Building a Diversified Portfolio: Guide for Angel Investors

Due to the novelty of business ideas, untested commercial viability, and various other reasons, only 10% of startups achieve success. There’s no other asset class where the adage, ‘not putting all your eggs in one basket’ rings truer.

Instead of pouring all your funds into a single startup, you must diversify across various kinds of startups to mitigate your angel investment portfolio’s overall risk. However, over-diversification can dilute returns, leaving you unable to outperform the market. Hence, it is extremely important to strike a balance between diversification and focused investments.

In this article, we will guide you on the optimal level of diversification for an angel investment portfolio and strategies to achieve maximum diversification benefits. Read on to know more!

Optimizing Your Angel Investment Portfolio: The Essential Guide to Diversification Strategies!

In the context of angel investing, diversification means investing in various kinds of startups instead of investing in only one startup to limit your risk exposure. Angel investments are a particularly risky asset class, primarily because investors typically at the pre-seed or seed stage, and only one in three seed-funded startups go on to raise post-seed funding.

So, even in the best-case scenario where you only need to hold your investment until the next funding round, you will be recovering your investment amount and making returns only 33% of the time.

Research shows that 77% startups fail due to a lack of commercial viability, macroeconomic conditions, lack of product-market fit, or competition. Hence, it makes sense to invest in multiple, varying types of startups to spread the risk around.

The general consensus is a startup portfolio of at least 10 companies will provide a reasonable level of diversification benefits while a portfolio of only three to five startups can be extremely risky.

Most angel investors do not take an active role in managing their invested companies. However, some angel investors are former professionals and key management personnel who want to nurture innovation in their domain of expertise by offering access to their network and acting as mentors.

Active angel investors can handle less diversification than passive angel investors. While having a portfolio of 20 or more startups might be reasonable for a passive angel investor, an active angel investor may be able to effectively manage a portfolio of a maximum of 10 to 15 startups.

Key notes for Best practice for Angel investments:

• Invest Across Industries(e.g., tech, healthcare)
• Include various business models (e.g., B2B vs. B2C)
• Stay updated on market trends for promising opportunities.

Strategies for Diversifying Your Portfolio as an Angel Investor

Some strategies for diversifying your angel investment portfolio are as follows:

Geographical diversification

The purpose of geographical diversification is to protect one’s angel investment portfolio against economic downturns from a specific region by investing across different countries or even continents.

Unless there’s a global recession brought on by black swan events or events like COVID-19, typically, at any given point in time, there will be economies that are struggling, some will be thriving and some will experience a moderate growth level.

For instance, while the USA, UK, and Japan are all developed economies, these are extremely different economic regions. They have different trade partners, regulations, levels of government intervention, and consumption behavior. Hence, by investing across these countries, you would be insulating your portfolio against any regional issues.

Let us understand this by looking at the returns of major indices in the world.

Index	Description	1-year return
FTSE 100	Tracks the London Stock Exchange’s (LSE) top 100 largest companies by market capitalization	7.83%
Nikkei 225	Tracks the performance of the 225 largest companies traded on the Tokyo Stock Exchange (TSE)	15.04%
Nasdaq	Tracks the performance of more than 3,500 companies listed on the Nasdaq Stock Exchange	30.12%

If your portfolio includes startups from the United States, England, and Japan, you might encounter losses from your English startups while benefiting from growth in your American startups.

However, if economic trends shift the following year, any underperformance in your American startups could be offset by gains from your startups in other regions, ensuring a balanced overall performance.

Sectoral diversification

AI startups are attracting hefty valuations at an unprecedented pace. Before the AI boom, similar levels of growth were experienced by fintech startups such as Stripe and Chime. In the future, with the growing remote working culture, productivity apps are likely to play a pivotal role and rise to prominence.

As the AI industry boosts the demand for data centers and energy, some may believe that innovations in sustainable energy production and data storage might pay huge dividends just as AI’s dependency on the high computing power of graphics processing units (GPUs) fueled NVIDIA’s growth in the last few years.

We may also see advancements in robotic process automation unlock unprecedented cost-savings in manufacturing businesses.

Numerous sectors are poised for high growth in the next few years and there’s no telling which ones might actually fulfill their promise since technological advancements and shifts in consumer preferences are extremely unpredictable. Hence, instead of betting on one or two sectors, you should consider diversifying across 5 to 6 sectors, if not more.

Diversifying across stages

By definition, angel investing means investing at an early stage where a startup cannot attract funding from venture capitalists or receive loans from lenders. However, you must not let this definition dictate your investing activity as it leads to the concentration of investments in highly risky ventures.

Instead, you should try to invest in early-, mid-, and late-stage startups. As a startup progresses through these stages, its growth rate as well as its risk wanes. Hence, diversifying across stages allows investors to balance high-growth, high-risk opportunities with more stable, lower-risk ventures.

People-based diversification

Founders from various backgrounds have gone on to build successful startups. Billion-dollar corporations such as Microsoft, Apple, Dell, and Facebook were built by dropouts such as Bill Gates, Steve Jobs, Michael Dell, and Mark Zuckerberg. On the other hand, in industries such as healthcare and AI, you are likely to see at least one PhD holder among the founding team.

Although startups are often seen as disruptive ventures led by young visionaries, the average age of startup founders is actually 42 years. This demonstrates that success isn’t concentrated among founders with specific traits or experiences.

Hence, it’s important not to limit your search to teams that align with a narrow set of preferences.

Also, if you dig a little deeper, you’ll find that sustainable businesses often thrive due to the diverse experiences and perspectives of their founders. Rather than investing in 30 startups led by 10 different types of founders, you might achieve better results by ensuring that each startup has or plans to have a diverse and balanced team.

Investing through cohorts and angel networks

Angel investments are high-ticket investments and hence, difficult to diversify. In every company you invest in, the minimum investment amount might be close to $100,000. So, you will need at least $2 million to invest in about 20 startups to achieve a reasonable level of diversification. On top of this, you must have investments across stocks, bonds, and real estate.

As a result, if you approach angel investing as an independent individual, you may need funds in excess of $10 million.

However, you can significantly reduce your investment amount by investing in partnership with other larger investors. You can do so by connecting with venture capitalists who regularly lead funding rounds or joining active angel networks. This could effectively bring down your average investment amount by 5 to 10 times.

Eqvista – Precise Valuations for Confident Decisions!

Angel investors who do not take an active part in the management of their portfolio companies should try to have an angel investment portfolio of about 20 startups. To reap the maximum benefits of diversification, you must diversify as per geographies, sectors, and stages, and ensure that your invested companies have a diverse team since you are investing in people as much as you are investing in businesses.

To keep your total investment amount in control while achieving a reasonable level of diversification, you should try partnering with other angel investors and venture capitalists by investing through cohorts and angel networks.

To effectively manage your angel investment portfolio, you will need to make agile decisions based on the latest information. Hence, you must invest in periodic portfolio valuations by seasoned valuation service providers such as Eqvista. Contact us to learn more about our service!