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Main Street Portfolios Are Investing in Unicorns

A Berlin Uber user. Shares in start-ups with high valuations, like the ride-hailing service, are appearing in mutual funds.Credit...Adam Berry/Getty Images

With Uber now reportedly valued at $50 billion, there are justifiable worries that some private start-up technology companies worth $1 billion or more — known as unicorns — are in bubble territory.

But don’t worry, the thinking goes. Main Street investors won’t get hurt as they did after the dot-com collapse of 2000 because the current crop of highfliers are privately held by expert investors like venture capitalists. So most civilians will be fine should things turn south this time.

Here’s an open secret: That’s fiction.

While public investors and 401(k) contributors have long complained that they can’t get access to shares of hot technology companies before their initial public offerings, that’s actually not the case anymore. Fidelity, T. Rowe Price, BlackRock and Janus, among others, have been quietly putting shares of private companies like Uber, Pinterest and SpaceX into their investment funds, hoping to lift the returns of certain mutual funds.

The good news is that investors across a broad range are able to invest in these pseudo-private companies, democratizing, to some degree, the investment process. The bad news is that should the bubble pop, these investors have already bought shares in the companies at sky-high valuations. And these people may not even realize it.

An investor in the Fidelity Contrafund, for example, which has a heavy weighting in technology firms, has small slices of Uber, Dropbox, Airbnb and Pinterest.

Perhaps troubling — or at least questionable — is how mutual funds like T. Rowe Price, Fidelity and BlackRock value these investments in unicorns.

Usually, their funds invest in public companies or publicly traded bonds. It is easy to determine how much the fund’s holdings in a publicly traded company are worth: The stock has an exact price.

Private company valuations, however, are quite different.

There is no meaningful stock market for these shares. Their values are based on what a small handful of investors — usually venture capital firms, private equity firms or other corporations — are willing to pay for a stake. Such investors come with a different risk appetite and motivations than, say, the average worker looking to save for retirement.

Venture capital firms often take a shoot-the-moon approach, willing to accept a long list of losers so long as their portfolios include some huge winners. In the latest issue of The New Yorker magazine, Marc Andreessen describes how only a small fraction of unicorns will become the next Google or Facebook.

Sometimes, the investor that helps set the new valuation is another company, like Baidu or Xiaomi, the Chinese Internet and electronic companies, both of which invested in Uber. Their interest in Uber may be strategic, making the exact valuation less important. Maybe Baidu, for example, one day hopes to form a partnership with Uber, so that Uber drivers deliver packages for Baidu? Who knows?

It’s virtually impossible to know exactly how the mutual funds determine the value of private companies. Not one of the mutual fund companies with which I spoke was willing to fully explain its methodology.

T. Rowe Price offered this statement: “Valuations are the responsibility of a cross-disciplinary valuation committee, which operates independent of portfolio management.” The company added: “The factors we consider include significant transactions in these securities, new rounds of financing, the company’s financial and operational performance, strategic events impacting the company and relevant valuations of similar companies.”

Fidelity was equally noncommittal. “We have a rigorous and thorough fair-market valuation process for mutual fund holdings,” the company said. BlackRock declined to comment.

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Mutual funds have invested in SpaceX, not yet public.Credit...Craig Rubadoux/Florida Today, via Associated Press

Many mutual fund companies do not even disclose their stakes in private companies. For example, many firms disclose only the top 10 investments in their funds.

Fidelity shows the value of its holding in a particular company — for example, it says its Contrafund has a stake in Uber worth $162 million — but doesn’t say how many shares it owns or how it arrived at that number.

Many mutual funds allow for up to 10 percent of a fund to be invested in what are called illiquid investments. While it’s tough to discern how a mutual fund has valued an asset, it’s often even harder to understand the terms of the deal.

In some cases, people involved in these transactions say, special deals are struck for preferred shares that include downside protection; some of the deals include deadlines for the companies to go public and penalties if they don’t. And some mutual funds have sold their private shares even before the start-up has gone public, people involved in the transactions say.

Some mutual fund managers suggest they like investing in private companies because they get a better peek under the hood than a public company offers. 

Another of the reasons that mutual fund companies say they need to buy into start-ups is the dearth of I.P.O. opportunities and the increasingly extended period that start-ups stay private. That’s true. But the mutual funds are creating a self-fulfilling prophecy by making such investments, which provide disincentives to private companies to go public more quickly.

It is worth noting that these stakes in private companies usually represent a tiny fraction of a total mutual fund’s portfolio. The Fidelity Contrafund says the $162 million stake in Uber is only 0.145 percent of its entire fund.

So if you’re an investor looking for a lot of exposure to unicorn technology companies, these mutual funds are hardly going to give you a concentrated bet. And that’s probably a good thing.

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: Main Street Portfolios Are Investing in Unicorns. Order Reprints | Today’s Paper | Subscribe

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