A hot tip for any savvy investor is portfolio diversification. By investing in different asset classes, industries, regions and stages you will reduce your risk, minimise losses and maximise returns.
Throughout this post we will look at risk and return, asset allocation, diversification and how Angel networks and funds can positively contribute to your investment portfolio.
How to balance risk and return
Balancing your risk and return through asset allocation allows you to spread your investments across different asset classes; equity, property, fixed interest (bonds etc) or cash (money in the bank), it could be any of the aforementioned classes. Each asset class has a unique risk and return profile. Generally, the higher the risk, the higher the return and vice versa. Cash carries the lowest risk and therefore earns lower returns. Whereas angel investing carries a higher risk, but could potentially earn higher returns.
How do Angel investors minimise risk?
Knowledge in numbers – Angels invest with other Angel investors, garnering a broad range of expertise, sharing knowledge and time.
Angel investors investing in early stage companies mitigate risk through careful screening of deals, extensive due diligence and post investment management. This can be efficiently achieved by joining Angel networks and investing with other Angel investors. Assessing investment opportunities, providing expertise, as well as networking and guidance to investee companies post-investment all lead to the same conclusion; angel investors can substantially reduce risk when working together.
Another risk mitigation strategy is diversification.
Why should I diversify?
Results from The ARI Wiltbank Study of 2016 (a large study of on angel investment in North America) determined that the overall cash on cash multiple was estimated at 2.5x capital with the holding period being approximately 4.5 years, and gross IRR of 22%. Further, 10% of the exits generated 85% of the cash returns.
Therefore many Angel investors build a portfolio of 10 or more investments across industry segments and stages to increase the potential of return on their investments. Given that the typical angel investor in New Zealand invests between $10,000 and $50,000 in each startup, the only way to invest in so many companies for all but the most active and wealthy angel investors, is to invest via a fund.
The importance of Angel networks and funds
The evidence also shows that investors that invest through Angel networks and funds make better investments than Angel investors investing alone, because of better due diligence and negotiating strength, more professional deal documentation, and the sharing of workload. But the most important advantage of investing through an Angel Network or fund is the pool of member investors.
When making individual investment decisions, angels tend to invest in what they know and understand. So how can you invest in a diverse range of companies? Do you have to be an expert in everything? There are some very smart angel investors, however it’s impossible to be an expert in everything!
Angel networks like Enterprise Angels (“EA”) have highly experienced business members with a broad range and depth of expertise in the kinds of companies EA invests in. It is this expertise combined with its professional staff that EA draws upon to assess, do due diligence, negotiate and provide the post investment assistance that has proven to increase the odds of achieving a successful investment outcome. Angel networks sometimes manage a fund, for example the EA Funds.
An angel or early stage fund pools money from investors and does all the work involved in finding and investing in early stage companies including post investment reporting. The number of companies a fund invests in will depend on the fund’s investment mandate and size.
Angel networks and early stage funds enable investors to grow a diversified portfolio. Investing in a fund allows smart investors to build a portfolio of early stage company investments with less money, personal time and effort and provides access they would not otherwise have to a high risk, high reward part of the market investing alongside experienced early stage investors. It is a very efficient mechanism for investors to build a portfolio of early stage company investments.