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Thursday, August 31, 2017

Do You Really Know What Your Mutual Fund is Worth ?



The trend of public mutual funds investing in non public companies has increased. Although regulations restrict the holdings to 15% of the total this is a disturbing trend and certainly means that in many cases the listed net asset value of a fund may not represent the true value of its holdings. It seems that in an effort to stem the tide of movement of funds into passive vehicles fund managers are willing to "swing for the fences" seeking triple digit returns with these investments in order to improve returns.

Investing in these companies is traditionally the work of venture capital funds which invest their own capital along with that of institutions and high net worth individuals in fact the latter must meet specific characteristics with regard to net worth and investing experience to meet the criteria of "qualified investor". Built into the business model of the venture capital firms is that for every Google there are 70 or more companies that go bankrupt and that valuation is more art than science. It might be based on revenue, profits (if there are any), valuations of similar companies, the most recent capital investments or many other categories.Venture capital firms  need only report valuations to investors.

Mutual funds must  publicly report the value of their pre IPO investments quarterly meaning that there can be large changes in valuation over a single day at quarter end. 
 The value is set by the board of the mutual fund This is despite the fact that they report net asset value of their funds on a daily basis.In fact different mutual funds can value the same company at very different valuations. Bottom line: the net asset value of a public mutual  fund with non public holdings fully never reflects the real value of the assets.
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 Additionally there is no allowance in the valuation of the fact that the money is basically locked in until the date that the company goes public..it it does at all. If the prospects turn negative the valuation used in pricing for the mutual fund may be virtually useless...the holding cannot be sold.

The most recent notable markdown of a pre IPO holding is the case of Uber...Talk about inconsistency  in valuation !

As the WSJ reports (my bold/red)

Mutual Funds Mark Down Uber Investments by Up to 15%

Investors including Vanguard marked down their Uber stakes for the June 30 quarter, while Fidelity maintained its estimate


Four mutual-fund companies have marked down their investments in Uber Technologies Inc. by as much as 15%, the first such price cuts that suggest these investors are souring on the ride-hailing giant following a scandal-ridden year.
Vanguard Group, Principal and Hartford Funds all marked down their shares by 15% to $41.46 a share for the quarter ended June 30, according to the fund companies’ latest disclosure documents. T. Rowe Price Group Inc. TROW -0.25% cut the estimated price of its Uber shares by about 12% to $42.70 for the same period.
Uber’s shares don’t trade publicly, so the mutual-fund companies that hold them must estimate the shares’ worth each quarter. Seven mutual-fund companies had mostly maintained a $48.77 share price since the fourth quarter of 2015, when Uber first sold its shares to investors at that price.
Fidelity Investments held its estimate of $48.77 as of June 30. The one outlier isBlackRock Inc., BLK 0.50% which wrote up the shares slightly each of the past two quarters, settling at $53.88 as of June 30.
Uber which in the midst of scandals and board disputes, recently replaced its CEO. If this NYT analysis is correct it may prove to be the biggest loss ever taken by a mutual fund in a pre IPO company.
According to the author UBER has a fundamentally flawed business model and will quite possibly just run out of gas (money)

From the NYT
While Uber has become popular as a taxi company for the digital age, and has been valued at nearly $70 billion — more than Ford, G.M. or Tesla — the company has been losing money faster than any technology company ever. It lost nearly $3 billion in 2016 (plus another billion or two in China), and it has already lost over $1.3 billion in the first half of 2017.
The dirty little secret of Silicon Valley is that seven out of 10 venture-backed start-ups fail because they never become profitable. The company Mr. Khosrowshahi will take over is on track to becoming one of those failures.
Continue reading the main story
That’s in part because Uber has never figured out how to offer taxi service at a lower price and still earn a profit. Consequently, it has become stuck in a trap, using its venture capital funding to subsidize at least 50 percent of every ride to cut fares and try to gain a monopoly position that can drive the competition out of business. As a result, the more customers use Uber, the greater into debt it goes.
Uber can subsidize rides for only so long. At some point, investors want a return on their money. They want to get to the stage where they can profit from the company’s I.P.O., or they turn off the spigot. Uber is standing at that precipice. More than anything, that’s what the recent revolt by Uber board members has been about. Uber’s initial investors and board members were willing to look the other way as scandal after scandal erupted because the business model seemed to be on track. But now some investors are publicly saying Uber is worth far less than $70 billion, and the Uber board is offering shares to new investors at a discount.
A recent report states that some existing  investors willing to sell off shares at a discount to current valuation as reported in mid August--allowing those investors to lock in their profits effectively leaving others (like the mutual funds) holding the bag(shares) 
Furthermore Benchmark capital also in a news item this month questions Uber's current valuation. Benchmark is one of the earliest investors in Uber,holds a 13% stake, and has a pending lawsuit.

Reuters notes many funds have stakes in Uber most relatively small relative to assets but this one is striking:
The $4.5 billion fund cited Uber among top contributors to performance in its report for fiscal 2015, alongside Amazon (amzn, +1.07%) and Netflix (nflx, -0.31%). The ride-services company's valuation in the fund surged 156% to $82.5 million, Hartford disclosures show.

Its pre-IPO stakes accounted for nearly 6% of net assets while most of its peers have kept their exposure below 1 percent, fund holdings show. Hartford declined to comment.
And there is this comment from a fund manager about UBER

"Who doesn't think Uber has a great thing going?" said David Kudla, CEO of Mainstay Capital Management, which has $2 billion under management

Here is a list of mutual funds holding privately held funds as of mid 2015 obviously the list by now is far larger


And from Fortune via Reuters  in 2016:

These Mutual Funds Have Been Juicing Their Returns With Unicorn Stakes

A Reuters analysis of fund filings and other data shows, though, that some have taken a more aggressive approach, boosting the share of these companies to more than 5% of assets and awarding them rich valuations that in some cases have helped them beat their benchmarks and peers by a wider margin.
Mutual funds' involvement also helped boost the number of so-called unicorns—private companies valued at $1 billion or more.
These private investments come at a risk, though. Many are young companies that have yet to make a profit. They are also harder to price and to sell than publicly traded stocks.
That could hurt investors in a downturn because fund managers forced to meet investor redemptions may have to sell liquid public companies while marking down the unlisted ones, said Larry Swedroe, director of research at Buckingham Asset Management in St. Louis.




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