Chris Dixon Explains the Babe Ruth Effect in Investing

From Chris Dixon at cdixon blog:

I think it is generally known that venture capital investors make the majority of their money off just a few companies that turn out to be big winners. This piece remains the best I have seen at succinctly quantifying how that plays out.

Dixon calls it ‘The Babe Ruth Effect.’ An investor in this field needs to train themselves to swing for home runs and ignore the natural concern about taking losses on too many investments. The home runs will more than offset the strikeouts.

the returns are highly concentrated: about ~6% of investments representing 4.5% of dollarsĀ invested generated ~60% of the total returns.

The best performing investors have a higher percentage of ‘home run’ investments, in this case defined as investments that go up 10x in value or more.

The best investors hit more home runs

In addition, the ‘distance,’ or magnitude, of each home run investment in the portfolio is multiple times greater in the best funds than it is for the rest of the field. So not only do you want to have a higher home run rate, you want your average home run to earn a higher return than the typical home run investment in the market.

For context, a good home run in the venture capital world would make its investors 20x their money, but a great home run will go up 70x.

Last, to illustrate the point of not worrying about strikeouts beyond a certain degree, even the best funds are going to lose money on at least 40% of their positions.

Even the top funds lose money on 40% of investments