When winning a race, in 51% of cases, the participant wins in most outcomes. This applies to both gambling and investing in the stock or cryptocurrency market. Only there is one “but”: the frequency of correct hits does not matter, but only the magnitude of the gains with the right hit matters. This effect is named after the baseball legend of the 20’s George “Babe” Herman Ruth, Jr. The famous baseball player, despite a large number of outs, remained one of the best hitters in the history of baseball. How exactly is this fact related to investing?
The reason why Babe Ruth has a connection with the investment strategy lies in their general principles and style of the “game.” This refers to the observation that those who focus on investing in assets that can potentially bring exceptional returns ultimately outperform those who focus only on investments with average returns. Although bets on high-yield investments can lead to a series of losses, the huge profits from successful transactions can easily offset all the losses. It does not matter how many “goals were scored.” The main thing is how much the prize with the right hit was. The Babe Ruth game style perfectly demonstrates this observation.
Many readers will notice how this effect is already evident in venture capital investment. Most new companies are dying out, and there is enough evidence to support this. For example, a study of Correlation Ventures, consisting of 21,640 transactions from 2004–2013, showed that 65% of venture capital transactions (or VC) returned less than the capital that had been invested in them. This fact is also confirmed by a similar set of data from Horsley Bridge, which examined 7,000 of their investments during the years 1975–2014.
Attentive readers may point out that the data may be distorted by a lot of bad deals of less “successful” funds. But the outcome of the Horsley Bridge data is that, on the contrary, the best funds had more outs, than mediocre ones. And even a weighed amount of investment per transaction does not change the overall picture.
In other words, the data shows that the number of failed investments in VC did not affect the total return on the fund. In fact, this suggests that these two parameters may be inversely correlated. Those who earned the most on the deal, and were wrong more often.
Returning to the Horsley Bridge data, it is important to note that the profitability of its best assets is mainly determined by several single investments, which ultimately bring a successful and unusual result. For funds with a yield above 5x, less than 20% of transactions brought about 90% of the total income from the total amount of invested funds. This provides a tangible example of the Pareto 80/20 law that exists in the VC.
The first, and perhaps most important, a concept you need to know is that the venture capital market is a game of searching for “home runs” (investments that return >10x), and not assets with average returns. It has two vital points for the day-to-day business of a venture capital investor:
Bad investments don’t matter;
Every investment made must have the potential for home runs.
For many investors from the traditional financial market, this way of thinking is mysterious and contradictory. The usual strategy of a financial portfolio assumes that the return on assets is usually distributed in accordance with the hypothesis of an efficient market (the bulk of investments is evenly divided between deposits). They tend to have no losses, and this forces them to avoid investments with a low probability of return, but attractive from the standpoint of possible excess income.
The ICO market, despite its distinctive features, is similar to the venture capital market. And so the investment effect of Babe Ruth works perfect here.
Take a look at the analysis of the ICO market for the 2nd quarter of 2018 from ICORating. According to the results of the second quarter of 2018, the average income from tokens was 55.38%. Of the 827 ICO projects that appeared in the 2nd quarter, only 61 began to be traded on the exchanges. After 75% of tokens appeared on the exchanges, they were trading below the ICO price. The remaining 25% were trading above the ICO price, and only about 8% of them showed a return of 200%.
Another striking example in the cryptocurrency market is the growth of Bitcoin in December 2017. The ICO and altcoin markets showed a slight increase or even a fall when the first cryptocurrency was conquering new heights. Those who had a certain number of falling tokens in a pair with Bitcoin in the investment portfolio remained in the black. Despite the massive decline after the New Year rally, they could boast of their successful investment.
Despite the similarity of the ICO market with VC, it has its own characteristics:
ICOs provide an opportunity to quickly collect investments (relative to VC) with the maximum possible participation of people from anywhere on the planet;
ICOs allow you to collect the necessary (sometimes much larger) amount of investment, even if the project has nothing but an “explosive” idea;
The ICO has no formal requirements for investment rounds. You decide on your own what your future investors will receive in exchange for their contribution.
Considering all of the above, the following question arises: How can investors in ICO projects maximize their chances of finding those “home runs?” Such methods can be:
Increasing the number of ICO projects in the investment portfolio “from 50 to 100+”
Most investors are too focused on a small number of projects. It would be better to double or triple the average number of projects, especially for investors at an early stage, when the risks of starting are even higher. If “unicorns” occur only in 1 to 2% of all cases, it will be logical that the size of the portfolio should include at least 50 to 100+ companies to have a reasonable chance to capture these elusive and mythical creatures.
Selection of ICO projects by specific parameters
The practice of selecting projects for investment is rather an art than a science, and therefore, there is no final selection methodology. If it were easy, then the profitability of such investments would be higher. Nevertheless, some common points arise when selecting the best projects.
The investment decision is based on two factors: the idea and the people behind it. But more attention should be paid to the team evaluation. Ideas are more malleable than people. It is much more difficult to change the personality than the role of the product. The vision and talent of the founder is the engine in the company.
Investors want to see projects that have a deep understanding of the value chain and the competitive dynamics of the market they create. And also how they can capture the initial niche and begin to snowball.
Good investors are looking for startups that grow exponentially with decreasing marginal costs, where the costs of producing additional units are constantly dropping.
An investor should know what innovative strategies a startup uses to gain market share from its larger rivals.
Product Launch Time
After analyzing the reasons for success in various startups, Bill Gross of Idealab came to the conclusion that the launch time of an innovation (product) is a crucial factor in success. It was the most critical element of his research, which also involved a team, an idea, a business model, and funding.
Summing up, it should be added that it is difficult and unnatural to use the Babe Ruth effect flawlessly even for experienced and successful investors. Human psychology is arranged in such a way that it is difficult for us to transfer mistakes, losses, and losses without consequences. Therefore, when a falling market takes away the last hopes of excess returns, you must be confident and remember: the number of unsuccessful transactions does not matter, but the size of winnings with a good choice does.