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By Christine Benz and Katie Rushkewicz Reichart, CFA | 07-09-2015 10:00 AM

Fidelity Delving Into Private Companies

In an attempt to see a longer runway for growth, some of the group's largest funds, including widely held Fidelity Contrafund, are investing in private companies.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Investments in some private companies have been popping up in a handful of Fidelity funds. Joining me to discuss this news and to share a midyear performance update is Katie Reichart. She is a senior analyst with Morningstar.

Katie, thank you so much for being here.

Katie Reichart: Great to be here.

Benz: Katie, let's start by discussing this news of some nonpublic companies popping up in a handful of Fidelity funds. Let's discuss the funds that seem to be delving into some of these private companies and also just how large these stakes are.

Reichart: Sure. We're seeing this trend not only at Fidelity but at other mutual fund companies as well. Some of the Fidelity funds investing in private companies are large-growth funds like Fidelity Contrafund (FCNTX), Fidelity Growth Company (FDGRX), Fidelity Blue Chip Growth (FBGRX), Fidelity OTC (FOCPX), Fidelity Trend (FTRNX), and Fidelity Magellan (FMAGX), just to name a few.

Benz: Let's name some of the companies that you're seeing in some of these portfolios.

Reichart: Well, a big one right now is Uber, which has been in the news quite a bit, and then others are Pinterest, Airbnb, and SpaceX.

Benz: What's the potential benefit to the funds of getting in on some of these nonpublic companies early?

Reichart: It helps them see a longer runway for growth. We are seeing a lot of companies wait to go public in this market because they are able to raise money in the private market. So, mutual funds that invest are able to get in on that runway for growth. Some managers also say that it kind of helps them with other investments they might own in the portfolio. It helps them do some competitive analysis. So, those are some of the reasons.

Benz: These aren't large positions at this point?

Reichart:  No, they are not. By SEC law, mutual funds can have as much as 15% of assets in private companies, but we don't see them at that level at all. Usually, it's just a couple of percentage points of assets in each fund.

Benz: Let's discuss some of the risks because this does remind me of when we saw a similar phenomenon going on back in the late '90s--the dotcom era. Let's discuss some of the perspective risks, even though these positions aren't very large at this point.

Reichart: One risk is liquidity risk. You can't really sell these positions. And even sometimes after the IPO, there might be a lockup period for some of these companies. And then, of course, valuation risk from a couple perspectives: For one, some of these companies are really seeing soaring valuations right now. So, that's a risk for when it comes time for an IPO, maybe they can't live up to those expectations; maybe some companies don't even make it to an IPO--that's always a risk. And then even pricing of these assets, since they're not publicly traded, each fund company might do it a little differently. That's a risk as well.

Benz: I know that you and the team have been monitoring firms' practices when they do own these nonpublic companies--how they arrive and how they should price them. How do they do it so that it's fair and, to the greatest extent possible, reflects the true value of the company at a given point in time?

Reichart: It can be a little opaque to people outside the firm. A lot of big mutual fund companies like Fidelity have pricing committees, and the portfolio managers aren't sitting on those committees. It's a separate independent group, and they can price those as often as daily. They often look at the latest financing round for these private companies and base their estimates off of that--although sometimes they may be adjusting those numbers based on liquidity or other factors.

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