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To what extent is your MF portfolio manager acting like a venture capitalist (with your money)? [and where oh where is this ever fully explicated in anyone's MF prospectus, or annual report, or SAI?]
That mutual fund in your retirement plan may be moonlighting as a venture capitalist.
BlackRock Inc., BLK -0.57% T. Rowe Price Group Inc. TROW +0.36% and Fidelity Investments are among the mutual-fund firms pushing into Silicon Valley at a record pace, snapping up stakes in high-profile startup companies including Airbnb Inc., Dropbox Inc. and Pinterest Inc.
The investments could pay off big if the companies go public or are sold, helping boost fund returns. But, as the recent turmoil in the market for technology stocks and initial public offerings has shown, such deals also carry major risks not typically associated with mutual funds.
"These are unproven companies that could very well fail," says Todd Rosenbluth, director of mutual fund research at S&P Capital IQ. If things go badly for a startup, "there may not be an exit strategy" for the fund fir
Last year, BlackRock, T. Rowe, Fidelity and Janus Capital Group Inc. JNS +1.58% together were involved in 16 private funding deals—up from nine in 2012 and six in 2011, according to CB Insights, a venture-capital tracking firm.
This year, the four firms already have participated in 13 closed deals, putting 2014 on track to be a banner year for participation by mutual funds in startup funding. On Friday, T. Rowe was part of an investor group that finished a deal to pour $450 million into Airbnb, said people familiar with the matter.
Last week, peer-to-peer financing company LendingClub Corp. raised $115 million in equity and debt, the bulk of which came from fund firms including T. Rowe, BlackRock and Wellington Management Co.
Investors put money into venture-capital funds knowing it is a bet that a few untested companies will become big winners, making up for many losers. But mutual funds, the mainstay of the U.S. retirement market with $15 trillion in assets, aren't typically supposed to swing for the fences. Instead, they put most of their money into established companies with the aim of making steady, not spectacular gains.
The risks of putting money into unproven startups were highlighted by the recent slump in technology stocks, which aggravated worries that valuations for pre-IPO companies may be inflated as well.
"We are not at the beginning of the cycle and that's probably the most diplomatic way to put it," says Chris Bartel, senior vice president of global equity research at Fidelity, noting his firm is cautious about investments.
Like other fund executives, he said startup investments represent a small portion of overall assets and that his firm targets companies that are likely to go public or be sold in the near future.
Nothing prevents mutual funds from buying pieces of startups, though the Securities and Exchange Commission limits them to keeping less than 15% of their portfolios in illiquid securities.
Mutual funds have turned to private technology companies as a way to boost investor returns while growth has stalled at larger, more well-known firms, says Mr. Rosenbluth of S&P Capital IQ.
But these deals are more opaque than most fund investments: Fund firms aren't required to immediately disclose such investment decisions to investors, and privately held companies are also more challenging to value, making it more difficult to gauge how a stake is performing.
For startups, fund companies are attractive because they have a longer-term investing horizon than venture capitalists.
Bellevue, Wash.-based startup Apptio has received funding from three mutual-fund companies. T. Rowe was an early investor and Janus participated in the company's recent funding round of $45 million last May, as did Fidelity, according to people familiar with the matter.
Sunny Gupta, co-founder and chief executive of the startup, which helps businesses manage their technology spending, said he was interested in having the fund companies on board in part because he "wanted a different style of investor" that also brought in-depth financial expertise.
Having mutual funds on board also helps on the road to an initial public offering because big-name investors can provide peace of mind to others thinking about taking a stake. With T. Rowe, for example, Mr. Gupta said "there is an incredible amount of brand recognition" on Wall Street.
Similarly, Bill Harris, the chief executive of Personal Capital, a personal-finance and wealth-management website in Redwood City, Calif., said BlackRock's knowledge of the financial world has benefited the startup since the fund company took part in a $25 million funding round last June. Mr. Harris said he hadn't sought out a fund company and that BlackRock had approached him.
The competition among fund companies is driving up valuations of recent deals, said one person with direct knowledge of startups' funding rounds.
The bellwether for the industry is T. Rowe Price, the Baltimore-based fund family that has backed 30 private tech deals since 2009, according to CB Insights.
Henry Ellenbogen, manager of T. Rowe's $16.2 billion New Horizons Fund, put money into Twitter Inc. TWTR +1.33% before it went public, and has since bought shares in other big names including LivingSocial Inc., a daily deals site, and GrubHub Inc., GRUB -4.18% a food-delivery service, according to T. Rowe.
Mr. Ellenbogen's fund returned 49.1% last year, beating its benchmark, the S&P 500, which returned 32.4%, according to fund-research firm Morningstar Inc. He invests only a small percentage of the funds' assets in any one startup and holds about 260 stocks in the fund, realizing that some of the startups might fail, according to a person familiar with his thinking.
BlackRock, never a big player in Silicon Valley in the past, has funded 10 deals in the past two years, including four this year: software company Hortonworks Inc. in March and Dropbox in January. BlackRock doesn't disclose which of its mutual funds have invested, and declined to say how much the firm put into each company. The deals generally "represent a small portion of the total portfolio of a fund, but with the intent of adding incremental returns," a spokesman said.
Fidelity, likewise, has stepped up. The Boston-based fund firm has participated in 14 privately held tech-company rounds of funding since 2010, including six last year and four this year that have closed, including One Kings Lane, a home-décor website.
Another fear among some analysts is that this rush into pre-IPO stocks has echoes of the 1990s dot-com bubble, when many fund managers got badly burned by ill-timed moves into technology shares. Janus and Fidelity had funds that suffered large losses in the dot-com crash.
A spokesman for Janus declined to comment.
Mr. Bartel of Fidelity conceded the firm is seeing valuations that "aren't as compelling," as they used to be but also said it is seeing more pitches than ever.
There are a couple of different things mixed up in this reporting.
Fidelity ventures is an entity in the family that invests primarily in Series B or later and is not associated with any mutual fund. The money for this venture fund comes from the high net worth individuals working for Fidelity such as fund managers. There are no mutual fund investors involved here.
The investing by some mutual funds in late stage companies with large sums of money at very high valuations has very little to do with venture capital in terms of risk profile and is more like convertible bond/preferred stock investing and it is somewhat of a game being played. It works like this.
Say, you are a fund manager with hundreds of millions of dollars that needs to be put to work and is dragging down your performance sitting in cash. Cash instruments pay very little. Buying more equities in your asset class may increase your Value At Risk more than your limit. You can use part of that money without liquidity needs to get about 8% annual returns with very little risk and a potential to gain 50-100% more with no additional risk. The catch is you need very large sums of money ($150M-$200M per investment).
You find a late stage company that already has established a market (in revenue or users) but needs a large cash infusion to scale up and prepare the company for an exit. Part of this preparation is to create huge valuations for the company to give the impression that it is worth a lot and a huge pool of money to ensure it doesn't run out of money while positioning itself for an exit (acquisition or IPO).
Traditional VCs won't provide this funding because the expected returns for this money in an exit is very low (1x-2x) rather than the 10x-20x VCs invest for. And it ties up a large amount of money in one company. Enter money funds that have large pools of capital and are happy with a 8-10% annual return and an option to realize 50-100% with a few years.
The key for the money fund is to find late stage companies that are not going to go down because they already have a market although they are not ready for an exit in terms of recenue or buyer interest. Even a fire sale exit for the company will likely result in a $100M-$200M transaction which is considered a huge failure these days.
So, you agree to put in money in that range in a late stage financing round with preferred shares that typically have 8% dividends that add on to your equity each year. These shares also have liquidation preferences that put your shares ahead of all others in a sale. So, unless the company goes down or sells for less than the amount of money you put in (but you have selected the company to have at least that much real valuation in worst case scenario), the return of capital is pretty much guaranteed. So, in the worst expected case, you get your money back probably with the 8% returns.
You let the company decide whatever non-sensical valuation it wants which is typically $1B+ at this stage of the company. This high valuation is great marketing for the company to look like it is worth a lot, does not dilute existing investors as you typically get 10% or less equity in that round, and the huge valuation prevents any further rounds which might dilute you or have liquidation preference over you. It is understood by all that this will be the final round of funding for that company. Hence, the huge amount of funding at that stage.
The expected exit us in 2-3 years. So you have a preferred stock that will let you get 8% annual returns with very little risk of losing capital and if the company has a huge exit, you may realize anywhere from 10%-100% returns on that money with your equity stake.
Not a bad investment for a fund with a lot of cash in its hands. You just need a lot of money that doesn't need to be liquid for 3-4 years (you can pool with other funds). The other catch is that there aren't a lot of companies to invest in at this stage and real valuation to guarantee return of capital so there aren't too many of these deals being made but they make headlines when they do because of the funny money valuations.
Yes, there are bubble deflating risks.But this is not really venture investing as people understand it to be.
@cman: I don't doubt that what you write may be true, in at least some cases; it would make sense that a large MF co. would want something in return for putting client skin in the game. However, if true, where have you ever seen this acknowledged in portfolio reports to MF shareholders? e.g. have you seen "Airb2b, PFD shares, 8% etc" in a detailed holdings list? [oh my, as I typed, I just realized there is a short list of securities described as "illiquid securities" that often follows a page or so after the detailed holdings data dump...... never mind...... that's where these are!]
Anyway, here's another blog art. from today, commenting on the subject, describing these pre-IPO illiquid investments metaphorically as "promising waters":
@heezsafe, I hear you on the transparency part but mutual funds have never been bastions of transparency, only what the SEC requires. In this case, the listing under illiquid assets may be related to these pre-ipo securities being SEC unregistered securities as they typically are. Besides, when you have such hit or miss situations, fund managers are reluctant to trumpet them prior to a hit for marketing reasons.
So, as long as the prospectus allows some small portion in such alternate investments, it is legal for them.
I wouldn't worry much about it, since they are typically very small fraction of the portfolio unless it is a fund specifically designed for such alternative investments. The aggregate sums in absolute numbers may seem be huge but then the aggregate asset bases are huge!
@cman: I don't doubt that what you write may be true, in at least some cases; it would make sense that a large MF co. would want something in return for putting client skin in the game. However, if true, where have you ever seen this acknowledged in portfolio reports to MF shareholders? e.g. have you seen "Airb2b, PFD shares, 8% etc" in a detailed holdings list? [oh my, as I typed, I just realized there is a short list of securities described as "illiquid securities" that often follows a page or so after the detailed holdings data dump...... never mind...... that's where these are!]
I noticed Twitter listed in a few funds before it went public. I like that there is some flexibility for some funds to do this, but I think it should be more transparent (what %, what holdings, etc.) I'd also like to see investments in names that aren't all the most faddish, "hot" private names, but I suppose those are the names investors want to see.
I noticed Twitter listed in a few funds before it went public. I like that there is some flexibility for some funds to do this, but I think it should be more transparent (what %, what holdings, etc.) I'd also like to see investments in names that aren't all the most faddish, "hot" private names, but I suppose those are the names investors want to see.
The reason mutual fund managers don't like transparency is precisely because many retail investors love to do back seat driving and there is nothing that will please everybody. Investors only like the names in retrospect or it can change in a day. They are the ones who create the fad.
So, there is more downside in transparency these days in the Internet world where second guessing and opinions can become very loud and disproportionate. There is no win-win solution here.
I would prefer that regular mutual funds not specifically designed for it in the objective NOT buy pre-ipo companies in places like second market where the valuations are usually based on hype and there is very little transparency from the companies. Self selection results in only hyped companies coming to second markets in the volumes funds need. Unlike financing rounds, it is very difficult to do proper DD and the upside is typically not commensurate with the risk.
Comments
4/18/14 Copy & Paste: Kirsten Grind WSJ
(Mutual Funds Moonlight As Venture Capitalist)
That mutual fund in your retirement plan may be moonlighting as a venture capitalist.
BlackRock Inc., BLK -0.57% T. Rowe Price Group Inc. TROW +0.36% and Fidelity Investments are among the mutual-fund firms pushing into Silicon Valley at a record pace, snapping up stakes in high-profile startup companies including Airbnb Inc., Dropbox Inc. and Pinterest Inc.
The investments could pay off big if the companies go public or are sold, helping boost fund returns. But, as the recent turmoil in the market for technology stocks and initial public offerings has shown, such deals also carry major risks not typically associated with mutual funds.
"These are unproven companies that could very well fail," says Todd Rosenbluth, director of mutual fund research at S&P Capital IQ. If things go badly for a startup, "there may not be an exit strategy" for the fund fir
Last year, BlackRock, T. Rowe, Fidelity and Janus Capital Group Inc. JNS +1.58% together were involved in 16 private funding deals—up from nine in 2012 and six in 2011, according to CB Insights, a venture-capital tracking firm.
This year, the four firms already have participated in 13 closed deals, putting 2014 on track to be a banner year for participation by mutual funds in startup funding. On Friday, T. Rowe was part of an investor group that finished a deal to pour $450 million into Airbnb, said people familiar with the matter.
Last week, peer-to-peer financing company LendingClub Corp. raised $115 million in equity and debt, the bulk of which came from fund firms including T. Rowe, BlackRock and Wellington Management Co.
Investors put money into venture-capital funds knowing it is a bet that a few untested companies will become big winners, making up for many losers. But mutual funds, the mainstay of the U.S. retirement market with $15 trillion in assets, aren't typically supposed to swing for the fences. Instead, they put most of their money into established companies with the aim of making steady, not spectacular gains.
The risks of putting money into unproven startups were highlighted by the recent slump in technology stocks, which aggravated worries that valuations for pre-IPO companies may be inflated as well.
"We are not at the beginning of the cycle and that's probably the most diplomatic way to put it," says Chris Bartel, senior vice president of global equity research at Fidelity, noting his firm is cautious about investments.
Like other fund executives, he said startup investments represent a small portion of overall assets and that his firm targets companies that are likely to go public or be sold in the near future.
Nothing prevents mutual funds from buying pieces of startups, though the Securities and Exchange Commission limits them to keeping less than 15% of their portfolios in illiquid securities.
Mutual funds have turned to private technology companies as a way to boost investor returns while growth has stalled at larger, more well-known firms, says Mr. Rosenbluth of S&P Capital IQ.
But these deals are more opaque than most fund investments: Fund firms aren't required to immediately disclose such investment decisions to investors, and privately held companies are also more challenging to value, making it more difficult to gauge how a stake is performing.
For startups, fund companies are attractive because they have a longer-term investing horizon than venture capitalists.
Bellevue, Wash.-based startup Apptio has received funding from three mutual-fund companies. T. Rowe was an early investor and Janus participated in the company's recent funding round of $45 million last May, as did Fidelity, according to people familiar with the matter.
Sunny Gupta, co-founder and chief executive of the startup, which helps businesses manage their technology spending, said he was interested in having the fund companies on board in part because he "wanted a different style of investor" that also brought in-depth financial expertise.
Having mutual funds on board also helps on the road to an initial public offering because big-name investors can provide peace of mind to others thinking about taking a stake. With T. Rowe, for example, Mr. Gupta said "there is an incredible amount of brand recognition" on Wall Street.
Similarly, Bill Harris, the chief executive of Personal Capital, a personal-finance and wealth-management website in Redwood City, Calif., said BlackRock's knowledge of the financial world has benefited the startup since the fund company took part in a $25 million funding round last June. Mr. Harris said he hadn't sought out a fund company and that BlackRock had approached him.
The competition among fund companies is driving up valuations of recent deals, said one person with direct knowledge of startups' funding rounds.
The bellwether for the industry is T. Rowe Price, the Baltimore-based fund family that has backed 30 private tech deals since 2009, according to CB Insights.
Henry Ellenbogen, manager of T. Rowe's $16.2 billion New Horizons Fund, put money into Twitter Inc. TWTR +1.33% before it went public, and has since bought shares in other big names including LivingSocial Inc., a daily deals site, and GrubHub Inc., GRUB -4.18% a food-delivery service, according to T. Rowe.
Mr. Ellenbogen's fund returned 49.1% last year, beating its benchmark, the S&P 500, which returned 32.4%, according to fund-research firm Morningstar Inc. He invests only a small percentage of the funds' assets in any one startup and holds about 260 stocks in the fund, realizing that some of the startups might fail, according to a person familiar with his thinking.
BlackRock, never a big player in Silicon Valley in the past, has funded 10 deals in the past two years, including four this year: software company Hortonworks Inc. in March and Dropbox in January. BlackRock doesn't disclose which of its mutual funds have invested, and declined to say how much the firm put into each company. The deals generally "represent a small portion of the total portfolio of a fund, but with the intent of adding incremental returns," a spokesman said.
Fidelity, likewise, has stepped up. The Boston-based fund firm has participated in 14 privately held tech-company rounds of funding since 2010, including six last year and four this year that have closed, including One Kings Lane, a home-décor website.
Another fear among some analysts is that this rush into pre-IPO stocks has echoes of the 1990s dot-com bubble, when many fund managers got badly burned by ill-timed moves into technology shares. Janus and Fidelity had funds that suffered large losses in the dot-com crash.
A spokesman for Janus declined to comment.
Mr. Bartel of Fidelity conceded the firm is seeing valuations that "aren't as compelling," as they used to be but also said it is seeing more pitches than ever.
.
Fidelity ventures is an entity in the family that invests primarily in Series B or later and is not associated with any mutual fund. The money for this venture fund comes from the high net worth individuals working for Fidelity such as fund managers. There are no mutual fund investors involved here.
The investing by some mutual funds in late stage companies with large sums of money at very high valuations has very little to do with venture capital in terms of risk profile and is more like convertible bond/preferred stock investing and it is somewhat of a game being played. It works like this.
Say, you are a fund manager with hundreds of millions of dollars that needs to be put to work and is dragging down your performance sitting in cash. Cash instruments pay very little. Buying more equities in your asset class may increase your Value At Risk more than your limit. You can use part of that money without liquidity needs to get about 8% annual returns with very little risk and a potential to gain 50-100% more with no additional risk. The catch is you need very large sums of money ($150M-$200M per investment).
You find a late stage company that already has established a market (in revenue or users) but needs a large cash infusion to scale up and prepare the company for an exit. Part of this preparation is to create huge valuations for the company to give the impression that it is worth a lot and a huge pool of money to ensure it doesn't run out of money while positioning itself for an exit (acquisition or IPO).
Traditional VCs won't provide this funding because the expected returns for this money in an exit is very low (1x-2x) rather than the 10x-20x VCs invest for. And it ties up a large amount of money in one company. Enter money funds that have large pools of capital and are happy with a 8-10% annual return and an option to realize 50-100% with a few years.
The key for the money fund is to find late stage companies that are not going to go down because they already have a market although they are not ready for an exit in terms of recenue or buyer interest. Even a fire sale exit for the company will likely result in a $100M-$200M transaction which is considered a huge failure these days.
So, you agree to put in money in that range in a late stage financing round with preferred shares that typically have 8% dividends that add on to your equity each year. These shares also have liquidation preferences that put your shares ahead of all others in a sale. So, unless the company goes down or sells for less than the amount of money you put in (but you have selected the company to have at least that much real valuation in worst case scenario), the return of capital is pretty much guaranteed. So, in the worst expected case, you get your money back probably with the 8% returns.
You let the company decide whatever non-sensical valuation it wants which is typically $1B+ at this stage of the company. This high valuation is great marketing for the company to look like it is worth a lot, does not dilute existing investors as you typically get 10% or less equity in that round, and the huge valuation prevents any further rounds which might dilute you or have liquidation preference over you. It is understood by all that this will be the final round of funding for that company. Hence, the huge amount of funding at that stage.
The expected exit us in 2-3 years. So you have a preferred stock that will let you get 8% annual returns with very little risk of losing capital and if the company has a huge exit, you may realize anywhere from 10%-100% returns on that money with your equity stake.
Not a bad investment for a fund with a lot of cash in its hands. You just need a lot of money that doesn't need to be liquid for 3-4 years (you can pool with other funds). The other catch is that there aren't a lot of companies to invest in at this stage and real valuation to guarantee return of capital so there aren't too many of these deals being made but they make headlines when they do because of the funny money valuations.
Yes, there are bubble deflating risks.But this is not really venture investing as people understand it to be.
Anyway, here's another blog art. from today, commenting on the subject, describing these pre-IPO illiquid investments metaphorically as "promising waters":
http://abnormalreturns.com/search-growth-shrinking-pool/
So, as long as the prospectus allows some small portion in such alternate investments, it is legal for them.
I wouldn't worry much about it, since they are typically very small fraction of the portfolio unless it is a fund specifically designed for such alternative investments. The aggregate sums in absolute numbers may seem be huge but then the aggregate asset bases are huge!
So, there is more downside in transparency these days in the Internet world where second guessing and opinions can become very loud and disproportionate. There is no win-win solution here.
I would prefer that regular mutual funds not specifically designed for it in the objective NOT buy pre-ipo companies in places like second market where the valuations are usually based on hype and there is very little transparency from the companies. Self selection results in only hyped companies coming to second markets in the volumes funds need. Unlike financing rounds, it is very difficult to do proper DD and the upside is typically not commensurate with the risk.