Does Crowdfunding Make Investment Sense?

The Pitch Recently, I encountered a company called Yieldstreet, which solicits assets through its online platform. In the lingo, it crowdfunds, by raising small amounts of money from many people via the Internet. There is a twist, though: Whereas most crowdfunders seek money for their own projects, Yieldstreet canvasses for other people. The firm serves as an investment matchmaker, connecting prospective buyers with those who seeking funding--for a fee, of course.

The company's proposition, which I cite verbatim, is as follows.

1. Access to innovative income-generating products;
2. Investments with typically low stock-market correlation;
3. Ability to invest in assets backed by collateral;
4. Short duration (six months to five years).

These goals are accomplished by "breaking the outdated mode of investing and bringing innovative investors access to opportunities usually only available to institutions." Or, to be more specific, by investing (mostly through loans) in asset classes that aren't normally available to individuals--among them, real estate, shipping, art, legal settlements, and private businesses. The company states that it targets yields of "7% or above." Many have been far above. For example, its Diversified Pre-Settlement Portfolio X promised a 13% yield.

The proposition seems attractive. Yieldstreet provides institutional-level assets that boast high payouts and are relatively uncorrelated with conventional portfolios. True, not everybody meets the company's admission standards, as its deals may be purchased only by accredited investors, but one needn't be a tycoon to surmount that hurdle. Accreditation is achieved by possessing a net worth greater than $1 million, or by earning more than $200,000 (for single taxpayers and $300,000 for joint filers) during each of the previous two years.

The Big Question There is, however, an open question: How have Yieldstreet's investments performed? The answer is not obvious. To my knowledge, no database tracks the company's results. (Morningstar would seem the likeliest candidate, and it does not.) Consequently, investors must get performance figures from Yieldstreet itself, without independent confirmation. That is not an ideal circumstance. When parlaying with the Soviet Union, Ronald Reagan famously invoked a Russian proverb, "Trust but verify." Investing with not only Yieldstreet, but also other crowdfunders, permits only the first step.

The company does list on its website some investment results for each of its offerings. However, that information can be tricky to interpret. Consider, for example, the security entitled Commercial Real Estate Portfolio II, which, according to the documentation, consisted of a $4.6 million loan that matured seven months later. Total payments of principal and interest were $4.81 million, which Yieldstreet calculates as generating an internal rate of return of an annualized 9.37%.

Had the portfolio's interest had been paid entirely on the loan's maturity date, the annualized return would have been lower: 7.84%. The higher figure reflects the fact that the investment paid interest monthly, accompanied by the assumption that those payments would be promptly reinvested at the same rate. That assumption is, shall we say, heroic. One could not have reinvested back into that same portfolio, which was closed. More likely, those payments would have earned little during the portfolio's life, having been swept into a cash account.

Those Pesky Defaults The greater worry concerns those assets that did not perform according to expectations. One example is the company's Vessel Deconstruction I fund. That investment was scheduled to conclude this spring, but it remains active, because the borrower has defaulted. So far, Yieldstreet discloses, that fund has earned $8.6 million interest--but it has paid only $5.5 million, some of which represents investors' principal. That's a paltry return on a $37.5 million initial investment!

How many Yieldstreet assets are nonperforming is difficult to ascertain. A class-action lawsuit recently filed against the company alleges that "at the end of the first quarter of 2020, nearly one third of Yieldstreet's entire portfolio was in default." However, that figure is higher than what appears from the company's disclosure, and it also exceeds this article's estimate that 12% of Yieldstreet's portfolio isn't "paying as expected." (The principle of trust-but-verify also applies to plaintiffs' claims.)

That some Yieldstreet deals have suffered defaults is fine. Just as it is in the nature of a scorpion to sting, it is in the nature of a high-yield portfolio to endure defaults. However, it is not to the company's credit that from 2018 through early 2019 it boasted about how none of its deals had suffered principal loss. Those who sell such investments should not pretend otherwise.

I am not opposed to crowdfunders, or to esoteric investments. Until better information is available, though, this marketplace is for sellers rather than buyers. Best to watch from the sidelines until performance measurement is standardized, so that prospective buyers can learn from conducting proper research, rather than gossip on a message board.

John Rekenthaler (john.rekenthaler@morningstar.com) has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.