In investing there is uncertainty about returns. Some investments do well, others do poorly. But that is not the only risk that investors are concerned about when they are investing professionally on behalf of others. There is also the issue of perception: it is one thing not to make money in a sector, it is another not to make money in that sector when everyone else appears to be making money in it. Similarly, it is one thing to lose money on a trade, it is another to lose money on a trade that people have tried many times before and is now widely “known” to be a money-losing trade.

In each case the investor is not just taking return risk but also perception risk. If the others are right, then not only will returns be below the benchmarks but there is also the question: why did you think you were smarter than everyone else? And, well, nobody really wants to hear that. Beyond a bruised ego, the perception risk will eventually also impact one’s ability to raise money for a fund. Why? Because most of the money put into funds is put there by people who are also professional investors and hence face similar perception risk!

I believe perception risk explains why there is so much herding into popular sectors and why, conversely, some sectors go underfunded for long periods of time after big losses have been incurred. For example in 2001, Brad and I together with a mutual friend tried to raise a fund on an investment program roughly similar to what eventually became USV. Nobody wanted to give us money. I remember one meeting with someone at Goldman Sachs particularly well. After we had explained how the next value creation in the Internet would be at the application level (because so much had gone into infrastructure during the dotcom bubble), the person we were pitching looked at us and said “So you are saying you will invest in shitty little companies?”

It will be interesting to see how this plays itself out in crypto now. Longtime crypto investors like to point out how Bitcoin has had multiple previous big corrections. While that is correct from a return risk perspective, it fails to account for perception risk. None of the prior corrections had remotely the same level of public visibility. So to think that institutional investors will by piling in right now is to ignore perception risk. To invest now means taking both return risk and perception risk. That’s why climbing out of the winter of the burst Dotcom bubble took time and that’s why the same is likely to be true for crypto.