since 2014, while Fidelity’s Contrafund bought a stake in 2015.

The question is, what price do the fund giants put on those shares? With a public company, you know the price of the stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. every single day. With private companies, mutual funds must generate their own valuation, and it may be months before investors learn that portfolio managers have soured on a company’s prospects. Fidelity, which valued its WeWork holdings at $411.5 million at the end of 2018, cut that number to $295 million this August and down to $193 million in September—before its recent implosion.

Before you get too worried, let us quickly add that WeWork is a tiny piece of each of these funds’ portfolios—less than one-half of one percent of U.S. Growth, and an even smaller portion of Contrafund’s portfolio—even at its loftiest valuation.

But a year ago, the media was lamenting that mutual funds (and hence, the average investor) couldn’t get in on these high-flying unicorn companies. Now it turns out that limiting how much a mutual fund can invest in private companies might not be such a bad idea.

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