Why I Changed My Topic This Week
I had a very different week of content planned. My original idea was to dive into the 2021–2022 inflation cycle, and particularly the misguided monetary and fiscal policies that fueled it.
But on Monday morning, I came across an article on CNBC.com titled When “invest like the 1%” fails. I immediately knew this was going to be about the JOBS Act.
Sure enough, the article outlined a wave of losses faced by investors in real estate projects listed on a popular investment website called Yieldstreet.
What the JOBS Act Opened Up
Yieldstreet is one of many investment portals made possible by the JOBS Act, the 2012 legislation that opened private placements to the internet.
There are several channels for raising capital under the JOBS Act, two of which allow participation from “nonaccredited” investors – i.e., investors not meeting net worth and income requirements set forth by the Securities and Exchange Commission. In other words, private investments that were once the domain of the wealthy and connected were now available to retail investors.
Why I Believe in the JOBS Act’s Promise
I believe in the JOBS Act—or at least the idea behind it. Raising capital for small-to-medium sized businesses (SMBs) is challenging even in the best of times.
After the 2008–2009 financial crisis, raising capital for smaller companies became even harder. Tech startups often had more options, but “main street” SMBs faced limited choices. The JOBS Act appeared to be a paradigm shift in how small businesses could raise capital.
From an investor’s perspective, though, private market opportunities come with unique risks. Having invested in several small businesses over the years, I’m well aware of these challenges. In fact, one of the reasons why we started the Fundamental Investing Institute is that we recognized the need for education and training – both for investors and capital seekers – created by the JOBS Act.
The Risk of Adverse Selection in Private Markets
There are many risks inherent to private investing, but the article highlighted one that deserves more attention: adverse selection.
In insurance, adverse selection refers to the tendency of higher-risk individuals being the most likely to buy coverage. Markets don’t function well under these conditions. For example, health insurance would be far more expensive if only sick people purchased it.
In private investing, adverse selection plays out in a similar way. The deals listed on portals like Yieldstreet were often those passed over by sophisticated institutional investors for being too risky. That leaves a disproportionately high number of risky deals available to individual investors.
In other words, while the best private deals still belong to the wealthy and well-connected, retail investors risk being treated as second-class.
Can Platforms Like Yieldstreet Protect Investors?
Platforms such as Yieldstreet can’t guarantee against losses. Deals promising returns of 20% or more—as mentioned in the article—should always be considered risky.
Yieldstreet and similar portals claim to conduct due diligence before listing offerings. But given the high number of failed deals cited in the CNBC report, it’s doubtful that this vetting process was particularly strong.
What’s Ahead for the JOBS Act and Private Investing
My guess is that we’ll unfortunately see more investor losses in the private market space.
That said, I hope this leads to reasonable reforms, especially around transparency and disclosure. The JOBS Act still holds promise for small businesses and investors alike, but perhaps reforms at the margins are needed to ensure it fulfills its potential. Check out my latest podcast episode The Real Risk Behind Online Investment Platforms.
