Note: I’m a shareholder in Seedrs. Also, if you follow my links to Seedrs and subsequently invest on that platform, you can get £50 for free towards an investment and I may receive a small marketing bonus.

Like dating a soap star, putting money into venture capital might seem fun, sexy and potentially rewarding – but it can be expensive, unpredictable, tricky to get into, and hard to get out of.

My previous article on the pros and cons of venture capital explained why. I also looked at how you might get started – via funds, VCTs, angel investing, EIS, and more – and the downsides that could put you off.

Passive investors in particular will find venture capital (VC) tricky.

VC usually involves expensive funds run by active managers, or else doing the time-consuming work for yourself via angel investing or crowdfunding – and probably having even less confidence in your returns.

I’m not about to reveal a VC index tracker that charges you pennies a year and makes these problems go away.1

However one of the leading crowdfunding platforms, Seedrs, has launched two halfway house solutions.

Or perhaps quarter-way house solutions.

Or maybe eighth-way! You get my drift.

These new approaches from Seedrs aren’t a panacea for would-be passive dragons.

But I applaud the experimentation, and I think they may be appropriate for some sophisticated and adventurous private investors who already have the important financial bases covered.

Wealth warning: Venture capital is a risky asset class. Crowdfunding is a new way of accessing it. The offerings I discuss below are only a few months old. Faced with this triple-threat I hope you can see you should only risk money you can afford to lose here – and first do your own deep research. This article is just a heads-up, and certainly not a recommendation for what you should do.

Automatic for the people

Quick recap: Crowdfunding on a platform like Seedrs or Crowdcube is easy-access angel or seed investing.

Crowdfunding enables you to buy shares in unlisted companies, but with far smaller amounts of money than would be deployed by a typical high-rolling angel – perhaps as little as £10.

You can invest far more if you want to. High net worth individuals regularly put five or even six-figure sums into crowdfunding companies.

But the big attraction is the low minimum investment. In theory, it could make grabbing a sliver of the next Facebook or Tesla or Starbucks accessible to everyone. That might seem far-fetched, but a handful of already highly-valued British firms did get their start with crowdfunding, including Brewdog, Revolut, and Monzo.

In addition there are often generous EIS or SEIS tax reliefs, depending on the firm. And sometimes crowd investors are also offered perks, such as free samples, subscriptions, or discounts. (Fun as a treat, but never a reason to invest.)

The bad news is that companies pursuing crowdfunding are usually startups. This means many (perhaps most) will eventually fail or be acquired for a pittance. This is high risk investing.

As I discussed in my last VC article, there are other issues, too.

There are plenty of flimsy companies raising money on these platforms. Sometimes you suspect they’re going to the crowd because no professional VC would touch them.2

Valuations can be pie in the sky, too.

With a stock market, at least you know the constant buying and selling activity of thousands of investors normally results in some sort of efficient pricing.

In contrast, crowdfunding companies usually seem to raise as much as they can at the highest valuation they can get away with – and there may not be much ‘adult supervision’ keeping the prices sane.3

Finally, just like with all seed/angel investing, crowdfunding unlisted companies typically locks your money away until there’s an ‘exit’, such as a trade sale or public flotation.

(Seedrs is pioneering a secondary market, and Crowdcube staff have told me they’re exploring the same. But unless and until such markets become more liquid, it’s best to assume your money is tied up until an exit.)

Automatic for the people

So – high-risk companies bleeding money, most of which will amount to nothing, some of which are borderline frauds, and perhaps one or two of which will hit the fabled ‘unicorn’ status of $1 billion.

Do you feel lucky punk?

Diversification is vital to try to improve the odds in your favour. That means little old you has to read realms of marketing material and ideally meet management – and still reject 10 or 20 companies for each one you invest in.

And then it will probably go bust, anyway.

For active investing junkies like me, seed investing like this is manna. I read a dozen start-up business plans a month, attend a pitch night every two or three weeks, and enjoy picking the brains of management. Building up a portfolio of more than 30 unlisted firms has been fun, and I’m looking forward to reaching 50.

But most normal people will feel different, and this is where Seedrs hopes its two new services will come in:

• Auto Invest
• EIS100 fund

Both do a similar thing – but they’re implemented in very different ways:

Auto invest

This enables you to invest automatically in firms raising money on Seedrs that meet your predefined criteria. You choose how much you want it to invest in the matching opportunities, and you can cancel an investment if on inspection you don’t like what Auto Invest has put your money into – before that firm’s crowdfunding campaign closes, and for up to seven days after.

Basically Auto Invest expedites the process of investing on Seedrs. The actual investments it makes are just the same as if you’d done it manually by yourself (which means you still get EIS or SEIS tax relief if applicable, of course.)

Seedrs EIS100 fund

Seedrs says “…the EIS100 Fund offers investors passive exposure to the venture capital asset class at scale.”

Yes, they used the word ‘passive’ – but hold your horses, as this is not the same thing as a fire-and-forget Vanguard index fund.

In fact, it’s not really a fund – it’s more like Auto Invest on steroids.

In brief, here’s how it works.

To begin, Seedrs is raising a set amount of capital for EIS100 from its investor base, with a minimum individual investment of £1,000. Once the round closes, the EIS100 fund will start deploying chunks of the money raised into new pitches that fit its predefined criteria.

To be eligible for EIS100 investment, a pitch must already have hit at least 70% of its funding target, it must qualify for EIS relief, and it must have at least 100 unique investors. Like this, the fund presumably aims to benefit from the wisdom of the Seedrs crowd in pre-filtering opportunities.

There are also a few rules as to how much money the EIS100 will put into any particular raise.

The aim is for the fund to invest its money into 100 companies over 12 months across many sectors, though the small print sensibly warns this will depend on what exactly comes to the platform and is eligible.

There will be a 0.25% platform fee, calculated over eight years but collected as an upfront 2% charge. There are no other recurring charges. However on any successful exits by companies EIS100 invests in, Seedrs will charge its usual 7.5% carry fee on the profits – and this is the clue that it’s not really a fund, but as I say more Auto Invest operating at scale.

You won’t see a fund in your Seedrs account. Rather you’ll (ultimately) see 100 or so nominee holdings, as if you’d made all the investments yourself.

This does mean that any exits should involve you getting your profits returned as and when they occur (rather than being rolled up as in a fund, to be invested or distributed at the managers’ discretion).

Similarly you might also be able to sell your individual ‘fund’ holdings via the Seedrs secondary market.

This graphic illustrates how the structure pans out:

Source: Seedrs

Note that in the EIS100 FAQ, Seedrs says it’s not actually a fund. Which makes one wonder why it calls it a fund?

I can see ‘fund’ is easier to market than say my ‘Auto Invest On Steroids’ description.

But I wonder if it will cause confusion, or problems down the line?

Anyway please do see that FAQ for more details – and also read the extensive investment memorandum – and note that the EIS100 round is already over-funding, so head to Seedrs if you think – after the caveats above and to come below – that it might be right for you, to start your research.

Incidentally if more EIS100 funds are launched in subsequent years, then we’ll eventually get annual ‘vintages’ like you see with traditional VC.

What I like about these automated solutions

While the ‘passive deployment’ – as Seedrs puts it – that’s offered by these two services is far from passive investing as we know it, they could make life a bit easier and address a few issues.

• Diversification – Both Auto Invest and EIS100 should see investors who use them end up with VC portfolios spread across a lot of investments. Okay, so it’s possible to override any particular investment with Auto Invest, but at least it’s encouraging widespread deployment. With EIS100, wide diversification should happen automatically. Placing a lot of bets like this is important with VC investing. You need to hit a few big winners!

• More easily capture returns from (the Seedrs tranche of) the VC asset class – Seedrs says it expects to engage with 15,000 firms over the next year. The vast majority of these won’t make it onto the platform, as they will be rejected at some stage of its own due diligence. Of the 500 or so that do get through its filters, it expects about 260 to achieve their funding target. EIS100 would put money into a selected 100 of these. Seedrs claims a platform-wide annualised internal rate of return (IRR) of just over 12% to-date – a figure that jumps to 26% when tax reliefs are taken into account. Now, we could spend hours debating how much of your hat to hang on these figures. Crowdfunding hasn’t been going for very long and few businesses have exited, so this attractive figure must be largely based on subsequent funding round valuations – and no doubt a few out-sized winners. But with that said, it does suggest the Seedrs ‘funnel’ is doing something right. These solutions could help one harvest that IRR.

• Less work for investors – If you believe the IRR figure just mentioned is vaguely credible, then it would be an attractive bolt-on to many portfolio mixes – and even more so with the tax relief. However given all the work involved in traditional seed investing, you might argue it’s still not enough to compensate you for many hours of reading flowery business pitches and so on! These passive deployment approaches do offer to get rid of all that. So you don’t have to (notionally) bill your time against any returns you make.

• Easier access to EIS tax relief – As above, basically. If you want to get EIS tax relief while investing in lottery tickets start-ups, both Auto Invest and the EIS100 could make the process easier (but see the downside section below.)

• A dispassionate robot might be a better investor than you – Studies of mainstream investors have taught us the average person is better off agonizing over the menu at Pizza Express than trying to decide on good individual investments. I wouldn’t be surprised if a rules-based approach to VC does do better than many individual investors who bring their own behavioral quirks and biases to the process. For example, I see far-fetched technical inventions getting funding on these platforms, and I’d bet my bottom dollar they’ve been backed by high IQ engineers, who as I’ve mentioned before in my experience can be among the worst investors. (No offence engineers, you’re incredibly useful for the other stuff you do!) Perhaps a robot would be savvier? I’ve even heard ‘scattergun’ VCs say it’s not worth spending too much time looking out for frauds, because they’re rare and trying to avoid them will only gum up your odds. Maybe Seedrs will prove that just spreading your bets widely can match or beat traditional active VC investing?

Downsides to automatic angel investing

Hopefully that’s given you a flavour of the potential attractions of these new approaches to crowdfunding.

I do see clouds though, too, which I’ll briefly run through.

• Lack of individual scrutiny/diligence – For some in the VC community, the idea of amateur investors piling money into unlisted start-ups is already a crazy proposition. Where is the 100-man years of experience, the MBAs, the legal backup, the broad networks to tap for background information? Crowdfunding fans would dispute those complaints, of course, but they’re not utterly unreasonable. Now add in semi/fully automated investment (albeit via the filters and checks I’ve mentioned) and you are a very long way from traditional VC investing. Too far? Time will tell.

• Funding targets are a moveable feast – Platforms and the firms seeking funding might dispute this, but my observation is companies may set low targets with the aim of achieving a successful raise, and then gathering much more money in during so-called ‘over-funding’. I see this pattern a lot. It’s a debate for another day, but anyway selection filters based around firms achieving a certain proportion of what might be an arbitrarily low funding target will perhaps not prove as robust at weeding out unpopular/unloved ideas as you might hope – especially if the auto-solutions then tip weak ideas into over-funding, which could increase the incentive for a pitch to set a low target.

• Potential Heisenberg-ian issues – To mangle the go-to quantum physics metaphor, Seedrs‘ faith in its filtering and IRR to-date is predicated on data covering funding before either Auto Invest or the EIS100 got going. These new services could distort future returns, for good or ill. While the EIS100 includes a few safeguards to presumably try to avoid it distorting the market (from maximum investment percentages to maximum total money invested) it’s hard to escape the thought that if they take off they could eventually change outcomes on the platform. (The EIS100 has only raised £1.2m so far of the £1 to £5m Seedrs originally expected, so currently this is moot.) Similarly, Auto Invest could negate the ‘wisdom of the crowd’ by automating ‘pile on’ investing. If these solutions became big features of the platform, firms seeking investment might even somehow game for them. Seedrs will need to be alert and adaptive to this potential.

• Lots of detail to tell HMRC to get EIS tax relief – Seedrs says its platform makes claiming EIS reliefs easier – with digital tax certificates accessible on-site – but you will still end up with 100-odd items to declare to HMRC with the EIS100. In my experience, for each qualifying investment you have to open a form, get certain details off it, and put them on a tax return. I do 5-15 a year, and it’s fiddly. You’ll want to set aside some time to do a hundred! (That said, depending on how much you invest it’ll probably be well worth it on an hourly rate…)

• No chance to discover you’re a good VC investor, or to have fun! – As I’ve said before, I was drawn to seed investing because I wanted to expand my investing and business knowledge. If I was worth £20m I’d be doing it via traditional angel investing but I’m not, so I’ve chosen to explore crowdfunding – warts and all – with 3-5% of my portfolio. For me, the learning is a huge part of why I went down this route. If I wanted to outsource VC investing I’d probably look to traditional funds, or even VCTs for the tax reliefs (though the high charges are off-putting).

• Why isn’t Seedrs running its own VC funds? – Seedrs is putting a lot of store on its own due diligence and pre-filters as to why these solutions could be successful. Indeed if that 12% IRR it claims to-date across all successful fundraising on the platform holds up over the long-term, I think it will be a remarkable and impressive figure. So much so, that you wonder why Seedrs hasn’t put its smarts into creating a conventional VC fund? The FAQ cited above claims it wants to give investors in the EIS100 liquidity opportunities as individual firms exit, hence it avoided the traditional fund route, but that’s never been a concern for traditional VC houses. Such funds charge a lot more than 25 basis points a year, too! I suppose Seedrs might argue the crowdfunding platform – and even the crowd of individual investors it attracts, who may go on to promote the funded companies and so on – is part of the secret sauce, and that it wouldn’t expect to see 12% IRR without it. Still any cynic would ask this question, and it often pays to be a cynic in active investing.

Do androids dream of electric exits?

I started this article vowing to write no more than 1,200 words, and here we are with another 3,000 word-sized monster!

No doubt some Seedrs insiders might still think I’ve skimped over aspects of their offerings, or been too glib in my pros and cons. The investment memorandum you can download from the EIS100 pitch page is 78 pages long, by way of comparison. (And I’d urge you to read it if you’re thinking of investing.)

Similarly, I’m sure some of you believe even writing about all this (rather than a 97th article about global tracker funds) is a dereliction of duty.

So I’ll just conclude by saying the answer is to go and do your own research on Seedrs if your interest is piqued, take this simply as an introduction, and maybe continue the conversation (constructively, please) in the comments below.

I’m fascinated by the evolution of this market, but it’s very early days.

Remember, if you follow my link to Seedrs and subsequently invest then you may qualify for a free £50 credit to your account – and I may get a bonus, too. But please don’t consider investing just for this cash! Again, this is high-risk investing where outcomes vary wildly. Do a lot of research before considering investing more than fun money. I also suggest you read Angel by Jason Calacanis for a blunt introduction to seed-style investing.

1. It’s not impossible we could eventually see something – an investment bank could decide to offer some sort of synthetic note that tracks a VC index, for example. But it’d still be a complicated product. [↩]
2. This is called ‘adverse selection’. [↩]
3. With that said, traditional stock pickers need to learn new methods to value early-stage firms. I often see people talking about P/E ratios or even asking for dividends when talking to start-ups about valuations. That won’t get you far in valuing new companies. [↩]

The Gordon Equation1 is a popular rule of thumb for gauging expected equity returns.

It’s been used by investing luminaries such as the late great John Bogle, Bill Bernstein and others to get a sense of what the future could hold for our investments in the long term.

All good investment plans rely on having some idea of your investments’ growth prospects. Using average historical return data is one way of estimating your chances, but it’s not necessarily the best.

The Gordon Equation is arguably a better signal because it bundles current valuations and long-term trend data into one simple formula – one which anyone can calculate.

I’ll take you through it now, and explain how it works.

I’ll also deliver the customary caveats and misuse warnings. (Now that you could have predicted!)

The Gordon Equation formula

The Gordon formula can be applied to any broad equity market index, such as the MSCI World or FTSE All-Share.

It looks like this:

Expected real return from equities = Current dividend yield + Real earnings growth

Let’s try plugging in some numbers:

Expected return FTSE All-Share = 4 + 1.4 = 5.4% (annualised2)

Expected return MSCI World = 1.7 + 1.4 = 3.1% (annualised)

That’s it. The Gordon Equation tells us that prospects for the UK over the next couple of decades are pretty cheery overall, while it douses our flame for global developed markets.

So where did I get those plug-in numbers from?

Current dividend yield

The dividend yield is the percentage return paid by your holdings as dividend income.

For a tracker fund, the dividend yield is the total dividend payments (over the last 12-months, typically) divided by the Net Asset Value (NAV).3

Grab the dividend yield from an index tracker that follows the market you care about, and you’ve got the first half of the Gordon Equation.

I got the 1.7% above from the current yield of the iShares MSCI World ETF.

The 4% came courtesy of the Vanguard FTSE All-Share Index Trust.

Expect the numbers quoted to vary a little, depending on your source. For example, Vanguard’s FTSE 100 ETF has a slightly different yield to its index fund (which varies again by Inc or Acc version.)

Don’t stress it – expected returns have all the accuracy of nerf gun darts. They are not laser-guided munitions and can only get us into the splash zone.

Real earnings growth

For the second number, we’re talking about the expected annualised growth rate of earnings per share. Yes, we are!

By earnings I mean corporate profits and by real I mean after inflation is stripped out.

Some versions of the Gordon Equation refer to real dividend growth instead. In the long-term it’s all the same hamburger, as rising profits and dividends usually go together like early marriage and divorce.

We’re looking for a long-term trend rate and we’re looking for a credible source to give it to us.

Here’s a few taken down from the Credible Source Shelf:

• Investing sage Bill Bernstein recommended a 1.32% real dividend growth rate for the US in his excellent book, The Investor’s Manifesto.

• That’s similar to the 1.4% real earnings growth forecast by fund provider Research Affiliates for global developed markets.

• Then there’s the 1.5% real earnings growth for developed markets calculated by AQR, another fund provider with a great track record in research. AQR also proposes a 2% figure for emerging markets.

In my examples I plumped for the middle ground of 1.4%. Different practioners use different assumptions, so pick your poison and don’t drop into the bookies on the way home.

Incidentally, these three sources all adjust their aim to take into account the increasing use of share buybacks.

Handle me with care

As I’ve hinted, the Gordon Equation isn’t a trip to the future in a Delorean, but neither is it a crackpot prophecy.

The equation has a decent track record of guiding expectations into the right ballpark, over the long-term.

If you consult Gordon everyday like a Magic 8 ball then you’ll constantly get a different answer, because the dividend yield varies in tune to the rise and fall of market P/E ratios.

I suggest you use it annually to keep your plan on track. Combine it with our piece on estimating your overall portfolio expected return to keep a grip on the bigger picture.

Take it steady,

The Accumulator

1. Finance professor Myron Gordon of the University of Toronto created the Gordon Equation. [↩]
2. i.e. The expected average annual return. Note annual returns will not be smooth in practice! [↩]
3. Technically the yield you’ll receive as an investor is the total dividend divided by the market price, but for trackers price and NAV are usually the same. [↩]

What caught my eye this week.

I don’t write much about active investing on the blog these days – but I remain the same investing junkie who was buying housebuilders in 2011 and getting gold miners wrong in 2013.

I was therefore thrilled this week to meet a fund manager I’ve admired for well over a decade – Nick Train, who runs the Finsbury Growth & Income and Lindsell Train Investment trusts, among other things.

Train’s writings on the Lindsell Train website have been must-reads for me for years. But I was still steeled for disappointment on meeting the man in the flesh.

A lifetime ago I used to interview bands, and it was almost always underwhelming. The one time I did interview a band who truly lived up to my youthful notions of rock-and-roll1 I sheepishly retired from band-interviewing! I’m much older, a tad wiser, and have fewer delusions about people these days.

The funny thing is I don’t even invest the way Train does. I think it’d be great to identify and hold the best companies forever, Train-style, but experience has taught me I can’t do it.

I can’t even buy and hold Train’s funds! Although I do own a little FGT right now.2

So in some respects this was simple investor-groupie-ism.

Anyway, Train did not disappoint. He seemed about as level-headed as one of the best fund managers of his generation could be expected to be – and winningly paranoid about what the world and the market could yet do to his portfolio. He even warned against applying the word brilliant to anyone who owes their fortune and livelihood to something as capricious as the stock market, and to Lady Luck.

Fund managers get a rough ride these days, and understandably so. Academia – and common sense – has shown active investing is a zero-sum game – and a weight of evidence has demonstrated that after costs, most active funds lose to the market.

Nearly everyone reading this will be better off using tracker funds than active ones – let alone doing what I do, which is pick stocks.

But as I’ve said before – to some criticism from the passive purists among you – every fund manager (as distinct from wealth manager or banker, where this definitely does not apply) that I’ve met has been really interesting to talk to, and most have made me a little jealous of their day jobs.

Obviously it helps that we have a passion in common – but that’s my point. Criticize these guys for cognitive dissonance if you like, but don’t think the best don’t live and breathe investing. They fail to beat the market because it’s incredibly difficult to do so, not because they’re out playing golf.

The era of the star fund manager is long gone. I expect most readers under-30 can’t name a famous investor besides Warren Buffett, and amen to that.

But I don’t mind admitting I’m from another era, and a little weird.

And that I was a little bit starstruck – and a little envious – of Nick Train!

[continue reading…]

1. Mercury Rev, if there are any indie musos out there. [↩]
2. I never invest in open-ended funds, and only occasionally in investment trusts. The fun for me in active investing is finding great companies, not great fund managers. [↩]