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These dynamics impact a surprisingly large number of Americans. For example, the $100+ billion Fidelity Contrafund (FCNTX) holds hundreds of millions of dollars worth of start-ups like Pinterest, Uber, Dropbox, SpaceX, 23andMe and Blue Apron, according to its latest N-Q SEC filing covering the September 30, 2015 period. The valuations of these start-ups are at the core of the problem since they can quickly move in either direction and add significant risk.
Often times, a mutual fund will look at a start-up’s most recent funding valuation, the valuation of publicly-traded competitors and broader equity indexes. Liquidity is another key concern since the shares of these start-ups cannot be easily sold like publicly-traded equities on major exchanges. Mutual funds don’t disclose their valuation techniques publicly in great detail, citing competitive reasons, but there are stark differences between funds.
The SEC’s last valuation review found start-up valuation methods to be appropriate, but concerns of a tech bubble have reignited regulatory interest in these techniques. Since mutual funds are permitted to hold up to 15% of their assets in illiquid investments, individual investors may be exposed to a high amount of risk—especially if the industry were to experience a liquidity crisis and start-up shares were unable to be liquidated at reasonable prices.
The SEC requires mutual funds to submit an N-Q filing each quarter that outlines their holdings, which can provide insights into whether or not a fund holds shares in a start-up. If start-ups are present in the filing, investors can add up the exposure to determine what percentage of the total portfolio they account for and how much risk that entails. Tracking start-ups between N-Q filing periods and between mutual funds can provide an idea of pricing reliability as well.
There’s no easy way to hedge against start-up exposure, since they cannot be short sold and no options trade on them. In some ways, a put option against the tech sector may be one way to hedge bets, but the best way may be to simply select mutual funds with limited exposure. It’s also worth noting that some exposure may be appropriate, especially with many start-ups driving returns for venture capitalists that are well in excess of the public markets.
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