5 min read
Moneyball & understanding investing
Until the wider acceptance of Bill James ‘Sabremetrics’, immortalised in ‘Moneyball’ by Michael Lewis in his book from 2003, the rating of Major League Baseball (‘MLB’) players was determined by subjective talent scouts and a few basic statistics. James first defined Sabremetrics as ‘the search for objective knowledge about baseball’ in 1980. But it took over 20 years for Sabremetrics to be accepted as a powerful tool in rating players and understanding their impact on the financial side of baseball.
What in the world does this have to do with understanding investing? Like baseball and Sabremetrics, technology has enabled a new breed of asset manager to connect in a more meaningful way with the end investor.
Explaining asset management is like explaining baseballAlthough I’ve lived outside of the US for 18 years, I can’t let go of baseball. Friends in London and in Ireland laugh and say “it’s a kids game”, recalling days spent playing rounders in short pants. That is, until I tell them how hard it is to use a round bat to connect with a round ball speeding towards you at 100mph. Ted Williams, arguably the greatest hitter who ever lived took nearly 5 years off from baseball to be a fighter pilot in two wars because his eyes and reflexes were that good. If your eyes are so good that you can hit a baseball 40% of the time, it makes sense that you can pick off a few enemy fighters. I discovered Sabremetrics in the 1980’s, and it was complicated back then. Sabremetrics looks at the minutiae of every single event on a baseball field, and turns these events into meaningful metrics. As its usage in the front offices of MLB franchises grew, so did its commercialisation with the likes of Moneyball.
Keeping things simpleOn Episode 173 of the Fintech Insider podcast, Shaun Port from Nutmeg said “those who sell complicated things tend to keep them complicated. We like to simplify things and make them accessible.” This has worked for Nutmeg, and it worked for Michael Lewis. With Moneyball, Michael Lewis simplified something very complicated in Sabremetrics and wove it into a story (and a movie) about the Oakland Athletics baseball team. Moneyball has made millions for Michael Lewis, with a movie to boot.
“It never occurred to anyone in the market for baseball players to assign values to the minute components of a baseball player’s performance - until baseball players became breathtakingly expensive”, Michael Lewis, Moneyball.Active asset management is still complicated and expensive, as is running a baseball franchise. Among other things, you need to be a master of data and fundamentals to be successful at both. I gave a primer on asset management recently in my last post on digital asset management. Explaining asset management is like explaining baseball to one of my Irish or English friends. It’s going to take a long time, and it’s not going to be very exciting. When you get to play the game, or even just watch a game, it all makes sense. Like my friends on this side of the pond who don’t watch baseball, not everyone gets to watch asset managers in action.
Educating investorsPeople new to investing generally understand the basics with percentage returns and fees, but once you start talking about alpha, beta, Sharpe ratios and tracking error, people get lost. It’s just like when I start explaining things like batting average, slugging percentage and runs batted in to my Irish and English friends. When their eyes gloss over, you change the subject. It’s better to show them a YouTube video. But without knowing how to separate the All Stars from the benchwarmers, you’re not going to pick the winning team.
The demographic that generates 90% of asset manager revenues is driven largely by professional investorsThe asset management landscape is changing faster than people realize. The demographic that generates 90% of asset manager revenues is driven largely by professional investors such as pension funds or other institutions and wealth managers. These professional investors pool together the wealth of individuals into bulk investments with multiple asset managers, and they charge fees on top of the asset manager’s fee for their services.
New options for asset managementIn the wake of the global financial crisis, new options have emerged. Robo-advisors empower individuals to bypass institutions and their fees and invest directly into asset manager’s investment funds. Robo-advisors such as Wealthfront, Nutmeg and Scalable Capital pair your appetite for risk with their own algorithms to propose a portfolio of low-cost investment funds for you. Many robo-advisers take great care to provide educational resources and insights to bring you up the curve, as it’s in their best interests as well as yours. Some take a hybrid human/robo approach, others are all robo. Outside of robo-advisors that make the decisions for you, you can do your homework and build your own portfolio through platforms like Fidelity, Hargreaves Lansdown or DeGiro. How do you pick the right asset managers and investment funds though? All of those YouTube videos and metrics will leave your head spinning. How do you find some useful, meaningful and easy-to-understand metrics that empower you to invest on your own?
What metrics do asset managers use?The key roles in an asset management shop are the portfolio managers who make the day-to-day investment decisions. The best portfolio managers outperform the markets regularly by having a good strategy and then executing it based on intelligence, instinct and intuition. Jason Voss from the CFA institute explains the ‘3i’s’ well here. Portfolio managers are like the manager of a baseball team rather than a player though. The best portfolio managers score high on the 3i’s, but without a few coaches and a team, they can’t execute. With Sabremetrics, some very useful measures are now commonplace, and my favorite is WAR, or Wins Against Replacement, which is the Monte Carlo simulation of baseball. WAR measures the number of wins that any single player is theoretically responsible for across a 162-game baseball season compared to an average player. WAR is used as a basis for all types of metrics, even the financial projections for individual teams. Like the portfolio manager and the 3i’s, a baseball player’s rating is meaningless without their team.
WAR-rating vs. star ratings?Is it possible to have a WAR-type rating across investment funds? Fund-rating houses have their star-ratings, but you need to have a university degree in finance to understand what goes into them. What’s the difference between a cheap 3-star fund and an expensive 5-star fund if I’m only investing to save for buying property? The fund-rating house will tell me to ask my financial advisor. Can I tell you what goes into a WAR rating? Maybe some of it, but it doesn’t matter. Because I’m a baseball fan, I can understand the context of a player with a WAR of 10 and one with a WAR of 2, and it’s immediately meaningful to me. Without my finance degree, I can’t make sense of the difference between a 3-star fund and a 5-star fund. I know that 5 stars are better than 3 stars, but in what context? Should I just dump all of my money into 5-star funds? Beyond a fund’s star-rating, the traditional metrics are percentage returns and fees, i.e., how much money are they making me and how much am I paying them? The historical stand-bys of baseball statistics are batting average, home runs and runs batted in, but compared to WAR, they’re myopic when expressing the value of a player. The old-school stats are fun to track, but just like percentage returns and fees, they can hide a player’s true flaws.
“[We’re] looking at the places where the stats don’t tell the whole truth - or even lie about the situation”, Jack Armbruster, derivatives trader, as quoted in Moneyball.
Beyond the starsA portfolio manager friend of mine tells me that metrics like hit ratio and win/loss ratio are commonplace within asset management shops, but we don't hear much about them as individual investors. Hit ratio measures the number of times a portfolio manager makes good decisions vs. bad decisions. Win/loss ratio measures how much money they made with good decisions vs. how much they lost with bad decisions. For example, a portfolio manager might be right more than they’re wrong (hit ratio), but unless they time the market and take big enough bets, they won’t make much money for you (win/loss ratio). . Will we see a WAR-type rating from asset managers any time soon, i.e. one that the average investor can immediately relate to and understand? I’m hopeful, but asset managers place so much reliance on institutional investors and wealth managers to inform and onboard the end investor. After all, institutional investors and wealth managers are professional investors that are qualified to explain the merits of one asset manager vs another - for a fee.
Why is this important?With the intergenerational transfer of wealth underway from Baby Boomers to Gen X-ers and Millennials, asset managers and wealth managers would like to remain the caretakers of whatever is handed down. Why? Because there are billions of dollars in fees at stake for the top asset managers. The mere fact that someone’s wealth is being transferred will trigger a decision on what to do with it. Forever the optimist, I think we will see an increase in asset managers’ connectivity to their end customers’ needs, taking an interest in the hand holding of the wealth transfer and reaching new demographics in the process.
I think we will see an increase in asset managers’ connectivity to their end customers’ needs, taking an interest in the hand holding of the wealth transfer and reaching new demographics in the process.Will it be hit ratio and win/loss ratio that asset managers translate into some sort of meaningful metric that connects with new demographics? There’s a considerable distance between asset managers and the end investor, so trying too hard to reach them is like the Boston Red Sox trying to make fans out of my Irish and English friends. The Boston Red Sox don’t target their demographic, just like asset managers rarely market directly to the individual investor.
The Boston Red Sox don’t target their demographic, just like asset managers rarely market directly to the individual investor.Asset managers leave it in the hands of their distribution partners - the institutional investors and wealth managers - to reach the end investor. There’s a little regulation called MiFID that’s important as well, but we won’t get into that here. These partners understand the key metrics, but are too far away from the portfolio management process to field questions on what one asset manager’s hit ratio is vs. another’s.
Why do people buy what they buy?We covered this on Episode 173 as well - the average investor doesn’t think “I need to buy an investment fund” based on its product features. It’s more “I’d like help achieving my financial goals”. In a conversation with a friend of mine from India, I mentioned the Windermere Hierarchy on how people make buying decisions, He brushed it aside, telling me that where he comes from, people make buying decisions based on the emotion triggered by the product or service, or how it makes them feel.
People make buying decisions based on the emotion triggered by the product or serviceJason Bates, one of the co-founders at 11:FS, talks about “surprise and delight” when it comes to user experience - those sound like feelings to me. Tom Blomfield from Monzo points to an “I want that too” feeling...see what I’m getting at? I’ve spent a fair amount of money on the Boston Red Sox over the years, and I will continue to do so, because of how the experience makes me feel. Keeping track of wins and losses, WAR ratings, the All Stars and the benchwarmers are all just product features that deliver the outcome: a passionate baseball fan.
The importance of making investing accessibleMoneyball is just a book, and a good movie to watch on an airplane. Reading it made me appreciate and understand the business of baseball and how technology can make the financial side of the game accessible to the average fan. How can asset managers use technology to make the fun side of investing accessible to the end investor? Further, how do you build new digital propositions without burning the bridges to your distribution partners?
The key is to build new propositions for new customers. Serve the underserved.Borrowing a page from the book of digital banks, the key is to build new propositions for new customers. Serve the underserved. Come talk to me at email@example.com if you want to find out how. Pete Townsend is the Asset Management Lead at 11:FS. Connect with him on LinkedIn, Twitter or email firstname.lastname@example.org to find out more about how Pete and 11:FS can help you or your business with asset and wealth management.