Making evidence-based decisions in baseball and investing.
For more than a century major league baseball teams have used scouts to scour the high school and college ranks for the next generation of great players. Scouts looked for skills – speed, power and other specific tools considered essential to play in the bigs. They used their keen eyes to spot the players with the most talent. They trusted their instincts to gauge their potential to improve. They perceived the best of the bunch.
Every major league team took this approach. Until Billy Beane came along.
Beane is the General Manager of the Oakland A’s, and was famously played by Brad Pitt in the 2011 hit movie, MoneyBall. Billy Beane was a keynote speaker at a conference I attended a couple of weeks ago in St. Louis. His presentation was a fascinating look at the unconventional approach his team took to selecting players.
Surprisingly, his story has important parallels to modern investing.
A NEW WAY OF THINKING
Beane’s approach is a classic example of conventional wisdom being turned on its head. Instead of trusting the perceptions and predictions of scouts, Beane and his math genius assistant Paul DePodesta relied on the numbers. They looked at performance stats, not at how a player ran, threw or swung the bat. And they emphatically focused on the stats that most strongly correlated to producing runs and wins. These turned out to be not batting average and RBIs (which scouts traditionally tracked), but on-base percentage and slugging percentage.
Beane and DePodesta used evidence, not emotion. Science, not sentiment. Their statistical models produced a list of prospects that most teams ignored completely – no-names with what seemed like limited raw talent. But what Beane’s picks did have was the special ability to get on base. Beane knew the math from there: Getting on base leads to runs. And runs lead to wins. And wins lead to playoff appearances and bigger crowds.
Their draft picks were slammed by fans and lampooned by talk radio hosts. Until the A’s started winning. And they won a lot. The A’s reached the playoffs in 2000, 2001, 2002, 2003, 2006 and 2012, despite consistently having among the lowest team salaries – typically about 25 percent of the mighty Yankees.
Beane’s success was a big win for discipline over impulse. He relied on objective, measurable performance, no matter how much it conflicted with the accepted rules of player selection, conventions that had changed little since Hank Aaron put on his first pair of spikes.
The rest of baseball was slow to follow, but has. Now most teams supplement their scouting efforts with the same kind of statistical analysis that Beane and DePodesta brought to the big leagues. The conventional wisdom has evolved.
SCOUTING FOR INVESTMENTS
The investment industry has relied on its own scouting system too – expressed through the speculative strategies of active fund managers, the predictive buy and sell picks of analysts, and the emotional riffs of market commentators. Indeed, the industry’s superstars are often described like scouts. They have “a great eye” for value, “an uncanny ability to see where the markets are going,” or a “rare instinct” for the bond market.
This subjective, expert-based method for choosing investments has been the standard mode of operation for generations. And just like in baseball, challenges to the conventional wisdom have been slow to take hold.
But the challenges persist and strengthen. Speculative investors and advisors are now facing a tidal wave of data that demonstrate that stock picking and market timing are, on average, unlikely to keep up with market returns over the long term. Yes, it is possible for an actively managed mutual fund to beat market level returns in any given year, but over extended periods it is not likely.
Many decades of empirical evidence and peer-reviewed academic research tell us that investors who can resist the temptation to chase hot stocks or try to time a market top or bottom will likely be better off. Of course this data is in direct conflict with the central business model of Wall Street firms, which sells prediction in many ways. For now, only a quiet minority of investors and advisors embrace the objective evidence.
TRUST MATH, NOT INSTINCTS
You don’t have to be a diehard baseball fan to enjoy MoneyBall. Both the movie and the book by Michael Lewis on which it was based are fascinating looks at the difficulty of overcoming impulse and emotion in decision-making. As Beane describes, it is an ongoing struggle. For instance, he tries his best to never see his team’s games. He says watching the live action makes him “too subjective.” When he sees a player make a bad decision, he wants to yank him immediately, even if the numbers say that the offending player provides the best chance to win.
In his presentation to my study club in St. Louis, he translated this situation perfectly for advisors and investors. “Just think if you stared at your 401(k) every minute all day long. You’d want to sell bonds every time they went down, and buy stocks every time they went up. You’d make changes all day.” And the results would be a mess.
Jeff Griswold, CPWA, Principal & Wealth Advisor, of Merit Wealth Management, LLC. 404 SW Columbia Street, Suite 214, Bend. 888 51-MERIT (888.516.3748), Jeff@meritwealth.com, www.meritwealth.com.
