Asset managers are finding new ways to deliver private assets to everyday investors: interval funds, tender offer funds, and business development companies, to name a few. Old-fashioned mutual funds, however, have been investing in private companies in a venture-capital-like fashion for at least three decades—with disparate levels of success.
There are clear investment and business cases for mutual fund managers to own pre-IPO private companies. Pre-IPO investments can (but certainly are not guaranteed to) generate substantial investment gains, before and after their public offerings.
In the decaying world of active equity management, owning pre-IPO businesses also gives managers a value proposition to sell to investors: namely, differentiation versus passive index funds. As passive funds have vacuumed up assets in recent years, owning private business (which by definition are not included in passive public market funds) can be a survival tactic for active equity managers.
That value proposition is limited, though.
Mutual funds can invest up to 15% of their portfolios in illiquid securities, or positions that funds cannot sell in seven days or fewer—which includes virtually all private companies. A few funds have bumped against that ceiling before, and some speculate the Securities and Exchange Commission may loosen the limit.
To date, however, most mutual funds have been responsible. Only a handful have ever put more than 10% of their assets in private companies.
Still, mutual funds’ experience with private investments shows exactly why investors should exercise caution when considering venturelike portfolios. Young, private companies come with heightened risks: lower liquidity, less transparency, and potentially misaligned incentives. Private investing is not easy, even for well-resourced and connected firms.
Mutual Funds’ Private Investments Didn’t Pay Off in the Dot-Com Era
Morningstar has portfolio holdings data for mutual funds going back to the early 1980s. Still, because of mergers, rebrandings, and other corporate actions, it’s hard to identify the very first private company that found its way into a mutual fund portfolio.
Private placements like private investments in public equity showed up in mutual funds as early as the 1980s, but PIPEs are an off-market financing technique for public companies, not a true private investment.
One thing is clear: The prevalence of mutual funds dipping into private markets increased significantly in the late 1990s’ and early 2000s’ dot-com bubble. These early forays highlighted the risky nature of the game: A few positions were big winners, but most were losers, and the losses were often total.
In the early 2000s, for instance, Columbia Acorn ACRNX invested in a handful of young technology and biotech companies, including Bigfoot International, NeoPlanet (a Bigfoot spinout), Locus Discovery, MicroDose Technology, and Syrxx, among a few other private companies with harder-to-trace corporate histories.
Columbia Acorn’s total private company allocation was not huge—collectively, they represented 1%-2% of the portfolio—but the chart below shows that the losses were.
- Bigfoot began as a $4 million position in June 1998 before the fund marked it down to $134,000 when it last appeared in the portfolio in December 2001.
- The fund invested about $2.6 million in NeoPlanet in early 1999 and 2000. By April 2003, it marked the position down to about $40,000, a 98% loss.
- The fund plowed about $7.5 million in biotech startup Locus Discovery in late 2001. By the end of 2006, the last time the portfolio held it, Columbia Acorn marked it at just more than $500,000, a roughly 93% loss.
- Columbia Acorn put about $3 million in Syrrx, another biotech startup, but wrote the position down more than 80% before gradually pricing it higher until the fund roughly broke even on the company when Takeda Pharmaceuticals acquired it in early 2005.
Similarly, the aggressive Putnam OTC Emerging Growth, which was merged away in 2008, paid the price for investing in privates when the tech bubble deflated.
Like the Columbia fund, it didn’t overindulge in private companies—privates took up just 2%-3% of the portfolio at their peak—but almost all of its pre-IPO positions went to near-zero before the fund exited them.
A few, such as Equinix EQIX, now a nearly $75 billion company, stuck around after their IPOs, but the fund did not benefit. It appears Putnam OTC Emerging Growth sold Equinix when it tanked after its IPO. The fund’s experience shows that even successful private investments require a rare level of patience to stomach long periods of pain.
Worst-Case Scenario of Private Investments
The now-defunct Van Wagoner Emerging Growth Fund is the poster child for what can go wrong with private investing in vehicles that offer daily liquidity.
This strategy, another hypergrowth fund that, at one point, hit $1.5 billion in assets and was one of the 10 biggest small growth Morningstar Category funds, got torched after the dot-com bubble burst. It owned a host of both pre-IPO private businesses and post-IPO companies still subject to contractual lockup periods that, in general, prevent pre-IPO investors from selling their shares for six months.
The twist in this case was that, in 2004, the SEC levied fraud charges against the firm and its managers. Not only did the SEC admonish the fund for holding more than 15% in illiquid securities, but it also charged that the firm had improperly marked down some of its private positions as the overall portfolio fell to stay under the SEC’s 15% limit.
This highlights another, less-talked-about risk of mutual funds investing in private companies.
Asset managers inflating their private holding valuations to juice returns and increase fee-generating assets is a known concern. But at times, managers may feel pressure to understate their private positions’ values to keep from hitting regulatory limits as public holdings fall and leave a larger share of the portfolio in the illiquid positions. That’s bad for investors who seek to redeem at the understated net asset values because it means they are selling at lower prices than they could have.
Besides the valuation gaming, many of Van Wagoner’s private positions were complete wipeouts. The fund had some temporary success with software company Ariba, which the fund owned before and after its wildly successful June 1999 IPO. While the fund locked in some massive gains after it climbed nearly 600% through August 2000, the stock eventually cratered, dropping 95% between then and March 2001.
The dot-com bubble bust killed other small-cap growth strategies, but this one did far worse. From the start of the century through the end of 2004, the fund’s 86% loss was the category’s second worst, and it fell 70 percentage points more than Russell 2000 Growth, cumulatively.
From Dark to Dim With Private Investments
These ugly early experiences have not dissuaded asset managers from investing in private companies.
As of June 2024 (Morningstar’s most recent comprehensive analysis), about $17 billion of US-domiciled, US-equity-focused mutual funds’ assets were invested in private companies. That’s just 0.3% of total fund assets.
Collectively, between 2014 and 2024, US mutual funds deployed at least $30 billion into private companies. There have been some major successes, albeit mostly on paper, such as SpaceX and ByteDance, but funds have also suffered big losses on other companies like WeWork, DiDi Global, and Juul Labs.
Across all firms and funds, though, it is not obvious that these venture positions have benefited fundholders in the aggregate relative to what they could have earned in public markets. A big reason for that is that funds put a large chunk of the money to work in 2020 and 2021, a time of peak public market growth euphoria that hearkened back to the dot-com bubble and carried over into private market valuations, which have dropped considerably since then.
Perhaps that is the key lesson from mutual funds’ experience with venture investing: Like all investing, timing is everything. Throwing money at hot trends is rarely a recipe for success. Thoughtful, disciplined investing wins out in the long run.