- In addition to harming employees, venture investors, and some of its managers, WeWork’s collapse harmed a group many thought were protected from it — everyday investors.
- That’s because such investors owned stakes in mutual funds that had invested in WeWork; those funds recently were forced to slash the value of their holdings in the company, some by as much as 68%.
- More pain may be coming for such funds and their investors, because many still assign a higher value to their stakes than Softbank recently paid for WeWork shares as part of its bailout of the company.
- Many investors likely didn’t realize they were exposed to WeWork; mutual funds don’t tout such investments in the documents regularly viewed by ordinary investors.
- Read more WeWork news here.
When WeWork imploded, seeing its attempt at an initial public offering fail, its valuation collapse, and its cash stockpile dwindle to the point that it was within mere weeks of running out, some observers latched on to one bit of good news — the disaster left everyday investors unharmed.
Yes, thousands of WeWork employees, many of whom received shares or options in the company, were at risk of losing their stakes as well as their jobs. But those workers aside, the stakeholders who were going to see financial pain from the company’s collapse were going to be the kinds of investors who knew and presumably could afford the risks — venture capitalists and big institutional investors such as Softbank. That’s because US securities laws and regulations generally prohibit average regular individual investors from buying stakes in private companies like WeWork.
It turns out, though, that the story that retail investors were sheltered from WeWork’s melt down wasn’t entirely true. In fact, many everyday people were and are invested in private startups, at least indirectly through the mutual funds and publicly traded private equity and business development companies they’ve invested in.
Many such investors suffered losses when WeWork foundered. What’s worse, they likely had no idea they were exposed to such risk. Even now, they may not understand that they themselves were affected by the crumbling of the real estate behemoth and could be hurt if other giant startups — the so-called unicorns — collapsed.
“Are they aware that they’re investing in these unicorns?” said Mike Piecek, the commissioner of the Vermont Department of Financial Regulation and the immediate past president of the North American Securities Administrators Association. “On the mutual fund side, I would argue that the vast majority — if not 99% of the cases — the retail investor probably does not have any knowledge of that.”
Mutual funds have recognized huge losses on their WeWork stakes
But what they don’t know can hurt them. In recent weeks, numerous mutual funds have acknowledged in public filings and in reports to research firm Morningstar that they have slashed their estimated valuations of their stakes in WeWork and other startups. As might be expected, given the magnitude of WeWork’s collapse, the write-downs of the funds’ stakes in that company specifically were dramatic.
For example, at the end of the third quarter, T. Rowe Price’s Mid-Cap Growth Fund, estimated that the value of its stake in WeWork had declined by 68% — or about $92 million — since the end of June. As Morningstar detailed in a recent report, numerous other funds advised by T. Rowe Price — including the MassMutual Select Mid Cap Growth Fund and the Optimum Large Cap Growth Fund, and the VY T. Rowe Price Diversified Mid Cap Growth Fund — also slashed the estimated value of their WeWork stakes by 68%, shaving thousands or posting thousands or millions of dollars in losses on those investments.
Other funds didn’t recognize as great a percentage decline in their WeWork stakes, but still posted significant losses as a result of the size of their investments. Fidelity’s Contrafund, for one, estimated that the value of its stake in WeWork had declined by only 35% from the end of the second quarter to the end of the third. But that decline still translated into a $108 million loss on its investment.
While the extent to which WeWork impacted the funds’ Q3 performance is not clear, many of these funds underperformed the market.
The Fidelity Contrafund, for example, posted a 2.4% decline during the third quarter, compared to a 1.2% gain in the S&P 500 and a 0.1% decline in the Nasdaq. The T. Rowe Price Mid-Cap Growth Fund was down 0.7%. The John Hancock Mid Cap Stock Fund, which had one of the highest exposures to WeWork, was down 5.5% in Q3.
And there likely will be more losses to come, at least at some funds. The Contrafund estimated that the per-share value of its WeWork stake was about $35 at the end of September. Vanguard’s US Growth Portfolio had an even higher per-share estimate for its stake in the company, valuing it at $45.90 a share at the end of the third quarter, according to Morningstar.
But when Softbank bailed out WeWork a few weeks later, it paid as little as $11.60 each for the company’s shares — a move that will likely force other investors to cut the values of their stakes again in coming months.
Because there’s no established public market for private company shares, fund managers have a lot of latitude to determine the value of their holdings in startups such as WeWork. The values they recognize in their reports could well be much higher than what their shares would be worth in an open market.
“Until there’s public offering or other exit, you don’t really know if that’s a real valuation or if it’s just smoke and mirrors,” said Renee Jones, a professor at Boston College Law School who focuses on securities regulation.
Funds generally held small stakes in WeWork
The mutual funds’ write-downs of their stakes in WeWork come as Congress and the Securities and Exchange Commission are debating whether to make it easier for everyday people to invest directly in private companies. Proponents of such a move argue that with more companies staying private longer, retail investors, who today are generally barred from directly investing in such firms, are missing out on much of the growth and appreciation in value of those companies.
But consumer and small investor advocates worry that opening up private companies to investment from everyday people would put those people at greater risk of losing money without having the tools to effectively evaluate such investments. Private companies aren’t required to do disclose nearly as much information about their finances and operations as are public companies, and many startups fail before ever going public. Those advocates argue it would be better for retail investors if regulators encouraged companies to go public earlier in their life cycles than to liberalize the rules on investing in private companies.
For the most part, the stakes mutual funds had in WeWork were small compared to their overall holdings, limiting investors’ pain. The Securities and Exchange Commission rules bar such funds from devoting more than 15% of their total assets to so-called illiquid investments — stocks, bonds, or other instruments that can’t be easily bought or sold on public markets. Many funds that had stakes in WeWork devoted far less of their assets to such investments.
Of the funds Morningstar examined in its recent report, the average one had only about 0.5% of its assets invested in the real estate giant. The highest percentage stake was the John Hancock Mid Cap Stock fund, for which WeWork comprised 0.77% of its investments, Morningstar found. But Vanguard’s US Growth Portfolio and the Contrafund had just 0.09% and only 0.18%, respectively, of their assets invested in the company, according to Morningstar.
But even such small stakes can limit fund performance if they decline in a big way, as WeWork did. The bigger danger is that the drop in the value of one startup is an indication of a bigger problem in the private markets, and fund managers have to cut the value of their stakes in multiple startups at the same time.
There’s some indication that in the wake of WeWork’s decline, and the fall in the share prices of recently public companies including Uber, Lyft, and Slack, fund managers are starting to do that kind of broader reevaluation. At the end of the third quarter, many funds trimmed the values they placed on their stakes in Airbnb and other startups, according to Morningstar.
Investors “might not feel ton of pain on that investment” in WeWork,” said Piecek. But, he continued, “if there are continued write-downs among that asset class, and you have a 3 or 4 or 5 or 6 percent exposure … that is real pain and that will have a real impact on the bottom line.”
Shares in private companies can be hard to sell
And there are other dangers. Because such stakes are, by their nature, difficult to sell off, funds can be forced to hold on to them even when they’d rather hold more desirable stocks or assets. The result can be that the fund ends up with significant exposure to private companies.
Just such an event happened a few years ago with the Morgan Stanley Institutional Mid Cap Growth fund. In the wake of its underperformance, investors started selling off their stakes in the fund. To account for such redemptions, Morgan Stanley was forced to divest some of the fund’s assets. But because it found it easier to sell off publicly held shares than stakes in private companies, the portion of the fund’s assets devoted to the latter swelled from around 5% to more than 9% between 2014 and 2016, as Morningstar has previously reported.
The performance of Morgan Stanley’s fund bounced back in 2017. But being that exposed to the vicissitudes of startups — many of which die or fail to deliver much of a return to investors — could have sabotaged its performance relative to the rest of the market.
During the dot-com boom and bust 20 years ago, Garrett Van Wagoner managed a group of funds that were heavily invested in tech startups. The performance of those funds mirrored the big boom and bust of the tech stock market. As investors pulled out of his funds, Van Wagoner kept bumping up against the 15% cap on illiquid investments.
“On any given normal day, liquidity may not be an issue, but it’s always sort of the worst case scenario” that investors need to be concerned about, said Tom Lauricella, an editor at Morningstar.
Funds have been upping their stakes in startups
One bit of good news for everyday investors is that few mutual funds have invested in private companies. In a study three years ago, Morningstar found that just 3.6% of funds had invested in at least one of some 133 different private companies.
And the amounts that mutual funds have devoted to such companies is tiny compared with their overall holdings. Funds had about $11.5 billion invested in those companies in 2016 out of $8.6 trillion in total assets, according to Morningstar.
Mutual fund investment in private companies has been increasing in recent years, particularly since 2013, when the capital markets started rebounding after the Great Recession, according to Gary Kirkham, global co-head of technology, media, and telecom investment banking for Bank of America.
A variety of factors, including changes in laws and regulations, helped shift capital from public to private markets. As it did, companies started staying private longer, and much of the appreciation in their value began occurring before they went public.
Meanwhile, everyday investors were shifting growing amounts of money into index funds. To try to outperform those indexes, some fund managers started to invest in private companies, aiming to get in on such startups at a discount before they went public. Those investments were riskier than the public companies mutual funds typically invest in, but they offered the possibility of much higher returns, Kirkham said.
“If you’re a mutual fund and you are in are business of deploying capital and getting returns, that’s a pretty attractive market to tap into,” he said.
Few investors are likely aware of such investments
The problem is that most investors likely have no idea that the funds have taken on such risks and that they themselves could be indirectly invested in startups through their 401(k)s or other accounts.
The funds themselves typically don’t disclose their specific stakes in such companies in the prospectuses or in other documentation that they make available to everyday investors. At best, the funds may indicate in such documents that they may from time to time invest in non-public companies in general.
Mutual fund firms do make public their investments in startups in the periodic reports they make to the Securities and Exchange Commission. But the investments are typically buried in the small print of such disclosures, mixed in with the funds’ other holdings, often with little or no indication that they represent stakes in private companies. Unless investors knew about such filings and knew what to look for within them, and knew which private companies to search for by name, they’d generally have no idea that their fund was invested in them.
“Even a person who’s paying attention isn’t always enough to be up on the latest developments” in a mutual fund’s portfolio holdings, said Boston College’s Jones.