Fred Wilson On What It Takes To Be A Great Angel Investor

Fred Wilson is a seasoned venture capitalist with one of the best track records in the industry. He started Union Square Ventures in 2005 by raising $125 million for early stage investments in Internet companies. By 2017, he has managed to distribute $1.6 billion to his investors and he is not done. Fred recently gave a speech at MIT. Here are a few quotes that stand out for me:

On working with entrepreneurs:

Working with entrepreneurs is a challenging endeavor. It is also an incredibly rewarding endeavor.  I think of it as parenting or teaching a very willful and talented child. It is not for the faint of heart but if you do it well, if you do it right, you can have a tremendous impact on both the entrepreneur and the world. It is these dreamers, these hackers, these unsatisfied souls who end up making things and companies that push us forward and change our lives, mostly for the better.

On early stage investing:

Seeds and early series A investments are the way that you can make a hundred times your money in the venture business. I am not aware of another legal means to do that.

Enthusiasm and appreciation are crucial in VC investing:

A VC’s most important role is that of a cheerleader. I know that seems like nothing. How hard is it to be a cheerleader? But it is everything. And very few VCs do it.

You need a cheerleader in your life:

Joanne is the secret to my success. She understood that being supportive was important. She believed in me from day one. She pushed me and she knew who I can be before I did.

Good judgment comes from experience and experience often comes from bad judgment.

F*cking up royally is good for you if you take the time to learn from it. I am who I am because of Flatiron. This is where my belief system comes from, my instincts and my insights.

The best time to invest:

The best time to invest in something is when nobody believes in it besides you. You have to totally believe in it and you have to know why.

The entrepreneurs are VC’s customers:

The entrepreneurs are VC’s customers. This is something I learned for myself. I grew up in the business and it was always: “Our customers are our investors. We got to make our investors happy. We have to do a nice annual meeting. We have to write a nice letter”. This was something that resonated in the culture of Euclid Partners (his first VC firm). That’s wrong. Our customers are the entrepreneurs and the companies that they build. Our investors are our shareholders.

VCs are service providers to entrepreneurs. We ride on their coattails. Even though venture capital requires a sophisticated understanding of finance, markets, technology, markets, strategy, it is ultimately a people business. And learning how to be a successful VC is learning how to work with people. A particular breed of people, who are at the same time charismatic, brilliant, frustrated, anxious, and fragile. And our job is to meet them right there where they are and support them with all our might.

What is he looking for in an entrepreneur?

1. Charisma – entrepreneurs have to be able to convince people to suspend disbelief. They have to convince investors, people to join their team, customers, the skeptical world at large. It’s not salesmanship. It is something more than that. I really think of it as charisma. That is necessary but not sufficient.

2.Technical expertise – knowing how to make something, not outsourcing the making to somebody else is really important. It doesn’t mean that you have to build it, but you need to be technical enough to understand what is involved in the making of it.

3. Integrity – is this person going to be honest, is he going to be a good partner, can we work together?

What does it take to be a great angel investor

1.Build a broad-based portfolio. Lot’s of investments because most of them are not going to work out. You need a lot of diversification. More than a typical venture firm will need.

2. Build networks with other angel investors. The more other angel investors you know, the better because you want to syndicate your investments with other people. You want to have many people you can call to try to get in into the deals that you want to do.

3. You will have to help the entrepreneur to get to VC firms. I watch my wife do this all the time. She is tireless in helping the founder she works with to get their series A or even series B round because she knows that her investment is not going to work if she can’t get the follow-up capital.

How to get into the venture business

The conventional wisdom and the advice I often give are “go work in a bunch of startups”. Spend your 20s and 30s working in startups and then, spend your 40s, 50s, and 60s working in venture capital. This is generally a good advice. Most of the people I know who have done that are very good, but this is not the path I took. So, it is a little disingenuous for me to say that. Actually, none of the very best VCs from my generation took that path.

The Truth About Passive Investing

Some say that there is no such thing as a pure passive investing, just fifty shades of active investing. Even indexing is considered a form of active investing, because of the frequency of rebalancing.

Others point out that passive investing has nothing to do with the frequency of transactions and everything to do with the ability to impact the direction of a company you are investing in. The latter definition makes every form of public investing passive (with the exception of activist investing).

No matter the definition of passive investing you believe in, we can probably all agree that indexing has provided a cost-efficient way to invest in the growth of the world economy.

S&P 500 annual return (ex. dividends)

There’s nothing wrong in indexing (buying the S&P 500 for example), but you need to understand what exactly are you buying and decide for yourself if you can do better.

The S&P 500 goes through frequent rebalancing. It replaced ten stocks in the first three months of 2017. Some of the changes are due to acquisitions; others are due to poor stock performance. First Solar is one of the stocks that was recently replaced.

The S&P 500 is essentially a slow trend-following program run by a committee of people. The rebalancing is not based on strict technical rules. A group of people sits and decides which stocks to add and drop based on market capitalization, liquidity, domicile, float, sector classification, financial viability, length of time spent as a public company and the stock exchange it has been listed on.

The selection criteria have produced some odd timing. For example, AMD was recently added to the index, after a 500% move in the past year and a half. Do you think you can find a better entry spot?

While its timing has been often poor, over time the S&P 500 has managed to capture most long-term winners. It has kept the long-term winners and dropped the losers, many of which eventually went out of business.

About That Jesse Livermore Quote

“It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine–that is, they made no real money out of it. Men who can both be right and sit tight are uncommon.”

The above-mentioned quote is probably one of the more frequently cited in trading and investing circles. Many forget that there is an important nuance to that quote. It is the holding of great stocks in a bull market that will make you money. Try staying with a great stock through the turbulence of a bear market and then tell me how your holding is making you a ton of money. There are several things to consider:

1. You will experience several bear markets in a 40-year investment career and much more >15% declines in the stock market. You need to have a plan how to deal with them. A bear market can lead to a 50% or even 90% drawdown in any stock regardless of how great its fundamentals and its growth prospects are.
2. Not all stocks will recover after a deep market decline or it might take many years until they do. This is what market history has shown us over and over again. While well-diversified indexes tend to come back, individual stocks have had very different stories.
3. Very few can stomach a 50% or 80% drawdown in a stock. Most get scared and sell near the bottom. You think you are different and you will act cool, but you never know if you haven’t experienced it. Besides, you also need to consider the emotional toll and the opportunity cost of capital.
There is no difference between owning a stock that goes up 1000% in 10 years and owning a different stock every year that goes up 39% that year. In ten years, you will get the same return, assuming a 20% long-term capital gain in the first case and a 39.6% short-term capital gain in the second case. There’s no difference in the end result, but there is a huge difference in the experience. The first requires going through deep drawdowns which few people can stomach. The second comes with a lot smaller drawdowns and it is easier to implement.
Only 28 stocks went up more than 1000% for the past decade. This number would be a lot larger if the starting point is the bear market bottom in March 2009. This is why market timing matters.
There are more than a thousand stocks that went up more than 39% in the past year.
The odds of catching a few stocks that gain more than 39% in a year are a lot better than the odds of capturing a 1000% gainer in a decade.
Apparently, you can’t trade frequently if you manage over a billion dollars due to the sheer size of the capital. Trading often is also not an option if you don’t have the required time or the skills to do it.
The above-mentioned challenges are not new. They have been with us for decades and the financial community has found different ways to deal with them:
1. Some have decided to stick with well-diversified stock indexes and to add hedges. The result is smaller returns and smaller drawdowns. There is nothing wrong with this approach if its returns will be enough to achieve your goals. Some people have an unrefutable proof of years of poor returns that they cannot beat a plain vanilla 60/40 portfolio. Not everyone can be good at everything. It is ok to admit it. There is no shame in it. Once you do, you can dedicate your time and efforts to building other businesses and a career.
2. Indexing is not the only way to approach the challenge of inconsistent returns and market volatility. Market timing, stock picking and constantly adapting to changing market conditions can do that for you as well and deliver you a lot higher returns. No one says that is easy. It is not supposed to be easy. Otherwise, everyone would be able to do it and therefore the returns will be a lot lower. No business is easy. Each requires constant innovation and hustle.

Earnings Surprise + High Short Interest = Big Profits

Financial markets tend to underreact to genuine surprises and overreact to know threats. When a company reports better than expected earnings and sales number, it receives a positive reaction to their numbers and it has a high short interest, it can deliver hefty returns in a short period of time. CONN and RH are two recent examples. The new earnings season has just begun. It will likely provide several similar opportunities.

Innovation and Structural Edge – the Keys to Market Survival and Growth

 

Some say that discipline is the key to market success. While necessary, discipline is not enough. Otherwise, all quant systems would be always profitable. This is hardly the case. Market edges get erased all the time.

The statistical definition of a market edge is having an approach with positive expectancy.

If you have a 50% success rate and your average winner is two times bigger than your average loser, then you have an approach with positive expectancy.

Josh Brown says that any market edge is ephemeral. It cannot be sustained for long and only a few institutions have managed to adapt successfully to the constantly changing markets. Finding new edges on a regular basis might be very unrealistic when you manage billions of dollars.

Some market methods provide a structural market edge. A structural edge is an edge that doesn’t disappear forever, but it has a cyclical success rate. It goes through periods of making money, followed by periods of making no money. Structural edge is based on market forces that have always been a fundamental part of what moves prices: momentum, value, fear of missing out, fear of losing, range expansion and range contraction, the tendency of the market to underreact to genuine surprises and overreact to known threats.

Some say that the definition of insanity is doing the same thing over and over again and expecting different results. If you do the same thing over and over again in the market, you are guaranteed to get very different results. The same approach that makes a lot of money in a raging bull market is often a losing proposition during range-bound, choppy markets.

Trading or investing are not that different from any other business. You have to sustain a competitive advantage in order to continue to grow.

Markets change all the time. Great investors and traders innovate and adapt to constantly changing market conditions. The change might take the form of taking a break and moving to the sidelines or coming up with a new edge.

The main point of my latest book is exactly that: different setups work in different markets: Top 10 Trading Setups – How to find them, when to trade them, how to make money with them.