There are those who experiment and those who follow the formula

Enough words have been spilt over the concept of an angel index fund strategy to prompt me to put finger to keyboard. In short: If Ron Conway or Dave McClure or any other ‘super angel’ thinks that creating an index fund of startups is achievable, they’ll find the harsh reality of the future crashing down upon them.

Public equity index funds are fantastic investments for those investors who wish to be completely passive. They admit that they know nothing about individual stocks and are happy to be rewarded with the average return of the market. Most importantly, they realise that the greatest handicap to maximizing their wealth creation are Wall Street firms charging rich management fees and forcing high turnover to earn transaction fees that ruin their returns.

So now let’s break down the concept of an angel index fund for those limited partners (i.e. the guys giving the cash to the super-angels to invest) and the factors working against handsome returns:

- High fees. Because angel funds are small, the fees are high. There is significant effort in constructing an index fund of angel investments and so the primary benefit of public equity index funds, their low fees, are nowhere to be seen.

- The increasing birthrate of startups. The S&P 500 stays fixed at 500 companies but the number of web startups is increasing at an ever faster rate. It will become even harder to maintain a track record of investing in the first round of all the most promising startups because there will be an increasing amount of promising startups.

- The reason to create an index fund is fundamentally opposed to angel investing. The premise of angel investing says that the investor has a particular insight into how markets will develop and a special ability to select founders able to exploit those changes. That is, there is some skill involved. In the philosophy of index funds, that kind of statement would make you a religious dissenter.

- The number of startups an angel investor invests in is inversely proportional to the ‘value added per startup’ they can impart. Early stage investing is an unscalable, local business that has traits that are ironically the exact opposite of the types of firms they fund. Dave McClure is a heroically sharp and insightful person but his portfolio companies would receive more value from him if he only invested in 10 startups vs 500. At some point before the portfolio size reaches 500, new startups will figure this out and he won’t be the hottest investor in the valley.

The counter-points to the argument are that angels primarily add value in three ways: helping to hire people, helping to find other investors and helping to get the best price when a company sells. These are rare events so it may well be that an investor can have a portfolio of hundreds and still not max out there time. But as angel investors move to help more with product strategy and customer acquisition this makes ‘adding value’ (don’t worry I’m cringing every time I type that phrase like you) even less scalable.

Finally, let’s also not forget that Ron Conway’s first angel funds would have been a wash without the presence of a single investment: Google. A whole book, by New York Times journalist Gary Rivlin, was written a few years ago with a large negative undertone about this very thing.. Go read the book and put the statements in today’s context and there is suddenly a lot more nuance.

Now I absolutely believe that Ron has proven that his early failures in perhaps the craziest of investment vintages was an anomaly and he has gone on to invest in superb companies that will ensure that his current funds will return handsome profits.

It’s just that his job, and current investment strategy, will get ever harder with time. And that’s why the talk of angel index funds will die on the vine quickly.

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