Before Facebook (FB) went public the idea of investing in the mutual funds that already owned Facebook shares was touted by the media, blog writers and even the fund managers themselves. It's happening again as the Twitter (TWTR) IPO is upon us. The media, blog writers and fund managers are suggesting that an investment in a mutual fund or other similar fund that already holds Twitter shares or convertible instruments may be a good opportunity for a mainstream individual investor to consider. CNBC discussed this idea on October 3, 2013. Other SeekingAlpha contributors discussed the idea recently as well. This appears to be an extremely misunderstood subject. This article attempts to explain the key facts and uses a hypothetical example to explain the issues.
Problems with the Idea
- The "immediate profit" some individuals talk about when discussing a fund's holdings in Twitter shares is inaccurate and horribly misleading. The funds discussed by the CNBC reporter all appear to value their private company investments to market at the end of each quarterly reporting period, according to their filings with the SEC. Therefore, the valuations on the funds books as of September 30, 2013 are extremely important as that valuation, irrespective of the other holdings in the fund, is what an investor is effectively purchasing Twitter shares for. Unfortunately, many investors misunderstand that the cost of the Twitter shares that the fund paid is somehow relevant and is relayed to them when they invest. This is not the case because of the market-to-market quarterly accounting all funds discussed in this article appear to follow. This accounting treatment is normal and should be expected in most funds of this nature. It is therefore extremely important to note that GSV Capital Corp. (GSVC) has not yet reported its stock holdings and valuations for the September 30, 2013 period end and it appears it will not do so until the day of Twitter's IPO, November 7, 2013. Firsthand has reported preliminary valuations as of the period end in a press release dated October 8, 2013. In the case of GSV Capital Corp., an investor may wish to buy its shares with the hope of getting a small indirect piece of Twitter but ultimately it is unknown what price GSVC is valuing its Twitter shares at as of September 30, 2013 and that will be unknown until November 7, 2013. If an investor does not know what price they are paying for an investment, it's very difficult to justify the investment. Similarly, with Firsthand Technology Value Fund (SVVC), the fund has recently disclosed its preliminary value of its Twitter holdings in a press release. It is $24.53 per share. It is important to note that both GSV and Firsthand are public entities reporting their financial results to the SEC and may have to adjust the valuation of their Twitter shares upon finalizing their quarterly reports so even the $24.53 figure for Firsthand is not necessarily the final valuation of its Twitter holdings as of September 30, 2013.
- Fund diversification results in risk that returns will not mirror Twitter returns and the investment itself represents a fractional/small direct interest in Twitter. The largest Twitter holdings of any fund this author knows of or that was discussed on CNBC that any individual investor can invest in prior to the Twitter IPO is GSVC at 15.1%. However, investing in any entity that holds investments in a number of stocks means that the entity's valuation will increase or decrease based on each of the entity's stock holdings, and not just one stock. An investment in GSVC is an investment in GSVC's holdings, and not just Twitter. An investment in a fund that owns Twitter stock allows an investor an indirect investment in Twitter but it also subjects the investor to not only profits or losses derived from changes in Twitter's stock price but also the valuation changes in all of the other stocks held by the entity. No one knows the total stock holdings and composition of each of the mutual funds discussed herein. Also, those holdings may change at any moment at the fund manager's discretion.
- There are not many funds that an investor can choose from in order to execute this strategy. In general, U.S. registered mutual funds are not generally organized or best suited to invest in private company stock. Generally speaking, a typical mutual fund will avoid large ownership stakes in private companies. This is both because of fund mandates and also because of the miss-pricing risk associated with pricing the shares of a private company, among others. As a result, there are not many mutual funds or other types of investment vehicles such as a "40 Act" BDC that the public can choose from if they want to invest in this way, in order to obtain an indirect interest in Twitter or some other IPO candidate that is large enough to have any real impact on the investor's profits.
A Hypothetical Example
The table below outlines the estimated profit or loss for each fund's specific Twitter holdings at the current maximum IPO price at the opening of the IPO, assuming the first trade is at $25. The table also outlines the potential gain derived directly from Twitter holdings in these funds if Twitter closes its first day of trading with a 50% gain.
Big IPO Gains Would Result in Small Investor Gains
- If an investor was to still consider investing in a mutual fund in order to have some investment interest in the Twitter IPO then Firsthand Technology Value Fund Inc. may be the worst choice based on the calculations in the table herein. It is unknown if GSV Capital Corp.'s valuation of Twitter shares will be at or near $24.53 as of September 30, 2013 but we know Firsthand's valuation may be. That valuation is just slightly less than the current proposed maximum offering price per share. That suggests an investment in Firsthand that is designed to acquire an indirect interest in Twitter is not some amazing bargain as others have alluded to previously.
- The "what-if" 50% gain that is illustrated herein results in a modest gain for the investor. This does not include any effect from the increase or decrease in price of any other securities held by the funds on the day of the IPO.
- The table may be misleading as well in regards to GSV Capital Corp. and Optimum Large Cap Growth, as the "last reported valuation" for these funds' holdings in Twitter shares was from June 30, 2013. The hypothetical gain from investing in either of those funds is possibly overstated as the funds may value their Twitter shares above $19.81 for the September 30, 2013 period end.