Millions of investors own stakes in privately held tech unicorns, whose valuations remain unclear, through their mutual fund investments, and they don't know it. A Reuters analysis indicates that many U.S. mutual funds are hiking their stakes in unicorns like Uber, Airbnb and Pinterest to above 5%, leading to concerns about the risks associated with investments in such private businesses which are yet to turn a profit.

The Early Investment Advantage

Investing early in privately held companies allows a greater profit potential if the business does well. The success of Facebook Inc. (FB) and LinkedIn Corp. (LNKD) are good examples.

Raising investments in these privately held companies, whose valuations are speculative, enables the investing mutual funds to show better performance compared to their investments in listed companies. For instance, the Hartford Growth Opportunities Fund has Uber Technologies, Inc. as its fifth largest holding, amounting to around 6% pre-IPO stake of Uber. According to Lipper Inc., Hartford's Uber investment delivered "a 12.7 percent return in 12 months to Oct. 31 compared with a peer fund average of 5.2 percent." Similarly, Fidelity’s Pinterest investments have tripled since its initial investment in October 2013.

Such pre-IPO investments can significantly magnify fund performance because they do not get benchmarked against a standard market index. However, they come with their own risks.

The Valuation Challenge

According to the data available for October last year, Uber’s valuations varied widely. The Wall Street Journal reports that BlackRock Inc. valued its Uber stake at the rate of $40.02 per share, Hartford at $35.67, and Fidelity Investments at $33.32. With each firm valuing a private business according to its own methodology leading to varying results, the performance boost by markups becomes questionable.

While the markups have helped funds show better performance from these unicorn investments, there is a larger risk of downturns. Recent markdowns in Dropbox and Cloudera led to declines in valuations both for businesses and their investing funds. (For more, see Tech Unicorns Suffer More Markdowns.)

With many such tech unicorns yet to turn profitable, the uncertainty hovering on valuations would add to more risks for end investors who rely on their mutual fund investments for key essentials like retirement benefits. 

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