If you’re like everyone else out there looking to hit the IPO lottery, you’re waiting for your turn on the Uber line.
Keep on waiting…
Odds are that you won’t be a part of the investment groups who will reap huge profits once the transportation services company hits the streets.
It’s not the first time everyday investors have been left out of high-flying, massive wealth-transfer IPO’s—and it won’t be the last.
Alibaba (BABA) and Facebook (FB) are the poster children of wild price swings in the first days of their respective IPOs.
Along with Uber, today’s crop of hope-to-bes include Square, Dropbox and Snapchat.
There is a way for you to play the potential run-up in these companies, but all is not as it seems…
The Pre-IPO Mutual Fund Market Explodes
Generally speaking, unless you’re a preferred brokerage client, a friend of someone involved in a company IPO, or an institutional client, IPOs like BABA and FB, along with another recent stalwart, GoPro (GPRO) are off limits.
The growth in mutual funds that set aside investments in pre-IPO companies, however, offers an opportunity for “outside” investors to grab a piece—albeit in many cases, a very small piece—of the IPO pie.
Mutual fund operators as wide and varied as T. Rowe Price (TROW), Fidelity, and Morgan Stanley (MS) are deeply engaged in pre-IPO investing, with Reuters reporting the Fidelity’s Contra-Fund (FCNTX) holds $900 million (against a $11 billion portfolio) in pre-IPO companies.
Meanwhile Morgan Stanley’s Institutional Small Company Growth Portfolio Class A (MSSMX) has around 5% of its assets invested in pre-IPO companies.
All of this means that for investors looking to get that thin slice of the IPO pie in their portfolios, the impossible is suddenly possible.
But there are some small nits you need to understand…
Value Plays With Moving Target Values
Perhaps the biggest problem facing pre-IPO fund investors is the issue of mis-pricing, or re-pricing, of the underlying asset.
You see, those valuations you hear about every day that appear to continuously skyrocket are private values. Companies assessing those values may have totally different metrics that power the numbers.
Which is a big problem…
The Wall Street Journal reported that in a wide-ranging study with Dow Jones VentureSource, it found 12 instances in which the same company was valued differently by more than one mutual fund on the same date. That pricing gap ranged from just a few cents to more than double the stock’s expected stock price value.
That’s a big gap.
Indeed, the New York Times recently uncovered that both Fidelity and BlackRock (BLK) discounted the values of Snapchat and Dropbox holdings.
As mutual funds are required to value their holdings on a daily basis (from which the NAV’s are determined), marking up—or down—these pre-IPO values is critical.
The money quote on the difficulty for the mutual funds, and the big risk for investors, came from Mike McNamee, a spokesman for the Investment Company Institute, who said “This assessment [a good faith determination of what an investor could get in a sale of the asset] has been widely recognized to be more art than science.”
Since investors in these mutual funds have little to no idea about how those valuations are calculated, that investment you hope will double your money might just add pennies…
That IPO Pop Comes With a Price Tag
Next, understand something really important: you are not going to see that pop you’re hoping for when the IPO is completed.
Before you count on the $24 per share investors made on BABA on the first trade ($92 vs. $68 IPO price), keep in mind your investment is made in a fund that carries multiple assets, not just the IPO stock.
That (hopeful) gain is generally absorbed into the Net Asset Value (NAV) price of the mutual fund. Sure there’s a gain, but its diluted.
Even more depressing is the tax bill you’ll get at the end of the year. The mutual fund must provide the IRS with your gains, and since it will be a short-term gain, those gains will be taxed at the highest rate.
However, for those of you willing and able to play the pre-IPO game on a smaller scale, the good news is there are a host of options available today.
Each of these requires some spadework to dig into the portfolio, but it’s better to start with that grunt work before finding out when it’s too late….
Three Pre-IPO Plays to Start
T.Rowe Price’s New Horizons Fund (PRNHX) targets small, emerging growth companies. It was an early investor in BABA and FB. PRNHX requires a minimum $2,500 investment, and expenses run at 0.80%.
Fidelity’s Select Healthcare Fund (FSPHX) is engaged in finding biotechnology stars before anyone else. FSPHX always seems to find the best of the bunch. It requires a minimum $2,500 investment and expenses run at 0.77%.
First Trust US IPO ETF (FPX) closely follows the IPOX-100 Index, which includes Facebook (FB) in its portfolio. FPX does not charge a minimum investment fee, and expenses run at 0.60%.
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