Being entrenched in the cultural zeitgeist often involves the grammatical alchemy of transforming a noun into a verb. And Moneyball has become a verb. To Moneyball something means to use data to make better decisions. The genesis of the word is the title of a book that Michael Lewis wrote on the professional baseball team the Oakland A’s. Missed the book? There was movie. Brad Pitt was in it. And Jonah Hill. Even the late Philip Seymour Hoffman.   

The A’s were a small market team which meant they had less money to spend on players. This inherent and enduring disadvantage caused the General Manager Billy Beane who was responsible for picking players to look for another way.

Billy Beane with the help of some outside of the box thinkers came to the realisation that there were a lot of inefficiencies in how teams picked players and played the game. Teams valued certain player attributes and strategies. They ignored other attributes and unconventional strategies that had large impacts on winning baseball games if you looked at the data. One example is the physical traits of players. Teams paid more for people that looked like the prototypical baseball player and overvalued strength, speed and athleticism.

This is an article about investing and not baseball so I will spare readers the minutia of Billy Beane’s approach. If you are interested read the book. It is great. What got me thinking about investing was an interview of Michael Lewis I heard recently on the Freakonomics podcast. He was talking about a conversation he overheard between Billy Beane and Paul DePodesta (his deputy) about using the same technique for investing.

Billy and Paul were talking about Fortune 500 CEOs. They were interested in some data from Malcolm Gladwell’s book Blink. He found that 58% of CEOs were men that were over 6 feet tall. 30% were over 6 feet 2 inches. In the overall American population only 14.5% of men are over 6 feet and 3.9% over 6 feet 2 inches.

Billy and Paul quickly surmised that CEOs were judged the same way baseball players were. They had to pass the eye test. As a society we decided what CEOs should look like and people fitting that image had an easier time rising to the top of companies.

They thought it would be great to invest in companies led by people who didn’t fit the mold. Not possessing physical attributes commonly associated with being a CEO meant that to become the head of a company they had to be better at their jobs. They had to overcome typecasting. And this is what Moneyball is all about. Doing what the data tell us even if everyone else is doing something different.

Applying Moneyball to investing

On the surface this is a ridiculous proposition. Baseball was transformed – or Moneyballed – by taking the data analysis techniques used by the investment industry and other corporations. But just because professional money managers use data to drive decision making doesn’t mean that is the way that most individuals can or should invest.

Micheal Lewis followed the Oakland A’s for a year when he was writing the book. And it was quite a year for the team. The A’s matched the high spending Yankees that year as the winningest team in baseball. And using data worked well during a baseball season of 162 games. Each individual game in any sport is influenced by chance. Yet over the large sample size of a full season the statistical advantages identified by Billy Beane had an opportunity to play out which made the A’s successful.

In the playoffs things didn’t work out so well. The A’s ended up losing in the best of 5 game playoff series. Just like an individual game, chance has a bigger influence in the smaller sample size of a 5-game series.

We can apply this same rule to investing and use quantitative or factor investing as an example. A professional investor can dig through decades of share return data to try and isolate a factor that denotes superior returns. For instance, the quality factor. They can then back test this hypothesis that the quality factor leads to superior investment returns and apply different tolerances. Then an algorithm can be developed to identify the relevant shares that have these characteristics. Away they go.

An individual investor can’t do this easily. An individual may read that quality leads to outperformance and try and do some research and find 10 quality shares to buy in a portfolio. This is not the same thing as a professional investor who may own hundreds of quality shares while periodically re-ranking shares and changing the portfolio. The smaller sample size of the individual means chance will drive returns. The larger sample size by the professional means that the quality of the data analysis – and ultimately if quality does lead to outperformance in the future – will drive returns.

One avenue for an individual investor is to buy an ETF that follows a quality approach. The fact that the ETF is available may indicate a problem. But first back to baseball.

After Moneyball came out the way that baseball teams operated evolved. The General Manager who is responsible for picking players used to always be a former baseball player. If you look at the professional staff of baseball teams now the General Managers are former traders and statisticians. Baseball teams have built huge analytics departments to crunch data instead of relying on old men traveling around the country and watching high schoolers play baseball. The talent acquisition process and strategy of the sport is almost unrecognisable.

The Moneyball approach worked well for the Oakland A’s when nobody else was doing it. It was a competitive advantage. But not a sustainable one. Soon every team was doing data analysis to discover which attributes were being ignored that contributed to wins. The more teams that valued these attributes the less undervalued they became.

The fact that these factors contributed to success in baseball was a motivating factor for Oakland. But the other reason they took this approach is because they didn’t have a big enough budget to compete with the other teams. Once everyone was taking a somewhat similar approach it became about money again. The price of the previous unloved players went up so the deciding factor again became which team could spend the most money. The money to sign players and the money to build the best analytics department.

This happens in investing as well. In a world where only one investment firm is mining data to find factors that contribute to investment success it can be very profitable. As more firms start doing the same thing it becomes harder to outperform. In investing we call this the efficiency of markets. A perfectly efficient market means that prices always reflect value. In a perfectly efficient market there is no point in trying to beat the market.

I don’t personally believe markets can ever become perfectly efficient. And that is a widespread belief. However, there is lots of evidence that different markets have different degrees of efficiency. In widely followed markets that are investable by most investors it can be harder to gain an advantage. For example, big companies that are followed by many professional investors. In some more obscure markets like emerging markets, small cap shares and parts of the fixed income market there is evidence that there is less efficiency.

Can individual investors win in the investing game?

The larger point from Moneyball is that doing the same thing as everyone else is not going to yield different results unless you have some inherent advantage – like being able to spend more money as a baseball team.

As an individual investor this rings true. Professional investors have all the advantages when it comes to resources. They have extensive data, technology, and highly educated employees to crunch the numbers. They can hire whole teams to evaluate investment opportunities. This is their job so they can dedicate their time to uncover attractive investments.

Should you give up? That is one approach. You can simply choose to invest passively. And you aren’t giving up much by taking this approach. Most professional investors with ample time and resources don’t beat the index. And investing passively is a great way to build wealth.

No matter if you invest passively or are picking your own investments I still think you can win. That’s right. I think investing is rigged. And I think it is rigged to the advantage of individual investors who are trying to accomplish individual goals. But just like the Oakland A’s you have to do something differently than the way most people invest – both professionals and individuals.

Focusing on investing or how you invest is far more than focusing on investments or what you buy and sell. Professionals have no chance when it comes to investing. They have structural impediments holding them back and they don’t have enough information about the underlying investors to compete. In that spirit I’ve come up with 3 ways to Moneyball the way you invest. Those are in part 2 which you can find here.

In the meantime, I would love to hear your thoughts at [email protected] 

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