Morningstar - Q1 2023 - 38

Strategies
50
Rivian
EXHIBIT 5
Markdown Hesitancy The largest private equity owners were slow to lower the
value of their holdings during the market's 2022 decline.
2020
2021
2022
Aggregate Private-Firm Equity Returns, December 2021 to June 2022
Fidelity New Millennium Fund
Baron Asset Fund
Fidelity Advisor New Insights Fund
Fidelity Mid-Cap Stock Fund
Franklin Small-Mid Cap Growth Fund
Fidelity Ser Opportunistic Insights Fd
Fidelity Contrafund Fund
Fidelity OTC Portfolio
Fidelity Growth Company Fund
Fidelity Blue Chip Growth Fund
Baron Partners Fund
Franklin Growth Opportunities Fund
American Funds Growth Fund of Amer
Fidelity Advisor Growth Opps Fd
Morningstar US Market TR USD
Morgan Stanley Inst Growth Port
Morningstar US Market Brd Grt Ext TR USD
Source: Morningstar Direct. Data as of June 30, 2022.
-5.46
-12.43
-12.62
-13.62
-16.75
-17.77
-21.28
-22.83
-30.00
-30%
Return
-15
15
30
21.16
21.03
20.61
18.28
8.35
7.77
7.09
3.03
Share Price
34.30
as much as the Morningstar US Market Index's
decline ( EXHIBIT 5 ).
Three funds even marked up their private
holdings by 20% or more. There was
nothing nefarious behind the markups; a new
round of financing in June 2022 that upped
SpaceX's valuation by 25% drove the
change for each of the funds-Fidelity New
Millennium FMILX, Baron Asset BARAX,
and Fidelity Advisor New Insights FNIAX. Besides
SpaceX, there was little consensus on when
or by how much to mark holdings down.
In some cases, fund companies held the same
private security at nearly 100% premiums
to peers. DNA Script, a French company that
develops DNA printer technology, is perhaps the
starkest example. Both Columbia Threadneedle
and Fidelity bought shares of the company
in October 2021 during its Series C financing round.
At first, both held their shares at roughly the
same value, between $867 and $869. Throughout
early 2022, though, Columbia consistently
decreased the valuation each month, gradually
taking it down to $400 as of June 2022,
which represented a 53% paper loss on the
investment. Fidelity lowered the valuation more
slowly, landing at $734, for only a 15% loss.
for three fund families-Hartford Capital
Appreciation, Hartford Growth Opportunities,
John Hancock Mid Cap Growth JACFX, and
Vanguard US Growth VWUSX.
The three firms did not agree on Pinterest's
price in the funds even though they shared the
same subadvisor. When Wellington made
its initial investment in May 2015, the Vanguard
and John Hancock funds valued it at $21.45,
while Hartford marked it at $19.38, nearly
10% lower. The contrasts were not small nor was
one family consistently more aggressive or
conservative than the others. At one point in 2018,
John Hancock valued the company 25% higher
than Vanguard did, and each fund family
also posted the highest valuation in at least one
different quarter. This example shows how
38
Morningstar Q1 2023
fund families' different pricing procedures
can lead to divergent conclusions even when they
share the same manager.
The 2021-22 Drawdown
As public markets began to sell off in the
first half of 2022, fund companies were hesitant
to mark down private-firm equities at
the same pace that their public competitors
fell. From the beginning of the year through
June 2022, the Morningstar US Market
Index declined 21% and the Morningstar US
Market Broad Growth Extended Index
slid 30%. Of the 15 largest mutual fund investors
in private equity with reported portfolios
as of June 2022, only one-Morgan Stanley
Institutional Growth MSEQX-marked
its private equity holdings down by at least
These are not just paper gains and losses, though.
Valuation discrepancies have a real impact
on fundholders. A fund's net asset value, which
is the price a new investor will pay to own shares
of a mutual fund, includes these positions,
so valuation discrepancies can over- or understate
NAVs. The more private-firm equities a fund
holds, the bigger this problem becomes.
The Onus Is on Fund Companies
As the number of unicorns has increased and
mutual fund ownership of private-firm equities has
grown, it's worth remembering that not every
unicorn will be a winner. The onus is on
fund companies to perform robust due diligence
upfront and manage risks appropriately. K
Jack Shannon is a senior analyst, equity strategies, at
Morningstar Research Services LLC.
Katie Rushkewicz Reichart, CFA, is director of equity
strategies at Morningstar Research Services LLC.
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