The March Madness Theory of Investing
We are down to the Sweet 16 in the NCAA's men's college basketball tournament, otherwise known as March Madness, which depending upon your perspective is either the most exciting month in sports or the American collegiate plantation system writ large.
As is my wont, I seek out lessons in what I see, hunting for parallels in sports, politics, et al. to the world of investing and trading. In college basketball, the similarities are overwhelming: the parade of upsets has already given rise to many lessons that might go overlooked, but for your scribe’s eagle-eyed observations.
Here are a few thoughts:
1. Predicting the future is impossible: The defeat of several favorites, most notably Kansas and Maryland, remind us that predicting the future is a fool's errand. We simply never know what will happen next. It is as true for sports as it is for politics, investing or economics.
Chaos theory teaches us that these systems are complex, dynamic, non-linear and sensitive to small changes. The slightest unanticipated flap of a butterfly wing lays waste to the most thoroughly researched forecasts.
Only after you have accepted that you really don't know what is coming next, can you begin to make more intelligent investing decisions.
2. Home country bias: Investors tend to have higher equity exposure to the country where they live. The home country bias is true regardless of nationality. Familiarity with local companies and brands leads to a disproportionate weighting far beyond global capitalization.
We were reminded of this last week by Neil Irwin, who showed that the “familiarity heuristic,” or a tendency to overweight the value of what's familiar to us, applies even to bracketology, or the process of predicting how teams will fare in the basketball tournament.
3. Expert forecasts are about as good as those of nonexperts: The teams picked to go deep into the tournament by the experts at ESPN, Sports Illustrated, and fivethirtyeight among others were all knocked out early. As we have noted before, if the pros stink at this, why do you imagine you are any better?
As William Sherden wrote in "The Fortune Sellers," there is a “Big Business in Buying and Selling Predictions” -- even if they are for the most part wrong. My contribution to the oeuvre was to point out that forecasting is marketing.
We see the same thing when it comes to investing. Indeed, the troika of Wall Street, financial media and advertising devote billion of dollars a year trying to get you to, HEY! LOOK OVER HERE!, when you should really be just paying attention to the basics.
5. More information doesn’t help: There is an overwhelming, rich library of data, analysis and commentary on any team or player. Fans who try to use this to their advantage when designing their brackets will learn an inexpensive lesson.
Traders who try to do the same learn an expensive lesson. Why is this? First, the same facts are available to everyone. Hence, there is no competitive advantage to digesting more of them.
As it turns out, only a modest amount of data is needed to make an informed decision. Excess information only serves to generate an unfounded sense of self-confidence and a bias toward overtrading. In other words, too much information leads to underperformance.
6. Never underestimate the impact of dumb luck: There is an overlooked component to much of what we perceive as success, and that is the role of serendipity. As Charlie Ellis observed when he was overseeing Yale University's $15 billion endowment fund:
Watch a pro football game, and it’s obvious the guys on the field are far faster, stronger and more willing to bear and inflict pain than you are. Surely you would say, ‘I don’t want to play against those guys!’
Well, 90% of stock market volume is done by institutions, and half of that is done by the world’s 50 largest investment firms, deeply committed, vastly well prepared – the smartest sons of bitches in the world working their tails off all day long. You know what? I don’t want to play against those guys either.
Of course, you have to be smart, work hard, avoid mistakes and have a deep understanding of your chosen field. But, as Michael Mauboussin told us, when you get so many talented and hard working people in the field, as you have in finance and college and professional sports, luck plays a surprisingly large role. When everyone is competing at the highest level, a favorable bounce can make all the difference.
Much of what we perceive as success often has a component of randomness. Good luck working that into your brackets -- or portfolios.
7. Nobody knows anything: We have mentioned this before, but it is worth quoting William Goldman's 1983 memoir, "Adventures in the Screen Trade: A Personal View of Hollywood and Screenwriting." Goldman expounded on this premise in a 2009 interview:
No one has the least idea what is going to work….The minute people start acting like they know everything, we're all in trouble. Nobody thought Taken would do $100m. Nobody thought Liam Neeson would make it as an action star at this stage in his career. I heard a story that Slumdog Millionaire was going to go directly to DVD. I would have loved to have been in the room when that decision was made. ("Slumdog Millionaire" won eight Oscars, including for Best Picture.)
You can imagine what he would think of all the brilliant people who know so much about sports or investing.
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