Notes from the Diamond #8: Room For Doubt

David A. Salem
Email: david.salem@epsilontheory.com
Twitter: @dsaleminvestor

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Trivia Question #8 of 108. By how many pounds does the American League (AL) MVP for 2014 and 2016 outweigh the same award’s winner in 2017? Hint: both players remain active — at the top of their games, in fact — with the larger man weighing 42% more than his more diminutive counterpart.  Answer below.

Narrowing Gyre.  Let’s be honest.  While the topics on which these Notes focus — baseball and investing — are endlessly interesting to some of us, they’re inconsequential relative to some topics on which Ben and Rusty comment frequently and incisively, including the “widening gyre” in American politics and culture.  Depressingly, that gyre has grown wider since the prior note in this series was published, with multiple mass shootings, the jailhouse death of a monstrous criminal, and heated controversies spawned by such events having unfolded in the meantime.  Happily, there’s at least one aspect of life in these increasingly Dis-United States in which an angst-inducing gyre has been narrowing of late: the baseball’s world unending debate over an all-purpose test of on-field excellence.  This note examines the whys and wherefores of that narrowing — and explores an old but by no means outdated standard for gauging investment excellence that independent-minded stewards of long-term portfolios might find useful in an era of generally inflated asset prices and correspondingly low yields.

The author’s daughter (right foreground) overseeing Mike Trout’s BP at Fenway Pahk 8/9/19. Trout is in red and gray, mid-cage, bat in hand. Daughter and father enjoyed the game; Trout surely did not, his Angels losing 16-4 with Trout going 1 for 3 in four plate appearances (double, walk, strikeout, groundout).

Myriad Duties.  As was true of the factors animating baseball analysts’ angrily divergent views of optimal performance metrics earlier this decade, the more recent convergence of such views is rooted in large measure in the impressively mounting achievements of a player also featured in my last note: 28 year-old Angels outfielder and “WAR machine” Mike Trout.  Despite his uncharacteristically pedestrian performance for my baseball-loving 10 year-old at Fenway earlier this month, Trout is on track to become this year’s AL if not MLB champ in at least two widely followed statistical categories: home runs and runs batted in (RBIs). 

Why does this matter, and how has Trout’s evolving performance de-escalated the war among baseball cognoscenti respecting WAR?  Both questions are answered with characteristic elan by baseball pundit par excellence Ben Lindbergh in a recent Ringer post available here.  As noted therein, Trout’s uniformly solid discharging of the myriad duties shouldered by a position player has kept him at or close to the top of most baseball experts’ subjective rankings of the sport’s most valuable players since his MLB debut in 2011.  Including 2019-to-date, Trout has also ranked #1 five times, #2 twice, and #6 in annual rankings of the American League’s roughly 400 players sorted by the least-worst objective metric for assessing on-field excellence: Wins Above Replacement or WAR, more on which follows. 

Importantly, one of Trout’s five #1 WAR seasons came in 2012, when he notched the 31st highest single season WAR in baseball history (of more than 40,000 observations) while finishing #2 to the Tigers’ Miguel “Miggy” Cabrera in the essentially subjective process by which the Baseball Writers’ Association of America (BBWAA) picks a Most Valuable Player for each of MLB’s two leagues (American and National) each year. 

How could an impartial judge of on-field output possibly have deemed Cabrera’s more valuable than Trout’s in 2012 when Trout produced 41% more WAR that season (10.5 vs. 7.1)?  Beats me — but, much as I wish things were otherwise, I don’t make a living following baseball, as do the beat writers comprising BBWAA’s MVP juries.  In 2012, 22 of 28 such writers comprising that year’s jury voted for Cabrera, causing the six dissenters (all of whom voted for Trout) plus a large and vocal phalanx of “statheads” to complain that the 22 ascribed undue weight to Cabrera’s #1 rank in the trio of “traditional” batting stats comprising baseball’s hallowed Triple Crown (see box).[1]


Impressive as the stats for Cabrera just cited were — absolute and relative to Trout’s — when combined with other objective measures of offensive output to produce a broader metric of same known as Offensive War (OW), Cabrera contributed 13% less value-added to his Tigers on offense (measured by estimated team wins) than Trout did to his Angels in 2012: 7.7 OW for Miggy vs. 8.7 OW for Mike.

Value Added.  If you’re following along as carefully as my daughter did when reading this note (approvingly) in draft form, you’ve already caught a curious twist in our tale of baseball’s decreasingly fierce war over WAR: Miggy’s overall WAR in 2012 (combining Offensive War or OW with its defensive analogue) was 8% lower than his OW alone — 7.1 vs. 7.7.  In contrast, in finance-speak terms, Trout “added value” on defense as well as offense, performing certain deeds as an outfielder (i.e., improbable catches and the like) while avoiding others (i.e., errors) and in the process boosting his overall WAR to the aforementioned 10.5 from his offense-only WAR (OW) of 8.7. 


These WAR differentials may seem trivial to some readers, and inconsequential to most given weightier money and other matters confronting them, but bear with me, please: I’m using WAR to frame a consequential and conspicuously current concern respecting capital deployment — one entailing far bigger stakes for some readers than the estimated $8 million that a single WAR is worth in MLB these days.  Don’t find that $8 million estimate credible? Check out the nifty blog post from which it plus the nearby graph was lifted.  FWIW, the ten retired players to whom Trout’s evolving output is compared in the graph include eight Hall of Famers; the graph was prepared in March 2019, and thus excludes the roughly 8 WAR Trout has racked up during the MLB season now underway.

Something Big.  Crucially for our purposes here, Trout’s play this year makes him the odds-on favorite to achieve the AL’s #1 rank in the only “traditional” baseball stat (as defined in footnote 1) in which he’s not already achieved a league-leading single season rank at least once: home runs.  In short, the large and loud cadre of baseball analysts who deemed Trout’s stellar all-around play in 2012 sufficient grounds for an AL MVP crown despite Trout’s sub-#1 rank in all traditional batting stats except Runs Scored (129 vs. Cabrera’s 109) were on to something.

Something big, it turned out, with 2012 and Trout’s near-but-not-top rank in a host of statistical categories that year presaging truly extraordinary performance in the 6+ seasons Trout has played since his official rookie year.  (Trout played in some big league games in 2011 but not enough to disqualify him for the AL Rookie of the Year award he ultimately notched in 2012.)  At this writing, Trout’s career WAR (per BP) of 72.3 puts him 87th on the all-time list of big leaguers ranked by that stat — a mounting tally exceeding that of roughly 70% of the 267 players enshrined in Cooperstown.

The Fog of WAR.  What exactly is WAR?  Truth be told, my youngest daughter’s baseball precocity notwithstanding, neither she nor her dad nor indeed the “God of WAR” himself could furnish more than a Trump-like simpleton’s answer to the foregoing query without consulting cheat sheets like those furnished herein.  In fact, when asked near the start of what’s become the largest accumulation of WAR by a 20-something in MLB history what he knew about WAR, the young deity just referenced (Trout) replied, “That’s a good question.  Not a lot.”

A Brief Primer on Wins Above Replacement (WAR)

•  WAR is a stat that seeks to capture in a single number a player’s total contributions to his team.  For reasons discussed in the main text, WAR is an imperfect metric that’s best viewed as an approximation of player value rather than a precise measure of it.

•    Despite or perhaps due to WAR’s growing importance to allocators of human and financial capital in baseball, multiple methods for computing WAR have been devised, spawning endless discussion over the pros and cons of each.  Among publicly available WAR tallies, the three most widely followed are arguably those of Baseball Prospectus (WARP), Baseball Reference (bWAR) and Fangraphs (fWAR). 

•    Over any given season, WARs for the 1,000 or so men snagging more than trivial playing time in MLB typically shape up very roughly as follows:

•    Over any given MLB career, a player’s WAR will reflect longevity as well as effectiveness, as suggested by these career bWAR tallies for selected superstars:

•  For position players, WAR typically comprises a weighted average of stats for batting, baserunning and fielding, with adjustments for a player’s position and playing venues (stadia) plus multiple other factors of lesser import.  For the benefit of readers combatting insomnia, here’s how Fangraphs computes a position player’s WAR:

Position Player WAR = (Batting Runs + Base Running Runs + Fielding Runs + Positional Adjustment + League Adjustments + Replacement Runs) / Runs Per Win

•  For pitchers, WAR typically reflects runs allowed, with material adjustments to actual runs allowed to pinpoint a pitcher’s effectiveness independent of his teammates’ performance on defense.  As a further aid to readers seeking to nod off — or to ponder formulas even more complex than those needed to compute internal rates of returns (IRR) in a finance context — here’s how Fangraphs computes a pitcher’s WAR:

Pitcher WAR = [[(League Fielding Independent Pitching (FIP) – Player’s FIP) / Pitcher Specific Runs Per Win] + Replacement Level Wins) * Innings Pitched/9)] * Leverage Multiplier for Relievers] + League Correction

•  Over any given interval, a player can mess up enough to produce negative WAR, as has Albert Pujols of late (#31 in all-time career WAR despite -1.1 cumulative WAR over the last three seasons).  Pete Rose backslid similarly toward the end of his 24-year career, producing -2.5 cumulative WAR in his last five seasons.

End of Brief Primer on WAR

Here’s another good question — one that’s central to this note’s exploration of optimal metrics for gauging excellence in baseball or investing: must such metrics be as simple and straightforward as the Triple Crown stats that enabled Cabrera to trump Trout in AL MVP balloting in 2012?  To be sure, the ease with which anyone who’s crossed the threshold of baseball consciousness can not merely grasp but compute a player’s Triple Crown stats suggests that my kids’ kids will cite such metrics in assessing batters’ prowess — assuming such progeny emerge and their DNA causes them to ape their granddad’s avocational interests.

But the simplicity of MLB’s hallowed Triple Crown stats, like the simplicity of total return as one’s chief metric for gauging investment success, is not an unqualified virtue. In fact, such simplicity in gauging professionals’ performance can be hazardous to a ballclub’s health, or an investor’s wealth, for reasons described memorably by two of my favorite thinkers in my favorite fields of human endeavor.

Not Obvious.  “It is dangerous to spring to obvious conclusions about baseball,” sportswriter Roger Kahn has observed, “or, for that matter, ball players.  Baseball is not an obvious game.”  Nor is investing, defined for purposes of these notes as the deployment of capital over long time horizons with the aim of preserving and ideally enhancing its inflation-adjusted value net of planned withdrawals.  As investment pro Jim Garland has argued in musings that merit much closer attention than they’ve received by institutional investors as a group, “[I]nvestment risk isn’t a function of betas or Sharpe ratios or Value at Risk.  Instead, the primary risk facing [long-term investors] is …  the risk of a decline in the earnings and dividends from the corporations in which they’re invested.” 

Borrowing a term from farming, Garland refers to the hazard just described as “fecundity risk” — the risk that a portfolio will produce insufficient cash for its owner “to buy something important”.

A Brief Primer on Fecundity

Fecundity [writes Garland] is a “portfolio’s long-term ability to generate spendable cash for its owner”.

• Since most portfolios’ owners are legally empowered to withdraw principal as well income, the near-universal practice is to set withdrawals at levels commensurate with long-term expected real returns, with the latter typically guesstimated as follows:

Long-Term Expected Real Return = Income Per Se (Dividends, Interest and Rent) + Anticipated Capital Gains – Investment-Related Expenses – Applicable Taxes on Net Nominal Total Returns – Projected Inflation.

• Most investors excluding Softbank devotees recognize the perils of extrapolating capital gains (especially unrealized ones) into the indefinite future. But too few investors heed a corollary principle: that market values and the total returns they underpin often constitute “false positives” respecting a portfolio’s evolving soundness.

• Quoting Garland, “Jane Austen … and her character Mr. Darcy knew that long-term wealth should be measured by sustainable cash flows rather than by ephemeral market values. But what Jane Austen knew has been lost in the thundering dissonance of modern finance.”

• Computing with even approximate accuracy a portfolio’s sustainable cash flows is difficult at best, requiring as do most mission-critical tasks in money management — or baseball — a combo of art, science and craftsmanship. 

End of Brief Primer on Fecundity

I gave Garland’s seminal work on investment metrics a shout-out by featuring him in a TIFF workshop conducted shortly after the 2004 publication of a note Jim guest-authored for Peter Bernstein’s strategy service.  By happy coincidence, 2004 was also the year my beloved Red Sox used seminal analytics devised by baseball sage Bill James to win their first World Series in 86 years — a feat they’d repeat thrice more (so far) this century, including 2013, the year Jim delivered one of the best talks on investing I’ve yet encountered.

That talk — Memo to the Darcy Family: To Thine Own Self Be True — does a better job than I ever could propounding fecundity as the soundest metricfor gauging the evolving performance of so-called permanent portfolios: pots of money created and managed to enable their ultimate owners, taxable or tax-exempt, to buy important things — including but not limited to necessities — on an essentially indefinite basis.

Self-Awareness.  Given fecundity’s intuitive appeal as a metric for gauging permanent portfolios’ evolving health, one wonders when if ever during the century now unfolding a critical mass of such portfolios’ ultimate owners will become true to their own selves in the manner Garland commends.  How might such enhanced self-awareness cause principal-agent relations to change in the money management biz, and what events might catalyze such change?


Mr. Fitzwilliam Darcy (played by Colin Firth) and Miss Elizabeth Bennet (played by Jennifer Ehle).  This scene from a BBC adaptation of Jane Austen’s 1813 novel Pride and Prejudice ranked #1 in a 1995 UK-wide poll of the most memorable scenes in British TV drama.  Famously, Austen’s omniscient narrator describes Darcy’s prodigious wealth in income rather than net worth or market value terms, citing a “report which was in general circulation within five minutes [of Darcy’s entrance into the initial gathering of the novel’s protagonists] of his having ten thousand [pounds] a year”.

Answering the second question first (if not also stating the obvious), sustainable cash flow yields as distinct from recent returns and the market values underpinning them will reassume Darcy-like importance in wealth management when but perhaps ONLY when investors in WeWorks paying scant heed to such yields start losing far more than they win. 

As a true believer in Ben’s gospel that no one can foretell accurately when global capital markets will morph from the political utilities they’ve become back into “Two-Body Markets” (to quote Rusty) susceptible of effective analysis by thoughtful allocators, I won’t hazard a guess respecting when the losses just prophesied will materialize.   What I can foretell with confidence is that the forward-looking and hence unavoidably pliable character of Garland’s preferred method of gauging long-term portfolios’ evolving health will remain offputting to many fiduciaries, even after the tide turns and market values that such folks currently deem sound become fishy at best. 

I’m confident making this prediction because I’ve encountered such obstinacy multiple times in my career, most memorably when trustee groups for whom TIFF was managing money nixed portfolio moves animated by my team’s carefully considered judgment that technology stocks as a group couldn’t possibly generate sustainable cash flows commensurate with their fin de siècle valuations. 

Of course, I’ve also witnessed such obstinacy in an avocational as distinct from vocational setting, as noted in the above account of supposed experts making the silly but unsurprising choice to pick Miggy Cabrera over Mike Trout as AL MVP for 2012 despite Trout’s superior overall play as measured by WAR.  To be sure, Cabrera’s votaries rejected WAR-based arguments in Trout’s favor not because WAR is unduly speculative or forward-looking in a way that Cabrera’s Triple Crown-winning stats self-evidently were not; rather, Cabrera got the nod because three backward-looking stats he compiled more robustly than anyone else in his league including Trout (BA, HRs and RBIs) were more hallowed by MVP balloteers than the broader and better but equally retrospective valuation metric that Trout conquered in 2012 (plus five of the seven full or partial seasons since then!): WAR. 

Ardor for Ambiguity.  Its enhanced clout in player appraisals since Trout entered The Show notwithstanding, WAR continues to challenge even the brainiest baseball aficionados.  As anyone who’s consumed his analyses for ESPN or Fangraphs can attest, Sam Miller is among the brainiest (and wittiest) of such folks.  In an essay I enjoyed lots upon its initial publication in 2013 and re-read when assembling this note on the pursuit of excellence when gauging excellence in baseball or investing, Miller writes:

WAR is a crisscrossed mess of routes leading toward something that, basically, I have to take on faith.  And faith is irrational and anti-intellectual, right?  Faith is for rain dances and sun gods, for spirituality but not science.  Actually, no.  Faith is how we organize a complicated modern world … The complicated nature of WAR … isn’t an argument against it.  That’s just what human advancement looks like in the 21st century … I trust the recipes of FanGraphs, Baseball-Reference and Baseball Prospectus [BP] because these sites incorporate decades of research, the scope of which I could never match on my own.  These recipes will get even better because they get smarter with more data.  [BP] will soon incorporate into its WAR catchers’ ability to frame pitches.  The numbers next to each player’s name on that site will change.  Does that mean the numbers we have now are wrong?  Of course they’re wrong.  Everybody is wrong about everything all the time, and WAR leaves room for this doubt.  Doubt has driven us toward better answers for millenia, from Socrates’ “I only know that I know nothing” to the guys who made billions betting against a seemingly invicible housing market.  Don’t accept any number that doesn’t leave you room for doubt.” [Emphasis added]

“WAR Is the Answer” by Sam Miller (2013)

Dunno ‘bout you, but if I chaired an investment committee (IC) and were tasked with finding a new member for it, Miller might plausibly get my nod.  He’d get it because the tolerance and indeed ardor for ambiguity he displays is a vitally important  condition for investment success. 

Cognitive Errors.  More to the point, having a kindred soul like Miller at hand could boost the odds of getting the IC as a whole to practice what Garland preaches so persuasively in his Memo to the Darcy Family — teachings evocative of those Jane Austen illumines so artfully in her majestic novel about the Darcys’ evolving fortunes, Pride and Prejudice.  That novel’s central teaching  — that one should weigh all relevant info before acting or choosing consciously not to act — has obvious relevance to investing, even if its practical utility to conscientious investment pros is diminished episodically by tidal waves of cheap money that temporarily lift all boats, including those with skippers named Musk spiffy topsides but irreparably leaky hulls. 

The Austenian precept just flagged is germane to baseball too, of course, though typically tougher for ballplayers than investors to follow due to the high speeds at which baseballs and baseballers often move.  That said, clear eyes and a concomitant commitment to weighing all relevant facts before acting are undeniably vital for people who make their livings in baseball, including especially those who get paid not to play the game but to evaluate those who do. 

As we’ve seen, some of these folks messed up big time in 2012, weighing Miggy Cabrera’s dominance of three hallowed but batting-specific metrics against Mike Trout’s overall body of work and somehow judging Cabrera’s play in 2012 to have been more valuable than Trout’s.  It’d be unfair to Cabrera, and overstating my chief argument here, to label Miggy’s Triple Crown-winning stats in 2012 the baseball equivalent of Garland’s “ephemeral market values” — “noise” meriting scant attention as opposed to “signals” meriting the converse.  But, c’mon: given Trout’s extraordinary overall play since and including 2012, both absolute and relative to Cabrera’s, how can any competent judge of such matters deem Cabrera’s MVP award for Trout’s first full season as a big leaguer in 2012 to have been anything other than a cognitive error by those who conferred or applauded it?

Open Questions.  Which big money allocators (if any) are committing comparable cognitive errors at present?  As argued repeatedly in these notes, fielding such a blatantly censorious question presupposes a clear articulation of the metrics used to gauge investment success and the time horizon over which such metrics are optimally applied.  By my lights, the longer one extends the horizon over which investment success is judged, the more relevant Garland’s preferred metric of fecundity becomes — less as a precise gauge of the evolving utility of a portfolio than as a test of what the persons managing a portfolio truly know and think about each of its parts.

I know what you’re thinking as you ponder the words just written:

• Wouldn’t the ongoing fulfillment of these Garlandian expectations require the hired guns involved to know MUCH more about each holding they’ve selected than they typically do at present — to know each holding well enough to fashion the credible bottom-up assessment of its fecundity needed to compile top-down or fund-level estimates of what funds’ owners can withdraw and spend on a sustainable basis? 

• Wouldn’t principal- or owner-imposed requirements that money managers furnish such assessments trigger big changes in managers’ methods (i.e., asset selection, sizing, timing and reporting)?         

• Wouldn’t the widespread adoption of Garlandian metrics for assessing long-term funds’ evolving performance catalyze changes in institutional funds management as material as those MLB has undergone through the widespread adoption of advanced statistics like WAR and the complex array of task-specific stats that the WAR formula requires?

• Wouldn’t changes like those just conjectured enhance some investment pros’ value-added and in turn incomes, reduce others’ incomes, and likely force some if not many raccoons players out of the game of managing OPM for a living?       

You know how I’d answer the bulleted questions above — with enthusiastic yesses to all of them, mindful that the sabermetric revolution in baseball from which big money asset owners might usefully borrow certain tricks has spawned harmful as well as healthy changes in how MLB gets played, who gets to play it, and how much they get paid to do so. 

Certainly the enhanced stature and incomes of multi-talented stars like Trout or Jose Altuve — a player whose stellar advanced stats negate timeworn arguments that big leaguers must be big to be great — are welcome by-products of the cardinal importance ascribed to sabermetrics in modern baseball.  Certainly, too, the silver linings just flagged adorn menacingly large clouds: changes in MLB games’ length and character that have made them less fun for many fans and prevented countless others from becoming baseball fans in the first place. 

Two of MLB’s biggest stars: 6’2”, 235 pound Mike Trout (AL MVP in 2014 and 2016) and 5’6”, 165 pound Jose Altuve (AL MVP in 2017

On Deck.  I owe it to my youngest daughter if not also others with budding addictions to baseball to weigh in on MLB’s sagging “production values” (TV-speak for fan appeal) and will do so in a future NftD, though not the next one. That Note (#9) will focus on the inevitable and laudable extension of rigorous analytics to a hitherto unquantified and perhaps unquantifiable aspect of big league baseball (and big money investing): the impact of players’ character and temperaments on their and their teammates’ performance.  Consistent with the age-old principle that “you get what you measure”, MLB front offices are paying both closer attention to and more money for players’ invisible as distinct from visible gifts, with the former dowry defined broadly to include mindsets conducive to continuous improvement (“player development” in MLB-speak) plus interpersonal skills conducive to healthy team karmas and the winning records often spawned by same. 

Tellingly but perhaps unsurprisingly, the best player in MLB now and perhaps ever proved recently that he possesses interpersonal skills worthy of pro sports’ largest pay package ($432 million over 12 years), displaying acute empathy and grace in response to the sudden death of his Angels teammate Tyler Skaggs. 

Would exhaustive analysis of Mike Trout’s potential as a pro baseballer just before he became one as an 18-year old have foretold with actionable certainty the bounties he’d produce as a pro — analysis as thorough as the fecundity-focused probes that Garland commends to folks putting long-term capital to work?  Given the unavoidable uncertainties surrounding the future paths of young baseballers — or companies of any age or size — I doubt it.  But just because there’s room for doubt with any such analysis doesn’t mean it shouldn’t be undertaken.  It should — especially by allocators seeking to gain an edge under market conditions inimical to the profitable use of methods that served disciplined investors well in the past but have produced as many whiffs as homers since capital markets became political utilities Mike Trout signed his first pro contract in 2009. 

End

Mike Trout consoling Tyler Skaggs’s mother Debbie before the team’s first home game following Tyler’s death.  A longtime softball coach, Mrs. Skaggs delivered what the AP labeled a “heartbreakingly perfect strike” on the game’s ceremonial first pitch. Trout drove in six runs in the Angels’ 13-0 win, including a towering 454-foot two run homer off the first pitch he saw from Seattle starter Mike Leake.
Summer “school” for the author’s youngest daughter (2019). 
Nail colors are no accident.

Up next: the importance of character and temperament in “weak link” endeavors like pro baseball and institutional investing


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[1] I’ve put traditional in quotes because there’s no universally accepted rule for distinguishing baseball’s so-called advanced stats from all others, excepting perhaps a calendar-based rule rooted in the 1985 publication of stathead Bill James’s Historical Baseball Abstract, i.e., stats devised before 1985 can’t be “advanced” so they’re “traditional” by defaultThat transparently suspect point having been made, we’ll note that with the possible exceptions of On Base Percentage (OBP, which became an official MLB stat in 1984) and OPS (OBP plus Slugging Average), most statheads would agree that “traditional” batting stats comprise the two just mentioned (OBP and OPS) plus Batting Average, Hits, Homes Runs, Runs Batted In, Runs Scored and Slugging.  As my 10-year old daughter would be pleased to tell you if asked, Slugging = Total Bases/At Bats.  

Notes from the Diamond #7: Hittin ‘Em Where They Ain’t (Part 2)

David A. Salem
Email: david.salem@epsilontheory.com
Twitter: @dsaleminvestor

Log of notes in series available here
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Part 2: Addition By Subtraction

Trivia Question #7 of 108.  Taken as a group, the 51 countries or dependencies comprising Asia are home to a bit more than half of the world’s 44,000 or so listed companies.  What is the median number of sell side research analysts following the roughly 22,000 Asia-based firms just referenced?  Hint: the correct answer equals the number of no-hitters pitchers in Major League Baseball (MLB) have thrown on their birthdays, which itself equals the number of times two batters on the same team have “hit for the cycle” (single, double, triple, home run) in the same game.  As regular readers know, approximately 220,000 MLB games have been played since big league competition commenced in the 1870s.  Answer appears below.

Pre-Game Jitters.  Tired of waiting for the best MLB player of this and perhaps any generation — 27 year old Angels outfielder Mike Trout — to make his next appearance in MLB’s best ballpark?  Me too.  Frustrated it’s taken me so long to take this swing at the curveball I left hanging in Part 1 of this post when it got published several weeks ago? Me too.  Skeptical I can smack the curveball just referenced — i.e., outline investment policies conducive to the achievement of plump real returns over the next few decades of Trout’s blessed existence — or indeed convey useful thoughts of any kind via sentences comprising fewer words than the number of times Trout reached first base on walks in 2018 (a stunning 122 times in 608 plate appearances)?  Can’t blame you: as a guy who’s spectated many games in the ballpark alluded to above without wishing any would end sooner than they did, I have a natural if unfortunate tendency to craft sentences that run longer than most readers presumably prefer.[1]

Mike Trout

Obviously, there’s nothing I can do to accelerate Trout’s next appearance at Fenway (on August 8).  But I can scratch the other itches hinted at above — codifying concisely policies conducive to long-term wealth enhancement — and do so below via a series of tenets, none of which comprises more words than Trout’s age when he and the Angels inked recently the largest contract ever awarded a pro athlete: a deal that’ll pay Trout a total of $432 million pre-tax from 2019 through his age 38 season in 2030. 

Of course, since no one knows for sure how the economy and inflation let alone tax rates will evolve between now and 2030, no one knows for sure what goods and services the roughly $17 million per year in after-tax dollars Trout stands poised to earn under current tax schedules will buy him over the course of his newly-signed 12-year contract.  If, for example, inflation over the next dozen years runs as hot as it did during the most inflationary 12-year span in US history (1970 – 1981), the $17 million in after-tax income Trout is slated to pocket in 2030 will buy him the equivalent of a mere $7 million in goods and services if purchased today, CPI inflation having eroded the dollar’s purchasing power by roughly 60% over the 12 years ending  1981.[2]

Adding insult to potential injury, quite apart from potential surtaxes on certain outlays a highly compensated pro like Trout might reasonably be expected to make from time to time (e.g., hefty levies on fuel for private jet travel), wealth taxes of the sort proposed by certain politicians of late could prevent Trout from amassing even as remotely as much real wealth over the next 12 years as he would if the dominant zeitgeist for this interval were to resemble that of the 12 years beginning in 1981, i.e., disinflation and generally reduced tax rates.[3]    

Similar anxieties confront most individuals, families and indeed institutions that have already amassed substantial wealth as 2019 unfolds, including well-endowed non-profits that IMHO would be unwise to assume their investable wealth or current income produced by same will remain untaxed indefinitely. 

Indeed, even if the wealth just referenced is subjected to little or no explicit taxation in coming years and beyond, it could as noted above be subject to the implicit tax known as inflation: to currency debasement of the sort that, along with other ugly and corollary trends, led ultimately to the appointment of the investment maven on which Part 1 of this two-part paean to Hittin ‘Em Where They Ain’t focused: Yale CIO David Swensen.  (Part 1 focused as well on a baseball maven discussed further below: Branch Rickey.)  Other observers may disagree, but I doubt Yale would’ve hired a 30-something finance geek with no investment experience to run its endowment in 1985 if it hadn’t suffered a 60+% erosion in endowment purchasing power over the prior 35 years. 

What Trout Needs.  Like all investment home runs of which I’m aware, the riches that Yale has garnered by tapping Swensen as its CIO 30-odd years ago constitute just if not inevitable recompense for deducing correctly that the perceived risks of such a move exceeded the actual risks.  This isn’t to say that the latter were non-existent: Swensen might have proven inept in crafting investment policies responsive to Yale’s presumed needs, or the policies he ultimately devised might have proven infertile if the investment zeitgeist that subsequently unfolded had been different.  To Swensen’s credit, and Yale’s great and good fortune, the investment model he built embodied nicely if somewhat unwittingly an attribute inherent in all sound approaches to conscious risk-taking: asymmetry

“Heads I win, tails I don’t lose.”  That’s the ticket, we’d all agree, as reflected among other happy investor tales in this arresting fact: for more than a quarter century following Swensen’s assumption of his current post, a key tenet of his model essentially proved fallacious, with high quality bonds of the sort Swensen’s model disfavored producing returns roughly equal to marketable stocks as a group.  Of course, Swensen didn’t invest in the broad stock market during the quarter century in question (1985 – 2010), nor has he done so since.  Rather, he’s employed more or less exclusively active equity strategies, with a hugely profitable tilt toward privately-traded equities, including venture capital. 

The undeniable fact that such strategies bent but never quite broke Yale nor Swensen when they produced large unrealized losses in 2008 – 2009 merely reinforces the point made above respecting asymmetry: wittingly or not, Swensen has deployed Yale’s endowment in a manner that’s caused its unitized as well as total value to grow materially in real terms since 2009 under conditions resembling in certain ways those that caused such values to shrink materially in real terms over the 30-odd years preceding Swensen’s appointment as CIO, i.e., “guns and butter” fiscal policies coupled with large dollops of central bank largesse. 

Where would Yale’s finances and in turn Swensen’s reputation be today if such largesse hadn’t materialized over the last decade?  Reasonable people can reasonably disagree in answering that counterfactual question.  Ditto for a question that’s top of mind for me if not also you and should certainly be top of mind for investment pros fortunate enough to be advising Trout on the deployment of his investable wealth: will the dominant investment zeitgeist over the multi-decade horizon under discussion here be marked by the continuance of such largesse on a more or less globalized basis?  I  doubt it, but I wouldn’t bet the ranch against it.  Rather, I’d do what all fiduciaries worthy of the name try earnestly to do when engaged in policy-making: craft policies likely to produce tolerable results at worst across the widest plausible range of market scenarios and pleasing results at a minimum if the scenario or zeitgeist deemed most probable does indeed unfold.

Less is More.  What zeitgeist did I deem most probable in formulating the policies commended below — an investment model if you will intended to function effectively over a time horizon rivaling the span that’s elapsed since Swensen activated “the Yale model” many years ago?  Truth be told, I didn’t spend much time crafting a best guess or base case scenario for the global economy and capital markets when building the model below — not because scenario planning isn’t valuable if done astutely but rather because ET’s co-founders have shown convincingly in their writings that less is almost certainly more for investors seeking to divine economic and market trends in coming years and beyond.

Indeed, so convinced or more precisely humbled am I by Ben Hunt’s core message in Three Body Problem — “there is a non-trivial chance that structural changes in our social worlds of politics and markets have made it impossible to identify predictive/derivative patterns” — that I’ve adopted a base case scenario even leaner than that sketched by Ben in his masterful notes on zeitgeists entitled You Are Here and This is Water.

Specifically, while not questioning Ben’s perspicacity in divining all four phenomena flagged in the nearby box, the worldwide and necessarily long-term prism through which I ponder policy options makes me wary of policies premised on a fully globalized and sustained flowering of the first three trends. 

This isn’t to say that I think the trends Ben espies will peter out or reverse in the foreseeable future.  Indeed, I think such trends could very well accelerate, especially in the US and Old Europe, and more particularly if Rusty Guinn’s forebodings in Free Range Kids / Free Range Capitalism prove prescient; as Rusty notes, if taken too far, the ongoing transformation of capital markets into utilities could render investors as a group “utterly incapable of determining whether we should provide capital to a business or government venture, and under what terms.”

As for the fourth element of Ben’s perceived zeitgeist as summarized above — the displacement of cooperative games by interminably competitive ones — I’ve assigned a high probability to this condition in crafting the policies outlined below.  Fortunately and crucially, the less sound this premise actually proves in coming years and decades, the better I would expect the investment program sketched below to perform.  That may seem delusional — most attempts to exploit perceived asymmetries in capital markets produce strikeouts or singles rather than extra base hits or homers — so the onus is on me to defend the assertion just made.  I try to do just that as the modeling exercise below unfolds — one that begins logically (for a series exploring parallels between investing and baseball) with a favorite example of less being more in baseball.

Addition by Subtraction.  As regular readers will recall, Note #1 in this series opened with a trivia question concerning a Hall of Famer catcher who posted a 75-3 record as a pitcher in high school.  The rocket arm that made Johnny Bench (MLB 1967 – 83) nearly invincible as a high school hurler spawned ultimately a seemingly odd stat for Bench as a big league catcher: a relatively low number of runners nabbed stealing bases via throws from Bench.  The throws themselves were unfailingly swift and accurate, as one might expect from an athlete who’d practiced them countless times as a youngster albeit over twice the 127’ span between home plate and second base on a regulation diamond.  (Bench’s father and first baseball tutor knew well how to show young Johnny tough love.)  In fact, Bench’s arm strength became so widely respected in MLB circles that managers of opposing teams nixed base stealing attempts by all but their swiftest players when doing battle against Bench’s Cincinatti Reds.

Though such circumspection by Cincy’s opponents didn’t prevent the “Big Red Machine” from winning six divisional titles plus four league and two world championships during Bench’s 17-year playing career, it did boost opponents’ odds of beating the mighty Reds.  Addition by subtraction, one might call it: achieving more by doing less — by shunning endeavors in which one lacks a reliable edge or would otherwise confront unattractive odds.[4]

Edge and Odds.  I haven’t canvassed creatures fortunate enough to inhabit Little River Farm to ask how often Farmer Ben mutters “edge and odds” as he tends to their needs, but judging from how often Dr. Hunt chants that mantra in human interactions I’m guessing they’ve heard it many times indeed.  With good reason: in addition to pursuit of attractively asymmetric returns — the stated if sometimes unachieved aim of active managers and the only legitimate reason to invest in broadly diversified indexes like the S&P 500 on a buy-and-hold basis — savvy investors logically seek to focus their energies on opportunity sets in which they have an actionable edge in exploiting favorable or mispriced odds.[5]     

Millions of words having been written or spoken about “edge” in investing, I’ll say nothing about it here except that I’m defining it for purposes of this model-building gambit as know-how useful to the generation of above-market net returns if and when applied in an effective manner.  As noted above — and this is crucial to the model commended below — “edge” as just defined is most productively applied to markets in which an investor enjoys favorable or mispriced odds. 

Successful examples of such productivity include the two mavericks on whom Part 1 of this post focused.  As the first MLB GM to add black and Latino players to the talent pool from which his teams drew, Branch Rickey enhanced hugely his odds of assembling world-beating rosters; and while MLB franchises not headed by Rickey weren’t long in expanding imitatively their own talent pools, by the time they took such steps Rickey and his subordinates had developed a valuable edge in discerning which players of color most merited pro contracts. 

Similarly, David Swensen has enhanced Yale’s odds of partnering with market-beating managers by tilting Yale’s portfolio toward asset classes in which manager returns tend to be most dispersed; and while other allocators (big and small) weren’t long in expanding their own portfolios to include such holdings after Swensen showed the way, by the time they ramped up allocations to private equity, venture capital and other size-constrained niches favored by Yale, Swensen and his subordinates had developed a big edge in discerning which PE and VC managers most merited funding.  Fortunately for Swensen, and regrettably for allocators keen to be “like Yale”, this edge compounds over time, with Yale being a coveted client for managers seeking to maximize time spent investing by minimizing time spent fundraising.  Ain’t no better way to do that at present than to have Yale serve as one’s bell cow.

Pinpointing the Problem. And there ain’t no better way to convert a big fortune like the one Trout is poised to amass into a small one than to invest in volatile but potentially high returning assets without knowing them well enough to avoid ill-considered sales during inevitable bouts of punishingly poor returns.  What might Trout do to avoid such impoverishment?  Presuming as I do that he lacks the time if not also peculiar personal qualities needed to gain and hold an edge in investing, Trout should do what most individuals, families and institutions logically do when deploying substantial wealth: delegate the task to trustworthy pros who walk the talk set forth above — who focus their mental bandwidth and in turn clients’ capital on opportunity sets in which they have or can develop an actionable edge exploiting favorable or mispriced odds.

Tautologically, no opportunity set or selection universe meeting the criterion just specified can be boundless, because no pro’s or team of pros’ circle of competence is boundless (Herb Washington’s diverse talents notwithstanding).  Conversely, no person’s or team’s investment edge in a given asset class or sub-class is so acute that they can safely be relied upon to achieve the ambitious aims conjectured here (5+% annualized real returns over a multi-decade span) without doing one or both of two things: (1) deploying at least some capital outside their chief hunting ground or (2) violating liquidity and volatility constraints typically applied in the stewardship of substantial fortunes. 

Accordingly, when crafting limits on how capital under their ultimate control might be deployed, thoughtful principals strike a sensible balance between edge and odds, preserving needed flexibility while also keeping the breadth of assets or strategies deemed eligible for use within bounds consistent with the time-tested principle of knowing what you own and owning what you know.  After all, the seemingly boundless skills of an all-star allocator like Swensen or an all-star baseballer like Trout notwithstanding, in investing as in athletics, no one knows it all — not even Bo. [6]

Even Bo Don’t Know It All
Mike Trout (MLB 2011 – present, at left) and Bo Jackson (MLB 1986 – 94) earning their pay as centerfielders.  Jackson starred in “Bo Knows”, Nike’s wildly popular ad campaign for cross-training shoes circa 1989-90 that depicted Bo excelling at multiple sports and other pursuits including guitar-picking and musical theatre. The on-field plays pictured here both ended in catches by the players shown, natch.

Admiring Tackling the Problem.  Assuming the long wind-up above hasn’t caused Rusty ET faithful to dismiss me as a charlatan for merely Admiring the Problem, I’ll tackle the challenge conjectured here by outlining as concisely as I can the game plan I’d propose if Mike Trout or other well-endowed principals sought my best thinking on means of achieving 5+% real returns over the next few decades. 

As promised at the outset of this note, none of the tenets comprising my game plan contains more words than Trout’s current age of 27.  Nor do any of these tenets address directly the concern most commonly raised when I’ve shared the blueprint below with US-domiciled principals seeking my counsel, such as it is: shouldn’t investors who pay their bills in US dollars invest primarily in dollar-denominated assets?  My answer, in a nutshell: not necessarily — not if one assesses currency risk as we all should on a rigorously look-through basis, dissecting all anticipated liabilities to reveal the currencies underlying such potential outlays while dissecting similarly the currencies underlying assets available for investment.  Of course, the latter task is often easier said than done, with the true attributes of even seemingly straightforward assets like dollar denominated S&P 500 index funds differing greatly from their perceived attributes due to the geographic breadth of constituent firms’ operations.

Hold that thought — and the corollary thought that currency shifts tend to be accompanied over time by offsetting valuation shifts — as I outline my preferred investment analog to the convention-busting views on baseball that Rickey felt compelled to serve up in the Life magazine piece celebrated in Part 1 of this note.  Like Rickey, and indeed like Swensen when he submitted his preferred approach to capital deployment to Yale’s trustees for their initial approval back in the day, I recognize that what follows might be “most disconcerting” to many allocators; like Rickey — from whose Life piece I drew the self-aware red flag just quoted plus the following phrasing — I’ve “come upon [a method for deploying capital] that has compelled me to put different values on some of my oldest and most cherished theories.”  As will be seen, the game plan I’ve devised owes much to contemporary thinkers and doers who’ve displayed Rickeyesque cheek in challenging what Rickey referred to unflatteringly as “considered opinion”.  Here’s the plan, with its key tenets listed from most general to most specific and with noteworthy premises underlying such tenets appearing beneath each:

Tenet 1 – Create and maintain a sub-portfolio comprising cash, or liquid investments reducible thereto, in proportions equal to at least three years’ net cash needs under worst case conditions.

In theory, cash is a drag on returns of equity-oriented portfolios like the one commended here.  So too is an all-purpose hedge viewed even more skeptically by most allocators: gold.  Unwilling as I am to deem impossible over the multi-decade planning horizon conjectured here either of the disasters that can befall equity-oriented portfolios — depression-induced deflation or very high rates of unanticipated inflation — I deem it imprudent to “park” less than the equivalent of three years’ net cash needs in the “low returning” assets just mentioned, with a bias toward high quality debt instruments whose currency profile resembles closely that of the net cash needs such hedges seek to defray.

Tenet 2 – Favor ownership over creditorship, with the maximum feasible bias toward the only type of equities worth owning on an indefinite basis: stocks of owner-operated companies (OOCs).

Though further research on this all-important topic remains to be done, studies done by Steve Bregman and his colleagues at Horizon Kinetics  (HK) suggest that more than 100% of the vaunted “equity risk premium” that Yale’s equity-centric approach to endowment management presupposes is attributable to OOCs.[7] You read that right: exclude OOCs for purposes of comparing stocks’ long term rewards to bonds’ and the latter take the crown.  Needless to say, as has happened with every verifiably superior investment (or baseball!) gambit ever devised, the excess returns or “alpha” derivable from OOCs will likely get arbitraged away in due course.  That caveat having been filed, there are parts of the world where the supply of OOCs (listed as well as private) continues to expand invitingly — geographies that the investment model commended here rather fancies, as will be revealed shortly.

Tenet 3 – Maintain a very high bar for private investments, accepting long-term lock ups only when doing so provides exposures to specific forms of capitalistic activity not obtainable via other means. 

Venture investments occasionally clear this bar, though less frequently than most allocators currently clamoring for such exposures surmise.  As discussed in prior notes in this series (here and here), private equity (PE) investments clear the bar under discussion here even less frequently — a dirty little secret about the current apple of many an allocator’s eye that’s becoming less secretive by the minute as a young investment pro with Rickeyesque gifts for clear thinking and writing intensifies his assault on “considered opinions” respecting PE.  If you’re among the rapidly shrinking universe of allocators not yet exposed to Dan Rasmussen’s admirable assaults on such opinions, you’d do well to get acquainted with same via the musings posted on his firm’s website, including especially Dan’s fine essay in the Spring 2018 edition of American Affairs

To be sure, the company attributes that Dan and his team have come to fancy, including small market caps, limit how much capital he or other investors using similar screens can deploy without causing potential returns to sink below tolerable levels.   Since these screens, like the OOC-focused (and partially overlapping) screens that Bregman et al at HK employ, work at least as well outside the US as within it, Verdad deploys capital on a global basis — just as HK does, and just as Rickey did when populating his innovative farm system for the St. Louis Cardinals nearly a century ago.

Tenet 4 – Favor equity investments in companies employing or serving primarily people with abundance as distinct from scarcity mindsets.

For reasons flagged in multiple works by another Rickeyesque researcher — demographer par excellence Neil Howe —the US and major European economies generally flunk the test just articulated:  like not a few “rich” families with which I’ve had the pain privilege of interacting, the world’s “richest” nations at present (measured by GDP per capita) comprise an overabundance of individuals who lack the skills or drive needed to generate fresh wealth commensurate with their appetites and social ambitions. Small surprise then that the “widening gyre” and related societal maladies that Howe as well as Ben and Rusty discuss so arrestingly in their writings are most conspicuously manifest in corners of the global economy characterized by (1) relatively but perhaps unsustainably high per capita incomes (2) rising dependency ratios (i.e.,  retirees relative to working stiffs like me if not also you) and (3) relatively high debt ratios (i.e., unpaid bills for goods and services consumed previously). 

Add to the potentially toxic mix just described such intractable problems as the Eurozone’s fatally flawed currency union, America’s unsustainably undemocratic approach to self-government, and corporate America’s unsustainable addiction to the “financialization” whereof Ben speaks unlovingly, and it’s tough for any investment pro worthy of that label to defend non-zero policy allocations to US stocks as a group or to their European counterparts.[8] 

N.B.: I’d include non-zero allocations to Japanese stocks in the list of dubious policy fixtures just furnished but my own studies of evolving business and societal norms in Japan plus insights into same provided by my go-to guy on such matters (Andrew McDermott of Mission Value Partners) suggest that abundance trumps scarcity in most Japanese mindsets, i.e., expectations are low relative to most plausible outcomes (however unexciting such outcomes might be).  

Tenet 5 – Apply the tenets set forth above to the narrowest universe of eligible investments that gets the job done.

Having test-driven the investment model now unfolding with several savvy principals before finalizing this note for publication, I know that while Tenet 5 might appeal to my arborist friend Ben (for reasons outlined here), it won’t sit well with many readers.  After all, diversification being the “only free lunch” available to investors — or so financial economists would have us believe — why would thoughtful principals view less as more respecting assets eligible for purchase? 

They’d do so because, presuming sensible cash flow planning of the sort embodied in Tenet 1 and asset selection consistent with Tenets 2 – 4, the chief if not sole risk of the investment program sketched here is the potential jettisoning of inherently sound strategies during their inevitable bouts of disappointingly low returns (a/k/a whipsaw).  Such bad spells are inevitable because plump net real returns of the sort targeted here (5+% annualized over meaningfully long horizons) can’t realistically be achieved without potentially prolonged periods of below-target returns.[9] 

The most reliable means of guarding against whipsaw is to know what you own and own what you know.  As previously noted, the only reliable means of meeting such standards is to limit one’s universe of eligible investments to the maximum feasible extent.  By my lights, the optimal universe for deployment of the total return-oriented or non-hedging part of the portfolio contemplated by the framework extolled here is one hinted at in Trivia Question #7 posed at the outset of this note: Asian equities.  Leaving aside Asian nations that are off limits to western investors, or have too few or too thinly capitalized public companies to merit inclusion here, the median number of sell-side analysts following the ~22,000 stocks of Asia-domiciled companies alluded to in TQ #7 is zero.  This compares to the corresponding median of seven analysts for the roughly 4,000 listed companies in the US at present (down from roughly 8,000 since I sank into money management in the early ‘80s).

How many of the ~22,000 Asian stocks referenced above meet all of the criteria embodied in the tenets propounded above?  I don’t have a verifiably accurate answer to this question, for two reasons: first, because the criteria are somewhat subjective, with Tenet 4 (favoring abundance mindsets) serving as the poster child for such subjectivity; second, because I know what I don’t know (yet), namely many things I need to know about Asia in order to gain and hold an edge deploying capital in that region.  Strike that: taking Tenet 5 to a logical and IMHO entirely justified extreme, if granted unfettered discretion to shape the universe of assets eligible for purchase within the total return segments of long-term portfolios of the sort conjectured here, I’d enhance my odds of both avoiding whipsaw and gaining an edge relative to other investors by focusing my attention and capital on private as well as publicly-traded companies domiciled in but a dozen of Asia’s 51 nations and dependencies, as follows:

Sources: Worldometers; IMF.  Figures rounded for presentation purposes.  Readers inclined to @me for swallowing seemingly the demographic kool-aid served up by promoters of investment schemes focused on “emerging markets” (EM) should take due note of Japan’s inclusion in the opportunity set furnished above.  Like Ben, who bashed demography-driven EM schema during his ET Live! chat with Rusty on April 2 (premium subscription required), I’m inclined to short rather than go long on investment schema premised primarily on rapid population growth.   

Surrendering Preconceived Ideas.  “If the baseball world is to accept this new system,” Rickey noted in the heretical essay on baseball stratagem referenced repeatedly in this post, “it must first give up preconceived ideas.  I had to.  The [system] outrages certain standards that experienced baseball people have sworn by all their lives.”  The investment paradigm sketched above will outrage some readers, methinks, especially those who view the world’s biggest national economy at present [the U.S.] as the “safest” place to deploy capital and, as a corollary, the biggest economy making the above cut as an unsafe place to deploy capital. 

Truth be told, I myself generally view China as such, due largely to its suspect fidelity to the rule of law.  That said, the scarcity mindset growing increasingly prevalent in the US and Old Europe poses different but clear and present dangers to the rule of law! in such geographies, with the meme just mentioned (rule of law!) serving as shorthand for the intricately woven but increasingly frayed fabric of legal, commercial, social and political norms on which investors in US- and Europe-domiciled companies have customarily relied to safeguard and indeed nurture their ownership stakes.  All of which is to say that, while I’m as opposed to non-zero fixed or policy allocations to Chinese stocks as I am to such rigidities respecting US or European equities, I certainly wouldn’t exclude Chinese stocks from my hoped-for circle of competence (defined broadly to include Asia- or China-focused managers deploying capital entrusted to me). 

Nor would I pursue policies entailing unduly high bars to the ownership of equities denominated in currencies issued by any of the countries comprising my self-selected opportunity set, China not excepted.  Indeed, convinced as I am that Ben has divined rightly that “competitive and single-play games” have displaced “cooperative and multi-play [ones]” in international politics and economics, I’d assign better-than-even odds to the US dollar’s displacement as the world’s dominant reserve currency within the next quarter century or so.  I doubt the Chinese yuan or indeed any other currency excepting possibly gold will ascend to the throne that USD seems destined to vacate, of necessity or choice.  But I’m reasonably confident that by the time Mike Trout takes his rightful place in baseball’s Hall of Fame a decade or two from now, the global economy will be divided into three major currency blocs, with China, Germany and the US each spearheading the bloc in which their national currencies sit. 

I’m reasonably confident too that the scarcity mindset increasingly manifest in American politics and economics will produce ultimately a material downward revision in the US dollar’s value relative to both gold and a sensibly weighted basket of its “trading” partners’ currencies, with “trading” defined broadly to include services as well as goods.  Obviously and perhaps sadly for Americans lacking overseas holdings or other means of profiting from dollar debasement, USD devaluation to the degree divined here would generally flatter the Asia-centric investment program delineated above, spawning as it likely would currency-related gains on non-US stocks even after factoring in valuation shifts commonly associated with major currency moves. 

(If you’re unfamiliar with how and why such shifts occur, you should be especially wary of any raccoons investment pros seeking to manage your money for a fee while assuring you they have everything under control.  “Investing is simple,” one often hears, “but not easy.”  In fact, effective investing is neither simple nor easy, least of all for investment pros forced unavoidably and unendingly to balance their own pecuniary needs against their clients’ wants and needs.)    

Finally and not obviously, in the unlikely event that America scores decisive victories in the “competitive and single-play games” in which it seems destined to participate in coming years and beyond, I’d expect the Asia-centric investment program endorsed here to produce long term returns not merely matching but likely besting those produced by US-centric alternatives.  Why?  Because the restoration of Pax Americana that such victories would both presuppose and promote would almost surely put strong and steady winds into the sails of the Asian economies identified in the table above, including especially India (my single favorite target for capital deployment in coming decades) as well as smaller Asian nations likely to fare better on balance if Uncle Sam’s traditional values of liberty and justice for all triumph ultimately over Uncle Xi’s evolving ethics, such as they are.  Heads I win, tails I don’t lose.  That’s the ticket, we’d all agree — even if we can’t agree on the surest means of dialing such asymmetry into capital allocation protocols. 

Indeed, mindful as I am that the policy prescriptions proffered here may create a “widening gyre” (to quote Ben quoting Yeats) of opinions within the ET Pack respecting prudent approaches to capital deployment, I’ll try in my next note to inject centripetal forces into the mix by presenting to the Pack the single best metric known to me for gauging long term investment success.  By my lights, it’s as relevant today as it was when its principal modern proponent first drew it to my and other investment wonks’ attention in 2005.  Mike Trout was a young teenager playing baseball for free back then; and the so-called sabermetrics revolution that’s changed materially the metrics baseball cognoscenti employ for gauging ballplayers’ worth had only recently commenced.  As will be seen, just as sabermetrics is rooted in methods devised many years earlier by the great and good Branch Rickey, the money metric I’ll discuss approvingly in Note #8 is rooted in methods of gauging financial abundance devised long before the first MLB game was played 143 springtimes ago.


PDF Download (Paid Subscription Required): Notes from the Diamond #7 – Hittin ‘Em Where They Ain’t (Part 2)


On Deck

In search of excellence when gauging excellence


[1] Many lovers of sport including some lovers of baseball think MLB games have become too long and devoid of action since computer-based analytics came to the fore in pro baseball several years ago.  I share such concerns, with a carve out for games unfolding glacially at Fenway, and plan to discuss them plus potential remedial measures in a future note.

[2] You can check my math here, applying to Trout’s newly contracted pay package the 52% effective tax rate I’ve assumed here or whatever alternate rate you deem sensible given the idiosyncratic manner in which salary payments received by peripatetic entertainers like Trout get taxed.  Like rock stars on tour — which Trout essentially is — MLB players pay state-level income taxes pro rated to the number of days they play in a given state each season, taking credits against their home state’s levies.  As a New Jersey resident for tax purposes, Trout is poised to fork over a minimum of at least 9% of his pay in state taxes, with half or more of his salary being subjected to the ~13% tax extracted by the state in which Trout and his Angels teammates play half of their regularly scheduled games each season: California. 

[3] As Ben Hunt wrote when elevating the term to its rightful place as a key concept in Epsilon Theory (here), “zeitgeist” “is the macro scale of our social lives as investors and citizens.”

[4] Bench’s extraordinary gifts as a ballplayer are captured nicely in the brief profile posted here.

[5] Though capitalization weighting stocks for passive investment purposes is demonstrably inferior to other portfolio construction methods on a pre-tax basis, even a cap-weighted index like the S&P 500 has displayed historically and will likely continue displaying asymmetry of the sort alluded to here: the longer one lengthens the time periods over which returns are examined, the higher the percentage of positive outcomes rises.  Hence, even if the odds of investing in broadly diversified portfolios like the S&P 500 aren’t mispriced (and good luck diving inflection points in such mispricing), they are unarguably favorable in positive payoff terms for truly long-term investors.  The defects of cap-weighted portfolios are catalogued cleverly in a 2006 paper by Jason Hsu posted here and in a 2018 research note by Jason and his former Research Affiliates colleagues Rob Arnott and Vital Kalesnik posted here.

[6] Using the least-worst available metric for gauging baseballers’ on-field contributions to their team’s success (a cumulative measure known as Wins Above Replacement or WAR), Trout’s achievements as both a batsman and outfielder since his big league career commenced at age 19 in 2011 have already elevated him to a Top 150 spot in MLB’s all-time list of players ranked by WAR: when his ninth season as a big leaguer commenced in March 2019, Trout had compiled a lifetime WAR of 64, which is roughly equal to the median WAR for the 261 players (including four 2019 inductees) comprising baseball’s Hall of Fame.  Think Trout will join their ranks eventually?  Me too, especially since he’s already 16th in WAR all-time among center fielders, ahead of nine of the 19 such players who’ve been elected to the Hall.    

[7] As noted in its white paper on OOCs, HK defines an “owner-operator” as “a principal or an owner — often a founder — who is directly involved in the management of a corporation in which he or she maintains a significant portion — ideally the majority — of his or her wealth.”

[8] “Unsustainably undemocratic” as used here refers to the inevitable reformation of arrangements that today give roughly 30% of the American electorate a de facto veto (via the US Senate) over laws governing the residual 70%.  Of course, the same imbalance is manifest in US presidential elections decided ultimately by the electoral college — an artifact of logrolling by America’s founding fathers whose eventual elimination could and likely will entail political if not also social unrest inimical to the interests of passive investors in broadly diversified portfolios of US stocks.

[9] Ping me via dsalem@epsilontheory.com if you’d like to review data supporting this assertion.  Alternatively, take a look at the characteristically fine Wall Street Journal piece that my pal Jason Zweig crafted after he laid hands on the data in question.


Notes from the Diamond #6: Hittin’ ‘Em Where They Ain’t (Part 1)


David A. Salem
Email: david.salem@epsilontheory.com
Twitter: @dsaleminvestor

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Part 1: Zest in the Pursuit

Keeping Busy.  To help myself and perhaps other members of the ET pack move through the current MLB off-season more productively than Rogers Hornsby moved through the many off-seasons he endured,[1] I’ve crafted a two-part note about a cardinal challenge in both baseball and investing: hittin’ ‘em where they ain’t.  Part 1 focuses on pros who’ve met this challenge uncommonly well; Part 2 (slated for publication as spring training shifts into high gear later this month) will focus on means that investors might employ to meet this challenge in coming years and beyond.

Pet Peeve. The prior note in this series (Note #5) focused on personal traits enabling certain players to achieve greatness in investing or baseball, and ended with a question about one such great:

What would’ve become of the PE [private equity] industry if, instead of devoting a large fraction of Yale’s endowment to PE, [Yale CIO] David Swensen had deployed all such capital via managers investing exclusively in publicly traded stocks of owner-operated firms?  ‘Tis hard to say, but I’ll try … in my next note.

Before tackling the foregoing question, I feel compelled to do two things.  First, I’ll encourage readers who haven’t digested fully Note #2 (on excessive “juicing” by private equity and baseball pros) and the aforementioned Note #5 (on excessive mimicry of “the Yale model”) to do so before reading what follows, parts of which may seem naïve absent such auguries.  Second, I’ll raise and answer a question that’s both central to this series and worthy of more attention than it typically attracts in discourse about greatness in investing or baseball: what metrics should be used to distinguish truly great practitioners from merely good ones? 

To be sure, with computer-based analytics having transformed both the playing and business of baseball since the current century dawned, pros in that arena devote not merely ample but arguably excessive airtime to quantifiable metrics when grading past or current pros, be they on-field players or execs.  But there’s scant agreement on optimal metrics for divining true greatness in baseball, even and indeed especially respecting criteria for election to its Hall of Fame, and frustratingly scant discussion of optimal metrics for divining competence let alone greatness in finance. 

Pray tell, when was the last time you heard Paul Krugman an “expert” in finance articulate the precise metrics and time horizon underlying whatever critique of the Fed’s evolving policies they’re serving up on Bloomberg or CNBC?  Dunno ‘bout you, but I haven’t encountered such exactitude from a talking head since the San Diego Padres last won the World Series (WS).  That would’ve been … never, the Padres being the longest established MLB team to never win it all: 49 years and counting.[2] 

Gold Standard.  Why demand precision respecting both the metrics being used to gauge results and the time horizon over which they’re being applied when grading fiat-enabled capital allocators like Fed chair Jay Powell as distinct from return-oriented allocators like Swensen or me or perhaps you?  Why not?  If, as Ben Hunt argues persuasively in You Are Here, modern capital markets have morphed into political utilities, it seems not merely fair but essential that we ask whether such utilities’ ongoing administration is producing the optimal deployment of capital — taking due care to define optimal, of course.  By my lights, optimal in this context means the deployment of financial capital that enables the maximum number of citizens to achieve their full potential under whatever boundary conditions the allocators being judged are laboring and neither created themselves nor have the power to change

The italicized caveats are crucial, as exemplified by the tenures of the greatest and least-great Fed heads in my lifetime: Paul Volcker, Fed chair for eight years starting August 6, 1979; and William Miller, Fed chair for 17 months ending the date Volcker started.  Miller didn’t create the stagflation that gripped the US economy in the late 1970s; indeed, given Volcker’s not insignificant role in Richard Nixon’s decision to end the greenback’s convertibility to gold in 1971, Volcker arguably deserves no less blame than Miller for the stagflationary conditions both men encountered during their tenures atop the Fed.[3]  That said, Miller himself took no effective steps to end such torpor — a scourgewhose ultimate purging by Volcker makes his tenure at the Fed the gold standard for greatness in not only central banking but arguably also in capital allocation broadly defined.

For me, that standard or test is simply stated: did the person being graded act boldly enough for long enough to boost materially and sustainably the achievement of human potential? 

Strikingly Similar.  Which past or present players in investing or baseball meet the test for greatness just proffered while also serving as useful case studies for contemporary readers seeking to elevate their own games? 

Many candidates come to mind, some of whose achievements were flagged in prior notes and will be discussed further as this series unfolds, e.g., investor par excellence Jeremy Grantham and baseballer par excellence Joe Torre.[4]  Here and now, however, the tidiest answer I can give to the question just posed while also moving toward an eventual answer (in Part 2) to the counterfactual query raised at the outset of this note is by comparing the words and deeds of the investment pro mentioned in it to those of a legendarily accomplished baseballer whose temperament and indeed origins resembled Swensen’s: Branch Rickey.

Clear Eyes.  Like Rickey, who lived in central Ohio from his birth through completion of his undergrad studies at Ohio Wesleyan, Swensen trod a conventional path to and through college, earning a bachelor’s degree from the UWisconsin branch where his father served as dean of the college and chemistry department chair (UW-River Falls) and from which all five of Swensen’s siblings would also ultimately earn degrees.  So far as I can tell from published accounts of both men’s dealings as well as conversations with Swensen himself, their early 20s were essentially the last intervals in their lives when either Rickey or Swensen fancied getting along to even remotely the same degree as getting ahead.

Indeed, as Lee Lowenfish’s fine biography of Rickey makes plain, and as the ever-expanding universe of writings by and about Swensen makes equally clear, both men rose to the top of their chosen professions by practicing doggedly what Rickey’s fellow Hall of Famer Willie Keeler preached in his oft-quoted response to a reporter’s query about hitting: “I have already written a treatise [on the subject]”, Keeler crowed, “and it reads like this: Keep your eye clear and hit ‘em where they ain’t.[5]

Man vs. Machine.  While never easy, practicing what Keeler preached is markedly more difficult for current pros in both baseball and investing than it was in Rickey’s day.  There are multiple reasons why, including the adoption in both fields of genuinely meritocratic criteria for recruitment and advancement (more on which below) as well as a more dominant catalyst for change that Rickey lived and died too soon to have confronted in the workplace (and likely mastered if given the chance): computer-based informational technologies and the quantitative methods for deploying capital they facilitate. 

Importantly, in both pro baseball and investing the capital being deployed via increasingly quantitative or formulaic methods comprises human as well as financial capital, with the latter (money) being used routinely to obtain the former (talent) in baseball, via market-clearing contracts for free agent players and coveted executives, and with money in the form of fees being used routinely to obtain the asset management talent institutional investors deem essential to achievement of their stated return goals.[6]

Crowded Trades.  As the fine folks at Vanguard among other straight-shooting investment pros have observed, many institutional funds are pursuing return goals they have little or no chance of achieving.  More precisely, such funds have little chance of achieving their stated return goals with their current policies and strategies — means not uncommonly adopted with the specific aim of being “like Yale.”  Paradoxically, as suggested in Wannabes Beware, one reason among others why most institutional funds bent on parroting Yale will fail in the effort is because Swensen has proven so maddeningly effective in preaching publicly what he’s practiced during his commendably long (1985 – present) and ongoing tenure as Yale’s CIO.

To be sure, the illiquid strategies that Swensen has used so effectively on Yale’s behalf — comprising the lion’s share of Absolute Return plus all exposures above it in the nearby graph — haven’t attracted unduly large commitments from institutional investors as a group merely because David has expounded eloquently about them. Rather, locking up capital to the degree Swensen has on Yale’s behalf has become SOP in institutional funds management because in that arena, as in pro baseball, success breeds copycats.

Swensen’s success surely has, as did Rickey’s in developing a system for player recruitment and development that’s served as table stakes for MLB teams since it began producing riches for the Rickey-led Cardinals a century ago. 

Kevin Kerrane tells the tale briefly and well in Dollar Sign on the Muscle: The World of Baseball Scouting:    

[F]rom 1913 to 1917, [Rickey] experimented briefly with the idea of a farm system—direct control of minor-league teams by the major-league parent organization … The farm system was a strategy for saving money: instead of bidding against other major-league teams for minor-league players, Rickey wanted to grow his own.  After World War I, when the minors were in a financial slump, Rickey put his strategy into effect … [B]y 1939, the Cardinal empire included 32 minor-league teams and about 650 players. 

The Cardinals bought pitcher Jess Haines in 1920, and purchased no more players until 1945.  The system did save money. But it made money, too. Rickey was able to generate such a steady supply of young talent that he could sell off the excess at a nice profit, while providing the Cardinals with enough manpower to win nine pennants by 1946 … The competition among so many young players in the system operated as a kind of natural selection.  The minor-leaguers could be left on the farms until, as Rickey liked to say, they “ripened into money.” [Emphases added]

Searching Far and Wide.  As noted in the nearby box, building the pro sports equivalent of an early stage venture program was but one of several innovations Rickey conjured to better the various MLB teams he headed. 

Famously, one such initiative bettered not merely Rickey-led teams but America’s national pastime and indeed the nation more generally: the recruitment and ultimate promotion to the big leagues of non-white and foreign-born players

Like Swensen’s move decades later to expand materially the pool from which Yale draws money management talent by adding a globally diverse array of proven or promising players in illiquid investing to it, Rickey judged correctly that expanding the pool from which his teams drew talent by adding blacks and foreigners to it would pay off big time.  It did, with the more genuinely meritocratic criteria for roster construction that Rickey pioneered — like other innovations with which he’s rightly credited — ultimately becoming table stakes for MLB franchises seeking to field winning teams.[7]  Indeed, as of the most recent date for which reliable data are available (Opening Day 2018), 38% of players on MLB rosters were African-American or foreign born, including many of the sport’s most talented if not also most beloved stars.

Told You So’s.  No one can know for sure until the blessed day arrives how many African-American or foreign-born players will grace MLB rosters when the 2019 regular season commences on March 28.  Barring injury, however, one non-American who made his major league debut in 2018 will likely make the cut — for reasons that would’ve elicited cheers if not also an “I told you so” from Rickey.  Born and raised in Venezuela, 27 year-old Willians Astudillo hasn’t done anything as a pro baseballer that would’ve commended him to MLB front offices during Rickey’s many years heading such offices, unless they were headed by Rickey himself. 

Willians Astudillo at the plate for the Twins in 2018

Ever heard of Astudillo before reading this note?  If yes, it’s for one or both of two reasons: (1) an attractively brief and hugely fun video of his homer in a recent winter league game went viral or (2) Astudillo’s remarkable consistency in avoiding strikeouts — a prized skill indeed at any level of play in baseball — has created a big buzz in MLB circles, teeming as they are in the post-Moneyball era with quant jocks cranking out advanced statistics.

There were no such geeks holding full-time posts in pro baseball, and no advanced stats worthy of the name being compiled in baseball circles, until Rickey hired an immigrant to crunch numbers for the Brooklyn Dodgers in 1947.  Over the next four decades, a Montreal native and former NHL statistician named Allan Roth helped first the Dodgers and in due course not fewer than 20 MLB teams develop enhanced methods for allocating both human and financial capital — on the field (via shrewder defensive positioning and other tactics) and off it (via shrewder personnel policies). 

Roth also helped burnish Rickey’s reputation as “the Brain” of pro baseball by ghost-writing parts of “Goodby [sic] to Some Old Baseball Ideas” — a storm-the-ramparts piece published in Life magazine in 1954 that Michael Lewis mentions briefly in Moneyball, his 2003 bestseller on Billy Beane’s surprisingly lonely efforts as a modern GM to practice what “the Brain” had preached a half-century earlier.  

Lonely No Longer.  However lonely Beane (or Rickey) might have felt using methods that rival GMs deemed imprudent or distasteful, such loneliness was destined to fade.  And so it did, rapidly and rather fully as the Aughts progressed, owing partly to Lewis’s authorial skills and in larger part to Beane’s and later Red Sox GM Theo Epstein’s conspicuous success implementing such methods (a/k/a sabermetrics).[8] 

Similarly, however lonely Swensen (or his longtime and unfailingly supportive investment committee chair Charley Ellis) might have felt using methods that rival CIOs deemed offputting, such loneliness was also destined to evaporate, owing partly to Swensen’s powers of persuasion and in larger part to the stunningly good returns Swensen notched in the years surrounding his pathbreaking book’s initial release.[9] 

Selfish Concerns.  Having fretted publicly at the time of Pioneeering Portfolio Management’s initial publication in 2000 about its potentially deleterious impact on my longtime and highly rewarding vocation (managing money), I fretted privately at the time of Moneyball’s publication in 2003 about its potentially ugly impact on my favorite and generally lovely avocation (watching baseball). 

Sad to say, the concerns just referenced have proven well-founded, with low hanging fruits as well as most harder-to-reach edibles in the illiquid niches that Swensen helped popularize now getting eaten by institutional pachyderms even before they ripen, and with MLB games getting longer and generally more predictable as quantitative methods increasingly supplant intuition as the primary basis for decision-making in dugouts as well as front offices.

(Please don’t tell my kids, whose company I’m keen to continue having for Bosox games at Fenway, but the fraction of plate appearances ending with balls put into play has slumped discernibly since the so-called sabermetric revolution in MLB commenced — from about 74% in 2003 to about 68% in 2018— with strikeouts as a percentage of such appearances moving steadily and depressingly in the opposite direction: roughly 22% in 2018 versus roughly 16% in 2003.  More on such trends — and parallel trends in institutional investing, such as they are — as this series unfolds.[10])

Multi-Tasking.  Don’t get me wrong.  I still love investing, and watching baseball, and please don’t tell my clients — doing both simultaneously.  And I’m confident both domains will continue producing greats as defined above: pros acting boldly enough for long enough to boost materially and sustainably the achievement of human potential. 

Rickey and Swensen certainly qualify as greats by my lights, passing the test just mentioned and in certain respects an even sterner test of greatness for capital allocators of all kinds including but not limited to baseball execs and endowment CIOs: did the allocator being judged not merely handle effectively the external boundary conditions he or she confronted but take effective steps to reshape them in a socially beneficent manner?

Rickey obviously did, as Americans will be reminded anew in coming months via festivities MLB has planned to mark the centennial of Jackie Robinson’s birth.[11]  Swensen’s reshaping of boundary conditions governing his professional labors, while less obvious and momentous than Rickey’s earlier reshaping of his, has been material and laudable nonetheless.  By shifting meaningful fractions of Yale’s investable wealth out of marketable securities in general and tradable bonds in particular into illiquid assets better suited to the profitable exploitation of endowed charities’ perpetual life status, Swensen has created the proverbial win-win, lowering the cost of capital for enterprises in which Yale has invested while simultaneously boosting returns on Yale’s investable wealth.

As this unlocking of institutional potential has progressed — initially and most intrepidly at Yale and in due course at other institutions with so-called permanent capital to deploy — it  has catalyzed a parallel unlocking of human potential, with many intelligent and energetic investment pros granted opportunities that earlier generations of workaholics lacked to deploy such capital in a manner befitting its presumed longevity.

No One’s Perfect.  I recognize that the prior paragraph may make some readers gag, the illiquid strategies it commends having destroyed perhaps more wealth net of fees than they’ve created for institutions employing them as a group.  I recognize too that, as could rightly have been said of Rickey, Swensen’s rigorously data-driven approach to capital allocation hasn’t produced uniformly enlightened decision-making.  Obviously, none of Swensen’s slips have been bad enough to knock him off his lofty perch in his chosen profession, as happened twice to Rickey after he became a big shot in pro baseball: “demoted” (as Rickey saw things) from on-field manager to “business manager” (and de facto GM) by the Cardinals in 1925, Rickey underwent similar humiliation four decades and multiple championships later, when the same Cards terminated Rickey’s contract as the team’s sage-in-residence following its triumph in the 1964 World Series. 

Regrettably for Rickey, but fortunately for Swensen and me and perhaps you, managing money tends to be a more forgiving line of work than managing big leaguers.  While there’s certainly truth in Rickey’s oft-quoted boast remark that “luck is the residue of design,” let’s be honest: to a much greater extent in money management than in baseball, pros can commit impactful errors and still come out on top.  This is especially true of errors of omission, which Swensen arguably made in applying the tenets flagged in the nearby box when and how he did, and that many US-based institutional investors are arguably making as the current century unfolds.

Admittedly, none of the tenets just referenced has proven fundamentally unsound since Swensen’s painstaking studies of capital market history caused him to apply them on Yale’s behalf starting around the time the aforementioned Volcker wrapped up his winning campaign to bend general price inflation downward.  That said, if it’s OK for Rusty Guinn Astros fans to disparage that otherwise superbly managed team’s 2014 decision to “outright” or fire J.D. Martinez at what proved to be the start of a multi-year (and hopefully continuing!) stretch as one of the best power hitters in baseball, it’s presumably OK for Swensen votaries including me to note that bonds have performed much better relative to stocks over the full sweep of David’s tenure than his grand design for Yale’s endowment supposed, especially on a risk-adjusted basis.

Walking the TalkMy fellow ET contributor Peter Cecchini examined the phenomenon just referenced in a recent post, so I won’t discuss it further here, except to say this: as Peter hints, applying data-driven methods like those Swensen used to fashion “the Yale model” back in the day when fashioning investment policies in 2019 would be a mistake of potentially Snodgrassian proportions.[12]

Strike that: there’s nothing wrong with making data as distinct from tradition or intuition king in the policy-making process, as Swensen did as a novice CIO or as Rickey and Roth did for the Truman-era Dodgers, so long as one uses the best available data.

Having bemoaned above the tendency of finance types to opine on all manner of things without articulating clearly the metrics and time horizon underlying such judgments, I’ll walk that talk here by noting that “best” as I’ve just used it means data germane to the deceptively difficult task of enhancing the real or inflation-adjusted value of invested capital over the next 35 years. 

Why 35?  Because I haven’t a clue how materially societal and technological changes will affect the future duration of generational cycles; and the 35 year investment horizon that the estimable Dr. Hunt has referenced in Pricing Power (Part 1 and Part 2) strikes me as an attractively precise substitute for what I really have in mind: a mindset compelling fiduciaries deploying capital today to weigh the interests of future beneficiaries of such capital at least as heavily as the current generation of same.    

Clearly, not all readers are aiming to enhance real wealth over such an extended horizon, even with small portions of their investable wealth.  Just as clearly, many endowed charities are, with the typical publicly supported non-profit impliedly seeking annualized real returns in the range of 4-5%: ongoing enhancements to real wealth needed to offset such orgs’ customary endowment spend rates of 4-5%.[13]

What to Do?  Where in the world can today’s investors deploy capital with reasonable assurance of earning annualized real returns of 5% or more over long and potentially indefinite holding periods?  Just as no wonk worth listening to on monetary matters should critique the Fed’s evolving policies without stating clearly the metrics and time horizon he or she is using to gauge such policies’ success, no hired gun worth canvassing on the real return quandary just referenced should address it without first pushing the ultimate owners of any such capital to articulate with reasonable clarity the types and degrees of risk they’re able and willing to tolerate.  That said, I’m skeptical any strategies the typical investment committee at work today would readily endorse will do the trick, least of all US-focused PE of the sort Swensen funded aggressively and adeptly when most institutions would not and could not.  

Indeed, even as Yale wannabes continue ignoring data Swensen himself cited in Pioneering Portfolio Management respecting PE funds’ ugly tendency to underperform comparably leveraged investments in marketable stocks, stewards of long-term capital outside as well as within the endowment arena are generally ignoring readily available data pointing them toward plausible solutions to the real return quandary raised above.  I alluded to such data in the still unanswered! question with which this note opened and will discuss them and the investment pros who’ve brought them to my attention in Part 2 of this note.  As will be seen, like the astute allocators on which this post has focused — Swensen and Rickey — the pros in question seem to take special delight in hittin’ ‘em where they ain’t.

End of Part 1

PDF Download (Paid Subscription Required): Notes from the Diamond #6 – Hittin ‘Em Where They Ain’t (Part 1)


On Deck

Hittin’ ‘Em Where They Ain’t – Part 2: Addition by Subtraction

Jackie Robinson with Dodgers manager Burt Shotton and teammates (1947)

[1] Born in 1896, Hornsby was a player, player-manager, or off-field exec in pro baseball from 1915 until shortly before his death during the 1962-63 offseason.  Having notched 2,930 fewer MLB hits than Hornsby — generally regarded as the best right-handed hitter in MLB history — I’m hardly one to critique anything he did or didn’t do.  That said, Hornsby might have enjoyed offseasons more if he’d permitted himself to read or watch movies.  He refused to do either during his 23 seasons as an active player (1915 – 1937), convinced that doing so would harm his eyesight.  FWIW, Hornsby didn’t smoke or drink either.  He did gamble, however, compulsively and lucklessly enough (on horse races) to necessitate his working for pay during the entirety of his 25 years as an ex-big leaguer.

[2] Hope springs eternal in Sandi, however, especially for Padres fans with multi-year time horizons: taking a page from the team that won the most recent World Series using a strategy discussed at length below, the Padres have built what is widely viewed as the top farm system in pro baseball as the 2019 season approaches.  If the immediate past serves as reliable prologue to the future — a concededly shaky premise in baseball no less than investing, as also discussed below — the Padres will be world champs within a half-decade, that being the approximate interval between the Red Sox’s zenith in annual talent rankings of MLB farm systems earlier this decade and the team’s most recent World Series win (in 2018). 

[3] Readers seeking more info on Volcker’s role in Nixon’s abandonment of the gold standard in 1971 could do worse than start with the brief history of this decision published by an organization that, like this author, thinks Volcker subsequently did a superb job as Fed chair.  The Hoover Institution’s brief piece on the topic is available here

[4] I’m also planning to write about a pro whose guts and smarts would’ve made him a Hall of Famer if certain team owners hadn’t been so short-sighted and selfish: Fay Vincent, Commissioner of Baseball for a depressingly brief three years ending in September 1992.

[5] Lowenfish’s Branch Rickey: Baseball’s Ferocious Gentleman (2007) remains the best of the multiple Rickey biographies published to date IMO.  No full length biography of Swensen has yet appeared, but much has been written about David’s distinctive personality and methods, including the prior note in this series; a 2017 talk given by this writer (available upon request via dsalem@epsilontheory.com); and, most importantly and authoritatively, in Swensen’s pathbreaking book on institutional funds management and annual reports published by Swensen’s office  available here.

[6] Of the many books about the impact of computer-based analytics on pro baseball, the one I’ve found most illuminating is Travis Sawchik’s Big Data Baseball: Math, Miracles, and the End of a 20-Year Losing Streak, published initially in 2015.  With help from another brilliant baseball wonk (Ben Lindbergh), Sawchik has completed a second book on the steadily rising level of play in pro baseball (off and on the field) that’ll be released in June 2019 — The MVP Machine: How Baseball’s New Nonconformists Are Using Data to Build Better Players.  Perhaps because I’m more intimately familiar with the use and abuse of data science in finance than in baseball, I haven’t identified any books on quantitative methods for investing that I deem must-reads.  If I had to point ET faithful to a single such book while also honoring the principle that it’s better to teach hungry folks to fish than to hand them fishes, it’d be Benoit Mandelbrot’s 2006 classic The Misbehavior of Markets: A Fractal View of Financial TurbulenceFWIW, I try to read every word written by my friend and quant jock extraordinaire Mark Kritzman; a compilation of Mark’s remarkably voluminous writings is available here.

[7] Revenue-sharing protocols generally enable MLB franchises with aggregate big league payrolls beneath the threshold for MLB’s “luxury tax” ($206 million for 2019) to operate in the black even if their big league teams post losing records and miss the playoffs year after year.  How long this not unhappy condition for many team owners (MLB’s equivalent of closet indexing by active money managers?!) can or will last is an open question to be explored in future notes.  As will be seen, tensions between team owners on the one hand and an arguably overmatched players union on the other are mounting in a manner redolent of the widening gyre in American politics on which Ben Hunt has shed useful light in Things Fall Apart.  Whether America’s next national elections on November 3, 2020 will produce a day of reckoning for certain politicians or political views remains unclear.  But it’s virtually certain that a day of reckoning — and perhaps the first work stoppage in MLB since 1995 — will be upon us by this time in 2022, given the 2021 expiry of MLB’s current and increasingly outmoded Collective Bargaining Agreement (CBA).       

[8] This seemingly odd handle for the use of quantitative tools in baseball analytics derives from the leading association of such tools’ users: the Society of American Baseball Research (SABR), founded in — where else? — Cooperstown, NY in 1971.

[9] Over Yale’s six fiscal years ending June 30, 2003 — an interval embodying a wild ride for investors as a group — Yale’s endowment outperformed a 60/40 stock/bond mix by an eye-popping annualized margin of 12.3%: 14.3% per annum for Swensen’s bulldogs vs. 2.0% per annum for puritans maintaining a 60/40 mix of the S&P 500 and a broad US bond index (BBAgg).  Crucially for institutions pondering during the early Aughts whether they wanted to “be like Yale,” Swensen trounced the 60/40 bogey during both bull and bear markets for stocks: 23.1% vs. 6.1% annualized returns in the three years ending June 30, 2000 followed by 7.0% vs. -2.7% annualized in the three years ending June 30, 2003.

[10] Sports fans who deem football superior to baseball due to football’s seemingly zippier pace should note that the average NFL game takes roughly the same amount of time to play as the average MLB game (a tad over three hours) but with roughly one-third less ball-in-play time on average in the NFL than in MLB (12 vs. 18 minutes/game).

[11] MLB will surely and rightly stage similar events in 2034 marking the centennial of the birth of the greatest Latino player in MLB history: Roberto Clemente (1934 – 1972).  A fun and well-researched account of how the Rickey-led Pirates “stole” Clemente from the Dodgers during the 1954-55 MLB offseason is available here.

[12] Though He Who Must Be Not Named can plausibly lay claim to having made the worst error in MLB history (in Game 6 of the 1986 World Series), Fred Snodgrass of the then-New York Giants is viewed by most baseball historians as having committed the worst such gaffe: a dropped fly ball in the final game of the 1912 Series — won ultimately by the team that lost the Series in ’86!

[13] Unlike publicly supported .orgs and .edus that engage routinely in fundraising and are generally free to adopt whatever endowment spending rates (and corresponding return goals) they wish, private grantmaking foundations are subject to minimum payout requirements dictated by Congress. These strictures cause such foundations to  distribute mandatorily an average of about 5% of their wealth each year.

Notes from the Diamond #5: Wannabes Beware

If the Lord were a pitcher, he would pitch like Pedro [Martinez]. 
 — Pro baseballer David Segui

Plagiarism is the cardinal virtue of investing.
— Pro investor Jeremy Grantham (?)


Trivia Question #5 of 108: Which of the following phenomena has occurred just once since the inception of Major League Baseball (MLB) in 1876?  When choosing among the options listed below, note that in 143 years of MLB competition, 217,082 games have been played, with well over 30 million pitches thrown during almost 15 million at-bats.

A – A player’s mother hit and injured by a fouled-off pitch thrown by her son on Mother’s Day. 
B – A spectator hit and injured by two foul balls hit by the same batter in a single plate appearance. 
C – A player killed by a pitch. 
D – All of the above.


Among the many things investing and pro baseball have in common, perhaps foremost among them is a rich tradition of purposeful mimicry: a conscious copycatting of methods that have worked well for the persons who devised them originally and that can presumably be put to good use by others, competitors not excepted.  Of course, some methods are harder to mimic than others, including the idiosyncratic approach to pitch selection and execution employed by Pedro Martinez during his Hall of Fame career, or the equally inimitable approach to capital deployment employed by my former partner and valued mentor Jeremy Grantham.  Jeremy has served up so many witty and wise tidbits about investing since my path first crossed his 35 years ago that I’ll credit him as the original utterer of the above wisecrack about our shared profession’s cardinal virtue — even if Jeremy borrowed it from someone else or, contrary to my recollection, never uttered it as quoted here. 

If indeed Jeremy borrowed the wisecrack in question from another sage, that act might be the only instance of his having engaged in plagiarism, trivial or otherwise: like select pros in both baseball and investing who are properly deemed original thinkers, Jeremy constitutes an exception proving the rule that copycatting of demonstrably successful methods is a logical means of gaining an edge in either of the two arenas on which these notes focus — baseball or investing.

The problem with copycatting, of course, is that it’s not a wholly reliable means of getting ahead in either baseball or investing — endeavors in which changing circumstances beyond a player’s control or divination can affect outcomes to a substantial degree.  ET faithful know well whereof I speak respecting uncontrollable and unforecastable forces affecting asset prices, Ben Hunt having discussed such phenomena eloquently and arrestingly in his seminal essay The Three-Body Problemand follow-on series Things Fall ApartFocusing as this note does on the varied fortunes of wannabes in baseball and investing, it necessarily discusses how chance events have helped shape such fortunes, sometimes for the better, as with arguably the most skilled capital allocator in recent decades (Yale CIO David Swensen), and sometimes for the worse, as with the persons on whom the trivia question above focuses.  Sadly, the correct answer to that question is D — All of the Above — Hall of Fame pitcher Bob Feller’s mother having been smacked by a fouled-off pitch thrown by her son on Mother’s Day 1939; Richie Ashburn of the Phialdelphia Phillies having hit spectator Alice Roth with two bone-breaking foul balls in a single at-bat in 1957; and Ray Chapman having been killed by a pitch in 1920 under circumstances worthy of contemplation by risk-takers of all kinds, including especially those of us — perhaps most of us? — inclined to mimic others’ winning ways rather than attempting to fashion our own.

Amazingly, on the very day that Chapman got beaned, a how-to manual for young baseballers was published featuring images of Chapman and other MLB stars doing things that gave each of them a presumed edge.  Chapman’s highlighted forte was a batting stance that the manual’s author (baseball writer par excellence John Sheridan) deemed “the perfect model for all baseball players in his position at the bat.” 

Alas, such athleticism was of no help to Chapman during his ill-fated final at-bat, confronted as he was by a pitcher — Carl Mays — whose “submarine” delivery made it hard for even skilled batsmen like Chapman to see let alone hit balls Mays flung toward them.  Chapman’s difficulties that fatal day in 1920 were compounded by a heavily soiled ball — an acute hazard for batters obsoleted by rules changes catalyzed by Chapman’s death, to the unending gratitude of ball purveyors enriched by MLB’s post-1920 policy of jettisoning balls showing the slightest signs of wear and tear.  Unable to see the pitch that ultimately killed him, the normally nimble Chapman remained immobile during the roughly half-second it took for the ball to travel from Mays’ hand to his unprotected skull.  (Batting helmets hadn’t yet been invented and didn’t become mandatory in MLB until 1970).

What useful lessons if any might wannabes in baseball (or investing) like me (or you) draw from Chapman’s untimely beaning?  Two such lessons come to mind — both easily synopsized and both serving as useful segues to the discussion of conscious copycatting’s perils that constitutes the remainder of this note.

The first lesson gleanable from Chapman’s final at-bat is perhaps obvious: beware changed boundary conditions that render proven methods useless at best and hazardous at worst (e.g., a darkened ball hurled in a highly unconventional way). 

The second lesson is more subtle but even more germane to the sorry and indeed ongoing saga of the sizable slice of investors who’ve tried and failed to “be like Yale”: beware the use of demonstrably successful methods bereft of their  central virtues. 

[Readers puzzled by my use of slice in the prior paragraph are hereby reminded that it’s the collective noun for a group of lemmings.] 

Until Mays’ pitch hit him, Chapman’s final at-bat didn’t differ in kind from his 3,794 prior trips to the plate, 1,053 of which resulted in hits and all of which purportedly entailed Chapman’s assumption of the “model” stance referenced earlier.  In hindsight, that stance was a necessary but insufficient condition for Chapman’s success and ultimately survival as a batsman. 

This isn’t to say that a baseball wannabe like me or indeed even the most nimble batsman might have dodged Mays’ bullets more successfully than did Chapman on August 16, 1920.  Rather, it’s to say that extraordinary success in most fields of endeavor typically presupposes proficiencies that include but go beyond those susceptible of codification and copycatting — copycatting of the sort undertaken by wannabes convinced that a given “model” will surely yield results for themselves as stellar as those achieved by the model’s initial user(s).

The point just made — the chief point of this note for sorry souls who care little about baseball but lots about investing — was not coincidentally also the chief point of a review of Swensen’s pathbreaking book on institutional investing (Pioneering Portfolio Management) that appeared in Barron’s at the time of its initial publication in 2000:

Rooted as its success is in the idiosyncratic personality of the man who fashioned it, the ‘unconventional’ money management approach that Swensen extols is anything but a guaranteed path to profit for institutions lacking such talent. Indeed, numerous fiduciaries are likely to read this book and do precisely the opposite of what Swensen advocates: commit excessive sums to market niches whose strong past performance has removed the discomfort associated with truly superior investment opportunities.  [Ed.: highlight added]

I’m certain the seer bloke who wrote the review just quoted won’t object to my highlighting of Swensen’s idiosyncracies (more on which later) — because that reviewer was me.[1]  How well did my review of Swensen’s masterwork foretell its eventual impact on institutional investing?  Fairly well, I’d argue, given the massive movement of institutional capital since the book’s publication into two forms of investing that Swensen has long favored: absolute return oriented hedge funds (AROHF) and private equity (PE).  (N.B.: As did Swensen from the start of his tenure as Yale’s CIO until recently, I’m using PE in this note to encompass investments in non-listed companies of all kinds, regardless of stage.)  For good and important reasons, Yale doesn’t disclose how individual managers it employs have performed.  But a careful review of the superb reports that Swensen’s office has published since 2000 confirms that a key tenet of the investment philosophy David devised for Yale during his opening years as its CIO and has implemented faithfully throughout his tenure in that post has proven sound: favor forms of investing entailing superabundant dispersion of returns among investment pros engaged in such activity.

Can skilled allocators like Swensen and the select band of other institutional CIOs trained by him continue booking uncommonly plump profits through savvy manager selection and sizing, especially in the ARO and PE arenas?  For reasons discussed below, I wouldn’t bet against the leader of this particular band, nor its other members, even if the challenges confronting ARO managers that Ben flagged in Three-Body Problem and the overfunding of PE strategies that Rusty flagged in Deals Are My Art Form persist.

What I would bet against is the achievement of hoped-for returns by an ever-expanding legion of Yale wannabes — investors marching along the path depicted in the middle panel of the table furnished at this note’s end.  Prepared originally for an essay by yours truly on the real Yale model and its generally ineffectual copycatting by Swensen wannabes that’s available on request, the table just referenced also talks my own walk, if you will, flagging salient features of my preferred approach to deployment of long-term capital (A Third Way) as this not unhappy century continues to unfold.

Wait: given the growing centrifugation of markets and politics that Ben chronicles so convincingly in Things Fall Apart, how can conscientious capital allocators or citizens more generally be anything but unhappy about the century now unfolding? 

A few palliatives come to mind.

The first such palliative has been and remains readily available at zero financial cost: root for the team that’s won more World Series crowns than any other this century and seems well positioned to win more.[2]

Key Tenets of The Yale Model  
•  Favor equities over bonds – ownership over creditorship
•  Favor inefficient markets – as measured by dispersion of active manager returns
•  Sacrifice liquidity – as a necessary means to the end of exploiting inefficiencies
•  Diversify — to a prudent but not excessive extent

The second such palliative has been in shorter supply than the one just described since the current century dawned, though easier to come by over the last decade than I if not also most investment pros would have predicted if pressed for a forecast as the grim holiday season of 2008 was unfolding.  The palliative in question? Stick one’s nose into the fee trough for purveyors of alternative investments![3]  Constantly replenished as this trough was via massive funding of ARO and PE managers in the decade following publication of Swensen’s book in 2000, it continues to enrich many investment pros despite headwinds for ARO investors resulting from easy money policies pursued by major central banks throughout the current decade.

The third and final palliative for discontent in these disquieting times worthy of mention here is truly scarce — scarcer indeed than the analogous remedy for like ills being pursued by a growing number of MLB teams vexed by their underperformance in recent years.  Mindful as they are that this decade’s most memorably successful teams have relied heavily on draft picks to reach the top, the wannabe teams in question are essentially sabotaging themselves in order to hasten their rebuilds. 

The problem with such a strategy or model — which has undeniably worked well for the Astros and Cubs if not also another World Series winner in recent years that modesty prevents me from identifying by name here — is that the supply of potential draftees capable of reversing an underperforming club’s fortunes is deceptively small.  Indeed, such supply is even smaller than the supply of PE wunderkinds  who’ve contributed so heavily to the Yale endowment’s success since Swensen wrote the book on picking such pros nearly two decades ago: as a careful review of the aforementioned annual reports from Swensen’s office will confirm, Yale has booked uncommonly large gains from PE investments (as well as ARHOFs) during David’s tenure as its CIO, with the lion’s share of such value-added derived from that portion of Yale’s PE program dedicated to venture investing.[4]

No one knows whether or for how long Yale will perpetuate its hugely successful record of backing winning managers, especially in private markets and most notably in the subset thereof comprising early stage investments.[5]  That said, presuming as I do that Yale trustees are wise enough to let David continue serving as Yale’s CIO for as long as he wishes, I’d take the over on Swensen’s continuing success, today’s widespread copycatting of codifiable if not also quantifiable elements of Swensen’s winning “model” notwithstanding.

Of course, the most readily quantifiable element of the Yale model as devised and implemented by Swensen is also its most inimitable: its inventor’s long and ongoing tenure as Yale’s CIO — 33 years and counting.  As a future note on “coaching trees” in baseball and investing will argue, long CIO tenures like Swensen’s typically produce “compounding” in ways and to degrees not readily apparent to persons not engaged in institutional funds management. Uncommonly long and successful tenures like Swensen’s also make plain to serious students of the methods underlying them what casual observers of such labors typically miss, namely the relentless quest for excellence in which the very best players are continuously engaged. 

I discussed the personal qualities animating Swensen’s manifest quest for excellence in the review of his book mentioned above and will return to such attributes before closing this note.  Before doing so, however, I’ll give myself and readers who fancy such jollies a holiday gift by spinning briefly parallel tales involving baseballers whose long and successful careers owed much to their own relentless quests for excellence. 

As all good and perhaps most other Americans are aware, Cal Ripken played in more consecutive games than any player in MLB history (2,632), compiling 3,184 hits in 11,551 at-bats over the course of a career in which “The Iron Man” employed 20-odd different batting stances.  As the accompanying photos hint, none of Ripken’s stances were as distinctive as that of the acknowledged king of strange stances, Kevin Youkilis.  But all of Ripken’s many stances as well as the one and only stance “Youk” used during his salad days in The Show provided a sound foundation for what batting icon Ted Williams called “the single most difficult thing to do in sport”: make solid contact with baseballs thrown by competent big league pitchers.

Cal Ripken displaying two of the 20-odd batting stances he employed during his 21-year MLB career (1981 – 2001) 
Gar “The Batting Stance Guy” Ryness (left) and the Big Leaguer he’s most enjoyed impersonating over the years: Kevin Youkilis (MLB 2004 -2013)

Tellingly, notwithstanding his own ample athleticism and masterful mimicry of star hitters’ stances in countless paid gigs over the years, Gar “The Batting Stance Guy” Ryness has never had an at-bat in a real baseball game above the high school level.  He’s never been so blessed because he’s never developed what Ripken, Youk, and other effective batsmen throughout MLB history have worked hard to hone: a repeatable process for moving their bats through the hitting zone in a manner conducive to making solid contact with baseballs thrown by big league pitchers, regardless of how factors beyond their control or indeed self-initiated changes in their pre-swing postures shape up.

If the paean just offered to getting crucial deeds done in a repeatable and effective manner reads like it was lifted from every checklist you’ve ever used seen for vetting investment pros, that’s by design.  How many such pros work as intensely and tirelessly as Ripken and Youk did during their playing careers to hone methods enabling them to perform key tasks with extraordinary effectiveness?  Not many, IMO.  How many investment pros who fill the bill just submitted have engaged in such intense honing for as many years as Ripken did after achieving fame if not also tidy fortunes?  A vanishingly small number in my opinion and experience, albeit with two pros already saluted in this note being conspicuously among them: Jeremy Grantham and David Swensen.

Leaving fun and happy tales of certain close encounters I’ve had with Jeremy for future notes, I’ll recount briefly here one such tale involving Swensen, plus a similar tale involving arguably the greatest and unarguably the most intensely competitive third baseman in MLB history.

About a dozen years ago, I accepted an invite from David to grab lunch with him following a squash match between us on Yale’s courts that included a long and crucial point that ended with a muffed shot by Swensen.  Midway through lunch, his attention drifted.  He grew silent for a spell, stared down at the table, smacked an open palm on it, and muttered unsmilingly, “Damn. I should’ve won that point, not you.”

Wannabe as successful deploying capital via coveted managers as Swensen has been and continues to be?  Study his book and the Yale endowment reports commended above all you want, mimicking to whatever extent you wish the methods Swensen has employed in his tenure as Yale’s CIO.  Absent an intolerance of mediocrity rivaling Swensen’s, I’d respectfully suggest, I doubt you’ll be as successful as he’s been, or as you wannabe.

This same intensely competitive mindset was evident the day my path crossed that of Hall of Fame third baseman Mike Schmidt, on the 18th hole of his home golf course in Florida.  As my playing partner and I were strolling up the fairway after hitting our tee shots, we were puzzled by the sight of a cart racing up the fairway toward us.  Stopping the cart about 150 yards from the 18th green, its sole occupant leapt out of the cart, dropped a golf ball on the turf, quickly took a stance with the only club he’d brought along, and proceeded to hit the ball to within “gimme” distance of the hole.  Spinning around to face my playing partner and me as we came up behind him, Schmidt growled, “I knew I had that shot.  You can keep the ball.”  Schmidt then jumped back into the cart and roared off to the clubhouse.  Upon reaching it a few minutes later, my companion and I learned that a poorly struck approach shot on the 18th had cost the baseball legend a win in a high stakes match contested as our own round was underway.

Mike Schmidt (MLB 1972 – 1989)

Small wonder that a man pursuing excellence so relentlessly made it into his chosen profession’s Hall of Fame — a just honor for a twelve-time All-Star and three-time league MVP who averaged the same number of home runs per season during his 17-year career in the big leagues (32) as Babe Ruth did during his more celebrated albeit longer (22-year) run in The Show.

I’m sending Ruth to the plate so to speak as this note draws to a close because aspects of his remarkable life underscore nicely this note’s central point, i.e., that extraordinary success in most fields of endeavor presupposes proficiencies that include but go beyond those susceptible of copycatting.  The Bambino proves this point because, in sharp contrast to his fellow Hall of Famer Schmidt, whose batting methods were truly distinctive, Ruth the batter was a copycat to the core.[6] More specifically, from his earliest days playing sandlot ball at St. Mary’s Industrial School in Baltimore in the opening years of the 20th century to the end of his storybook career in 1935, Ruth parroted precisely and faithfully the stance, swing and even pigeon-toed gait of his first mentor on the diamond and his only true mentor off it: Brother Martin “Matthias” Boutlier.

To be sure, the techniques that Ruth borrowed from Boutlier did Ruth relatively little good during the first half-dozen of his 22 seasons as a big leaguer — the closing years of MLB’s “dead ball era” during which Ruth averaged fewer than nine homers per season.  Fortunately for Ruth, and the MLB team that employed him prior to 1920, Brother Matthias had seen to it that his prized mentee at St. Mary’s had also honed top notch pitching skills — skills acquired when Boutlier shifted Ruth from outfielder to pitcher after Ruth complained about a classmate’s ineffectiveness on the mound.

To Ruth’s if not also Boutlier’s credit, when MLB’s “live ball era” commenced, Ruth had little difficulty adapting to his radically changed environment, switching back to the outfield when playing defense and applying his hard-earned baseball savvy and skills more or less solely to the task of driving in runs.  In this pursuit, he succeeded admirably, notching an astounding 1,990 RBIs (runs batted in) as a “live ball” hitter.

What would’ve come of the Bambino if more tightly wound balls hadn’t been introduced in 1920 or subsequent years?  ‘Tis hard to say, though presumably Ruth would’ve carried on as a premier pitcher until his arm … or liver … gave out.

What would’ve come of Ray Chapman if he’d done the right but potentially embarrassing thing and dropped pre-emptively and safely to the ground upon losing sight of the pitch that killed him?  ‘Tis also hard to say, though presumably Chapman would’ve gone on to compile an enviable if not Cooperstown-caliber record as a batsman if he’d lived and played through the first several years of “live ball” competition.

What would’ve come of Jeremy Grantham if he’d done the easy thing and kept the firm he’d co-founded in 1977 heavily invested in small cap stocks as they were reaching the zenith of their popularity six years later?  In the event, Jeremy did what’s he done not a few times over the course of his career: outflank the competition by replacing demonstrably winning tactics with those entailing sufficient discomfort to justify fresh funding.  Doing this in a timely and effective manner presupposes a distinctive mindset: one resembling closely if not perfectly the mindset animating David Swensen’s ongoing labors on Yale’s behalf, and the mindset of Swensen’s countless wannabes not at all.

Finally, what would’ve become of the PE industry if, instead of devoting a large fraction of Yale’s endowment to PE, David Swensen had deployed all such capital via managers investing exclusively in publicly-traded stocks of owner-operated firms?  ‘Tis hard to say, but I’ll try … in my next note.

On deck: hittin’ em where they ain’t 

PDF Download (Paid Subscription Required): Notes from the Diamond #5 – Wannabes Beware

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Contact David directly at:
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Endnotes

[1] The full review appeared in Barron’s on June 5, 2000 and is available at www.barrons.com or by contacting its author here.

[2] ET management frowns on too-frequent shout-outs to the MLB franchise in question, so I won’t mention by name here the team that’s won four of the 19 World Series held since the current century commenced, including the most recent. [ET management note: sigh.]

[3] As ET faithful know, Ben and Rusty use italicized shout-outs like alternative investments! when referencing self-sustaining memes whose acceptance tends to be both uncritical and widespread.  Private equity circa 2018 exemplifies such a meme — still “bucketed” as “alternative” by many institutional investors and consultants thereto despite its near-ubiquity in institutional asset mixes.  Hedge funds remain similarly “bucketed” in institutional investment — and might ultimately merit such labeling anew if recent trends disfavoring such vehicles render them sufficiently upopular.  Readers seeking greater understanding of italicized shout-outs by ET contributors might usefully review the note by Ben in which they first appeared.

[4] Perhaps the most time-efficient means that skeptical readers can employ to verify characterizations of Yale’s investment results proferred here would be to peruse two of the 17 annual reports on Yale’s endowment posted on that school’s website: the 2007 edition and the most recently released edition, for FY2017.  Section 5 of both reports, entitled Investment Performance, breaks out Yale’s returns by asset class, reporting such returns over various intervals, including the 10-year periods ending in the fiscal year being reported upon.  By essentially linking asset class returns for the 10-year periods discussed in Swensen’s 2007 and 2017 reports, one can confirm what all of Swensen’s putative peers have long known: that David and his team are uncommonly good at picking managers within investment niches characterized by wide dispersion in active managers’ returns.

[5] According to the Yale Endoment report for FY2017, Yale earned a dollar-weighted IRR of 106.3% and a time-weighted return of 25.5% on its venture investments over the 20 years ending June 30, 2017.

[6] Planting his feet as far from the plate as rules allowed in order to avoid being “jammed” by inside pitches, Schmidt typically would turn his back toward the pitcher and pull his butt back and forth while awaiting deliveries, thus staying loose while also distracting or at least trying to distract his enemy on the mound.

Notes from the Diamond #4: Less Is More

Trivia question #4 of 108: Who is the only player in major league baseball history to pitch in 10 games, steal 10 bases and hit 10 or more home runs in a single season?  Answer appears below.

John and Ray Kinsella in the closing scene of the 1988 film Field of Dreams:

John:     Is this heaven?

Ray:       It’s Iowa.

John:     I could’ve sworn this was heaven.

Ray:       Is there a heaven?

John:     Oh yeah … heaven’s where dreams come true.

Ray:       Then maybe this is heaven.

Essential Attributes.  Wanna dull happy hour spirits in the watering hole of your choice in Boston’s financial district?  Proclaim for all to hear that, in sharp contrast to the way things were when you entered the money management biz in the early ‘80s, rooting for the Red Sox these days is more of a disqualifying attribute than an essential one for alpha-seeking money managers.  Why?  Because the team’s success in recent years permits fans to inhabit comfortably the figurative realm known as Red Sox Nation without displaying in full measure two traits traditionally deemed essential for long-term investment success: (1) independent thinking and (2) and sufferance.  That’s an archaic word, I know — sufferance — but it’s apt here, because the topic on which this note focuses — the use and abuse of peer group comparisons in pro baseball and investing — can’t be explored meaningfully without acknowledging an important fact: truly independent thinkers in both of the fields of endeavor just mentioned are almost always made to suffer, often for prolonged periods.

Exceptions That Prove The Rule.  Almost?  Yes, history revealing that at least some pros in each field have been skillful or perhaps merely lucky enough to win big without incurring embarassing setbacks and hence sufferance beforehand, while others have avoided the latter by ignoring peer group comparisons altogether, focusing instead on the fulfillment of self-imposed standards for success better suited to their idiosyncratic circumstances.  Exceptional players of the first sort make fun focal points for happy hour chit-chat — e.g., Bill Simon and Ray Chambers in the buyout arena circa 1982 et seq., Mike Trout in big league baseball circa 2012 et seq. — but provide scant learning for mere mortals like me if not also you[1]  Accordingly, this note focuses on exceptional players of the second sort: baseballers and investors who’ve triumphed by their own standards through the sufferance of discomforts their presumed peers deem intolerable.  To illumine such achievers’ good works as brightly as possible while also serving up actionable ideas to readers seeking to emulate their winning ways, this note focuses as well on players who’ve suffered mightily and continue to do so through the vain pursuit of goals ill-suited to their idiosyncratic circumstances.

At the risk of getting banned permanently from sports bars in Wrigleyville, or dinner parties in Cambridge, I argue below that the first and generally content type of sufferer just mentioned is perhaps best typified by the Chicago Cubs during their long and recently-ended championship drought, while the second and generally discontent type of sufferer referenced above is perhaps best typified by the Harvard Management Company (HMC) during its long and ongoing struggle to shine relative to its presumed competition.

Sensible Standards. Heavy stuff, I know, certainly for Harvard votaries and likely also for Cubs fans for whom their team’s first World Series win in 108 years was pure heaven.  As the lifelong fan of a team whose own title drought also ran painfully long (86 years) before finally ending in 2004, I can certainly understand why Cubs fans view big league baseball even more sunnily now than they did before their team won it all in 2016.  That said, like the Kinsellas in Field of Dreams, Cubs fans might do well moving forward to measure their baseball-related happiness not by standards extolled reflexively if naively by the fans of most teams in most pro sports — i.e., league and world titles — but rather by the more sensible standards traditionally if somewhat ineluctably applied by their Cubs forebears, more on which anon.

Similarly, like the alum whose independence of mind and tolerance for discomfort produced enough wealth to buy Harvard the handsomest building erected on its grounds in decades (i.e., Klarman Hall, opened earlier this fall), Harvard votaries might do well moving forward to measure the university’s investment results not by standards extolled reflexively if naively by uninformed observers — i.e., HMC’s performance relative to “peer” endowments’ — but rather by standards better suited to the behemoth size and peculiar character of the roughly $37 billion investment pool that HMC deploys on the school’s behalf.  More on that anon, too, but first a little fun — not unrelated to the topic at hand — in the form of reflections on the two MLB stars pictured below.

Good Value.  The pitcher shown here is CC Sabathia, a fine fellow (seriously) who at 300-plus pounds is purportedly the heaviest player in MLB history.  The other player pictured here is Kansas City Royals second baseman Whit Merrifield, a decidedly lighter and swifter player who in 2018 stole 45 bases — two more than the next most successful base stealer in MLB (Trea Turner of the Washington Nationals) and 35 more than the phenom constituting the correct answer to this note’s opening trivia question: Shohei Ohtani of the Los Angeles Angels.   (Coming attraction: a note on Ohtani and what his achievements presage respecting the changing status of women in baseball and investing.)  As gifted athletically as Sabathia is, I wouldn’t bet on him outrunning Merrifield (or Ohtani), even over the shortest of distances.  Nor would Sabathia’s longtime employer, which arguably has gotten good if not great value for the roughly $215+ million it’s paid CC since he joined the Yankees’ payroll in 2009: a cumulative WAR of 29.7 amassed over 1,810 innings of work in 284 games.[2]  Hold that thought — that HMC Sabathia is capable of producing highly satisfactory results despite its his heft — as we explore briefly why the pre-2016 Cubs serve as a credible exemplar of big leaguers triumphing by their own standards while also suffering discomforts generally deemed intolerable by their presumed peers.

Lovable Losers.  What standards worthy of being labeled as such did the Cubs uphold during their 108 year championship drought?  Consider this: from the Wrigley family’s assumption of a controlling stake in the Cubs in 1921 through the Tribune Company’s sale of the team to its current owners in 2008, the Cubs were consistently among the most profitable MLB teams, no matter how well or poorly they played.  Why? Because the club’s principals during this interval adopted and pursued unfailingly a cardinal goal as idiosyncratically well-matched to boundary conditions governing the Cubs’ labors as it differed from the cardinal and common goal of the Cubs’ MLB peers or more precisely these other teams’ title-hungry fans.  The Cubs’ foremost goal over the nearly nine decades in question?  Simple: to make Wrigley Field a splendid place for Chicagoans to spend a summer afternoon.  Make that summer afternoon or evening, the City of Chicago having blessed the installation of lights and hence also night games at Wrigley in 1988, albeit with a cap on the number of such games that today equals roughly 65% of the 81 regular season games each MLB team hosts.

Was winning truly secondary for the Cubs from 1921 through their purchase by the Ricketts family in 2008?  The answer depends on how one defines winning.  If victory is defined as winning hearts and minds, the Cubs over the period in question were unquestionably among the winningest organizations on the planet, within or outside pro sports — despite and in some respects because the Cubs’ home field inhibited the team’s effective use of personnel policies that well-managed MLB franchises commonly employ in pursuit of their own competitive edges.  Described summarily, these policies entail the construction of player rosters that give individual teams an edge on both offense and defense when playing in their home ballparks

Why hasn’t the Cubs’ front office implemented such policies at least as effectively as have competing clubs over the years? Conceding fully that the Cubs’ general manager since 2012 (Theo Epstein) is capable of feats unachievable by nearly all of his predecessors and most of the big league GMs at work today, Wrigley Field happens to have been situated and constructed in a manner that makes the winds buffeting it between the start of the MLB regular season in early April and its conclusion in late September too varying and unpredictable to craft player rosters in a manner affording the Cubs a true edge when playing home games.[3]

Hearts and minds won over: Cubs fans celebrating their team’s 2016 championship with their dearly departed

How did Theo become an exception proving the rule that Cubs GMs can’t build a world championship team?  We’ll discuss that topic at length in a future note, along with the intriguing question of whether and to what extent wind-blocking video boards installed at Wrigley during the run-up to Theo’s managerial triumph in 2016 facilitated its achievement.  Meantime, the record shows that attendance at Cubs home games has historically been the least sensitive to the team’s performance (measured by overall winning percentage) of any big league team.  In short, when P.K. Wrigley inherited the Cubs from his father in 1932 and promulgated a clear if somewhat unconventional metric for gauging the team’s future success, he laid the groundwork for decades of truly triumphant labors by the enterprise he headed.  As he told Harper’s magazine at the time, “The fun … the sunshine, the relaxation.  Our idea is to get the public to go see a ball game, win or lose.”[4] [Emphasis added]

CC Needn’t Sprint.  Turning back to investing in general and Harvard’s ongoing investment woes in particular, what would the manifestly brilliant Epstein do if forced to shoulder the uneviable task of piloting the world’s heftiest educational endowment?  I’m unsure, Theo never having managed money for his own alma mater (Yale) let alone the more heavily endowed university in his hometown (Boston) whose overseers have had such conspicuous difficulty crafting policies conducive to Harvard’s achievement of investment success as they themselves define it.  Of course, that’s precisely the problem — the problem underlying Harvard’s endowment woes and indeed those of all investors focused unduly on their presumed peers’ investment performance: as would be the case if Yankees management or even worse the Big Man himself defined athletic success for Sabathia as the stealing of more bases than Merrifield, equating success with the outperformance of presumed peers is foolhardy in an investment context if the boundary conditions governing one’s deployment of capital make defeat more probable than victory. 

Due primarily to the Harvard endowment’s heft relative to its self-selected peer group — i.e., 40% to 70% larger than this group’s next-largest members (Yale, Stanford and Princeton, in that order) in recent decades and multiples larger than most of the group’s other members — it’s unwise and arguably unnecessary for Harvard to attach utmost importance to beating Yale or indeed any of its putative peers in the investment arena.

Survey on Optimal Asset Size — 2018 Edition **

Assume you’ll soon take unilateral control of an endowment with zero inflows and an annual spending rate of 5%. Assume further that (a) your sole aim will be to maximize the fund’s net annualized return in percentage terms over a 25 year holding period with no interim measurement of results and (b) you can deploy capital however you see fit. How much capital would you ideally like to have in hand when your assumed 25 year tenure commences?

Mean Response       $4.0 billion

Median Response   $2.0 billion

By way of comparison:

  • Harvard endowment at 6.30.18           $39.2 billion
  • Yale endowment (ditto)                         $29.4 billion
  • Stanford endowment (ditto)                 $28.7 billion
  • Princeton endowment (ditto)               $25.9 billion

** Conducted by the author biannually since the early 1990s. Survey population comprises ~150 experienced institutional investors. Individual responses are kept confidential to facilitate candid responses, especially from participants pocketing large incomes on behemoth asset bases (!). Mean and median responses have ranged between roughly $2 billion in the early ‘90s and today (median only per above) to a peak of $7ish billion in 2007.

Cardinal Sin.  Sadly, the powers-that-be at Harvard have customarily begged to differ with the argument just advanced, as confirmed by the board-approved investment objectives (paraphrased in box below) that Stephen Blyth propounded at the start of his perhaps predictably brief tenure as Harvard’s investor-in-chief not long ago.  To be sure, under the leadership of its current and eminently qualified CEO Narv Narvekar, HMC isn’t pursuing goals as numerous nor as inchoate as those propounded by Blyth — at least not publicly and explicitly.  That said, as the saying goes, no organization can be better than its board; and the board to whom Blyth reported is more unchanged than not since Narv resigned his role as Columbia University’s CIO to assume the analogous post at Harvard two years ago.

Harvard Endowment Investment Objectives circa 2015-16**

  • 5+% annualized real returns on a rolling 10-year basis
  • Outperform “appropriate market and industry benchmarks” by 1% annualized on a rolling 5-year basis
  • Top quartile annualized returns on a rolling 5-year basis relative to peer group comprising next 10 largest endowments
  • Maintain portfolio whose “risk profile is in line with the University’s risk tolerance”

** Paraphrasing of Stephen Blyth in his initial (and final) report to the Harvard community during his 17-month tenure as CEO of Harvard Management Company (Jan 2015 – May 2016).

I like and respect Narv, and presume without knowing for sure that he’s not repeating his predecessor’s mistake of propounding multiple investment objectives without rank ordering them — a cardinal sin for investors given the tendency of goals rightly viewed as reasonable when viewed in isolation to come into conflict over time, especially under worst case conditions. 

Speaking of such conditions, I’d hope for Narv’s sake as well as his employer’s that he’s not committing additional sins of which his predecessor and the board to whom Stephen reported are justifiably accused, including most notably the articulation of goals incapable of being pursued in any sort of objectively verifiable manner, e.g., capital deployment consistent with Harvard’s “risk tolerance”.  Pray tell, how does one define the risk tolerance of an investment pool comprising 13,000+ sub-funds, many of which comprise restricted monies and nearly all of which are “owned” de facto if not de jure by one and only one of Harvard’s several operating divisions?  (See accompanying bar graphs.)

Every Tub On Its Own Bottom: Revenue Sources for Harvard’s Major Academic Units (FY 2017)

Sub-Optimal At Best.  I won’t discuss here the history nor perceived defects of Harvard’s longstanding budgetary policy respecting such divisions — a policy known colloquially as “every tub on its own bottom”  — except to note that the commingling of all such tubs’ wealth for investment purposes seems sub-optimal at best and irresponsible at worst.  Given the composition of what ET’s co-founders like to call the ET Pack, I likely needn’t defend the charge just leveled with many or perhaps any readers, the illogic of commingling investable wealth on behalf of the various tubs identified in the accompanying bar graphs being rather obvious.  But … just in case it ain’t obvious, what would happen to a financial advisor (FA) if he recommended the identical portfolio to two families, one of which relied on portfolio withdrawals to cover 88% of its annual outlays with the other using such withdrawals to finance just 16% of its spending?  I can tell you what’d happen if yours truly were supervising the FA in question: he’d undergo the same treatment that home plate ump James Hoye accorded Bosox manager Alex Cora in the fifth and final (for Cora) inning of Game 1 of this year’s American League Championship Series.

Cora Getting Ejected by Hoye
Game 1 of 2018 ALCS

Getting Structured for Success.   How can readers engaged in the management of Other People’s Money (OPM) reduce the odds that clients will subject them to treatment like that Hoye accorded Cora on October 13?  This being but the fourth of a planned 108 note series on investing and baseball, I better have and indeed do have numerous suggestions for reducing such odds.  However, to prevent this piece from becoming as punishingly long as Cora’s most memorable loss as a manager — the 18 inning slog comprising Game 3 of this year’s World Series — I’ll serve up just one suggestion here, saving the others for future notes.  Naturally, the mitigant I’m furnishing first is the most important of the bunch IMHO.  It’s also rooted firmly in concerns flagged above, the paramount one being the need to set goals that are clear, actionable, and above all else sensitive to whatever immutable boundary conditions govern the investment program being conducted.

Telling Turnover at the Top:
Yale and Harvard CIOs 1985 – Present
(Source: Yale Daily News)

Less Is More.  What might an investment policy statement (IPS) meeting the criteria just outlined look like?  For better or worse, there are as many sound answers to this question as there are sound stances taken by hitters as they await pitches at the plate.  (I’ve pasted photos of two especially interesting stances at the end of this note, foreshadowing the next  installment in this series.)  The foregoing caveat having been filed, I’ll suggest humbly that the most useful IPSs I’ve encountered tend to be quite brief — indeed, shockingly so to fiduciaries who believe mistakenly that the utility of such statements correlates positively with their length.  As suggested by the following example of a solid if not heavenly IPS — heavenly in the Kinsellaian sense delineated at page 1 — the utility of such statements tends in fact to be negatively correlated with their length.

Less Is More

Illustrative Investment Policy Statement

Risk Parameter. The investment pool covered by this mandate will be deployed in a manner that seeks to avoid at all costs 25% or greater peak-to-trough declines in the inflation-adjusted value of pool units.

Liquidity Requirements. As a further constraint on risk-taking, a minimum of 10% of the pool’s net assets shall be invested in holdings (including externally managed commingled funds) readily reducible to cash within 12 months; and a minimum of 30% of such assets shall be invested in holdings as just defined readily reducible to cash within 60 months.

Return Objective. The pool will be managed to maximize annualized real returns net of all costs over rolling 10-year periods while adhering to the risk parameter and liquidity constraints set forth above.

Governance. The Investment Committee (IC) is responsible for overseeing the pool’s deployment. It shall comprise at all times not fewer than three nor more than five members. It shall meet as needed though not less than twice each calendar year, with a majority of the IC’s members constituting a quorum for legal purposes. The IC’s duties are to: (1) establish appropriate policies and guidelines for deployment of the pool’s capital; (2) oversee implementation of such policies and guidelines; and (3) select and monitor the pool’s external custodian(s). All other aspects of the pool’s administration including but not limited to strategic and tactical investment decision-making shall be conducted by full-time professionals selected and monitored by the IC or by delegatees chosen and overseen by it.

Might additional flesh if not also muscle be usefully added to the bare bones statement provided here? Sure, although experience teaches that many efforts to do so end up being counterproductive: the equivalent not of adding useful mass to an already fit body but rather of adding barnacles to an otherwise streamlined hull. That said, in the many instances in which I’ve participated in and indeed led investment policy reviews, I’ve applauded if not initiated efforts to reshape the risk parameters and return objectives set forth here so that they and all other aspects of the resulting IPS reflect truly and fully immutable boundary conditions governing the capital being deployed.

Unsolicited Advice.  FWIW, if the reshaping just described were to be done by the powers-that-be at Harvard, they’d be well advised to craft not one IPS for all of the university’s investable wealth but several, each governing one of the several pools into which Harvard’s singular and sub-optimally large master pool might usefully be sub-divided for investment management purposes.  Given the endowment reliance ratios implied by the accompanying bar graphs, something like three to five distinct risk pools would arguably do the trick, providing greater nimbleness of action in the deployment of each such pool’s capital while also achieving the important aim of removing Harvard from the performance derby in which it’s long been engaged.  To be sure, outside observers including news media might continue comparing Harvard’s overall investment results to that of other leading research universities by computing the weighted average return of the several risk pools commended here — results that Harvard would surely disclose publicly.  But the persons responsible for deploying Harvard’s capital could and presumably would ignore such peer group comparisons, noting for public consumption that the weighted average being cited is meaningless given Harvard’s idiosyncratic approach to budgeting (“every tub on its own bottom”) and hence also to investing long-term capital sitting within each of its tubs.

Taking the Long View.  As we’ll see as this series unfolds, the longer the time horizon over which a given pool of capital will be invested and eventually spent, the greater the opportunity and arguably also the need to define success in terms different than those employed by the typical investor, institutional or individual.  Of course, the more  unconventionally a player or group of players in any arena defines success, the greater freedom they potentially have to enjoy life as it unfolds, tolerating if not occasionally celebrating experiences that their apparent but perhaps not actual peers deem insufferable.

On deck: the shifting fortunes of wannabes in baseball and investing

Gar “The Batting Stance Guy” Ryness (left) and the Big Leaguer he’s most enjoyed impersonating over the years: Kevin Youkilis (MLB 2004 -2013)

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Endnotes

[1] Of necessity more than choice for a series of notes discussing both baseball and investing, I’m using “players” as shorthand for persons engaged in either of these fields of endeavor.

[2] Wins Against Replacement (WAR) seeks to quantify the wins a player adds to his team above what a replacement player would add.  Of the 100 top active MLB pitchers ranked by career WAR, CC Sabathia (62.2 cumulative WAR in 18 MLB seasons) ranks second, a tad behind Justin Verlander of the Houston Astros (63.8 cumulative WAR in 14 MLB seasons).  FWIW, the Royals have gotten truly outstanding value for money paid to Merrifield since the team promoted him from the minors in 2016, paying him the roughly half million dollars per season that most newbies pocket during their first few years in The Show, before they become eligible for salary arbitration: Whitfield’s WAR of 5.5 in 2018 placed him 25th among the roughly 1,300 players that appeared on MLB rosters at some point during the 2018 season.  Readers interested in exploring WAR in all of its glorious if not also controversial dimensions can do so here and here among other places.

[3] “True” as used here means a home winning percentage exceeding the remarkably stable long-term MLB average of roughly 54%.  Perhaps obviously, the Cubs have won fewer of their home games than this average implies since Wrigley became their home ballpark in 1916. A future note will explore the extent to which video replays and potentially other technological “enhancements” to officiating will cause the home field advantage (HFA) alluded to here to erode.   My hunch:  such changes will cause MLB’s single most perdurable stat (HFA) to erode materially.

[4] I lifted this quote from Scorecasting — The Hidden Influences Behind How Sports Are Played and Games Are Won by Tobias Moskowitz and Jon Wertheim.

Notes from the Diamond #3: Everything Has Its Price

Trivia question #3 of 108: From how many ballgames was former Baltimore Orioles manager Earl Weaver ejected before the first pitch had been thrown?  Answer in main text.  

“Baseball has everything” – a former Yale baseballer (identified below) who sank into politics

Off the Wagon.  By all accounts, Paul “Big Poison” Waner was one tough sumbitch.  Like his younger brother Lloyd — known as “Little Poison” — Paul was also a fine ballplayer, despite or perhaps because of his heavy drinking.  In fact, Big Poison boozed so habitually that the team for which he played for most of his 20 years in the big leagues, the Pittsburgh Pirates, included an abstinence clause in Waner’s contract one year — a clause the team waived proactively within weeks of its adoption when Waner’s slumping performance suggested he played better off the wagon than on it.  Big Poison’s interests having been realigned with those of his employer, he went on to complete a playing career that landed him in baseball’s Hall of Fame.  Little Poison made the Hall of Fame too, having smacked enough hits that, when combined with his brother’s, put the Waners atop the list of siblings with the most total career hits, the most accomplished trios in major league baseball (MLB) history — the Alous and DiMaggios — not excepted.[1]

Paul and Lloyd Waner in 1932

Extremely Difficult.  Why didn’t Pirates management foresee that inducements aimed at enhancing Big Poison’s play would have the opposite effect?  Perhaps it should have.  But those of us who’ve spent substantial time negotiating performance-based incentives (PBIs) — as principals, agents or both — are perhaps more inclined than others to give Waner’s misguided overlords a break: excepting only rare cases in which principals and those working for them wield both uniform metrics for gauging success and uniform time horizons for assessing its pursuit, devising effective bonus schemes for highly trained professionals is extremely difficult.  Indeed, relative to other purely cerebral challenges in both money management and baseball, structuring incentives for such pros that do more good than harm on balance is the administrative equivalent of what the ballplayer who did it more reliably well than anyone in his own time or since (Ted Williams) called “the single most difficult thing to do in professional sports”: using a bat to hit baseballs thrown by major league pitchers.

To help younger players do at least passably well what he himself had done so expertly, Williams devised the colorful graphic shown here for his classic how-to book The Science of Hitting — essentially a payoff table denoting the probability that a skilled batsman like himself would notch a hit when swinging at a ball pitched into each of the 77 discrete positions comprising the strike zone for a batter of his size (i.e., seven balls wide, eleven balls high).  Beyond simply wanting to introduce this intriguing chart to readers who’ve not seen it before, I’ve included it here because the logic underlying it has aided my own work as an allocator over the years, informing decisions respecting the deployment of both human and financial capital as well as corollary choices respecting incentives for investment pros to whom I’ve entrusted clients’ capital or my own.  

Immutable Conditions. What lessons about incentivizing highly trained pros have I learned along the way?  Among others, I’ve learned that it’s essential to keep personality traits plus other immutable boundary conditions governing a given principal-agent relationship foremost in mind when structuring it, adjusting not merely tactics but strategies to suit such conditions.  Williams did precisely this in determining not merely how to apply his bat to a given pitch but whether to swing at all.[2] Of course, Teddy Ballgame (as Williams was known) didn’t publish the aforementioned bible for batters until after his playing career ended, either because he felt he was learning important new lessons about hitting even as his career wound down, or because Williams wanted to maximize his competitive edge until he hung up his cleats, or perhaps both.  Dunno.  What I do know is that I myself still have lots to learn about the art and science of structuring effective principal-agent relationships in money management; and I hope without knowing for sure that I’ll be engaged in such work for many years to come — if not until the anticipated Hall of Fame induction of the current Bosox player whom Williams likely would have most enjoyed mentoring, then at least through the end of what’ll hopefully be a storied MLB career for the player in question, a 26-year old wunderkind whose parents deliberately and presciently gave him the initials MLB.

How many more years will devotees of MLB (the game if not also the man) have the pleasure of watching Marcus Lynn “Mookie” Betts play before the mandatory five-year waiting period for his election to baseball’s Hall of Fame commences?  Again, dunno, nor does anyone, MLB the man not excepted.  More to the point of this note, to what extent has Mookie’s Williams-esque dominance of statistical measures of big leaguers’ output been the product of specific contractual incentives aimed at eliciting such results? I doknow the answer to that question, and reveal it below, after revealing a few (for now) of the things I’ve learned about the use and abuse of PBIs as a longtime student of both money management and baseball.

Readers looking for additional (or alternate!) sources of wisdom or experience on contractual arrangements in money management will find well-crafted papers on it by academics here, here and here, and by practicing accountants or attorneys here, here and here.

Thing 1 — Don’t Whip A Winning Mount.  Of the countless available photos of Hall of Famer Joe Torre — the only major leaguer to achieve both 2,000 hits and 2,000 wins as a manager — I chose the one included here for two reasons: (1) Torre appears not in the uniform he wore while leading the New York Yankees to the playoffs in 12 consecutive seasons but rather in the uniform he donned after telling the Yankees to take a hike; and (2) conveniently for me, Torre appears alongside another gifted manager on whom my second thingy (below) focuses.  Why did Torre swap Yankee pinstripes for Dodger blue in 2008?  He did so for several reasons, the decisive one arguably being Yankee management’s insistence that he swap a material portion of his base pay for the opportunity to earn certain performance-based bonuses: so many dollars each for winning divisional or league titles, or the World Series, were he to continue piloting the Yanks. Perfectly sensible, no? 

Try senselessTorre having already guided the team to nine divisional titles, six league titles and four World Series crowns as their manager, without any such discrete incentives having comprised part of his compensation.  In short, not only didn’t Torre neither want nor need such PBIs to do his best work, the mere suggestion that they form part of his contract insulted him to the point that he took his talents elsewhere, ultimately guiding the Dodgers to divisional titles in 2008 and 2009 en route to his 2,326th and final career win as a manager in October 2010.

The lesson for capital allocators in the Torre-centric tale just told?  Don’t assume money managers who prefer more stable pay constructs over those entailing potentially sizable but contingent bonuses lack the right stuff, with the latter defined broadly to include both the ability to do stellar work and innate confidence in their capacity to do so.  Believe it or not, some of the most skilled and trustworthy investment pros with whom I’ve worked and continue to partner are quite content to earn relatively stable incomes financed solely via asset-based fees, relatively being highlighted to acknowledge that asset-based fees on portfolios comprising volatile assets can fluctuate materially, especially if the capital being deployed emanates from clients with dispositions as volatile as the late Earl Weaver’s.  In his 2,540 games as manager of the Baltimore Orioles over 17 seasons (1968 – 82 and 1986), Weaver evinced enough angst about the proceedings to get himself ejected 91 times, including ejections from both games of a doubleheader three times and from two games before they’d even started.  I don’t know who had the privilege of managing The Earl of Baltimore’s money, but I don’t regret that I wasn’t part of what was likely a long and ever-changing line of such cats.      

Thing 2 — Don’t Underestimate Primal Needs.  Readers clued into the 2018 MLB playoffs now unfolding will be familiar with the neo-modern strategy known as bullpenning: reducing the edge that batters typically gain when facing a given pitcher multiple times by rotating hurlers more frequently than the typical 20th century manager or indeed 21st century starting pitcher would cotton.  I’ve labeled bullpenning “neo-modern” because no less a baseball sage than Hall of Fame manager Tony LaRussa deduced the merits of strict pitch counts a quarter century ago, putting them into practice as skipper of the Oakland Athletics in 1993.  Alas, as is true of many pioneers in money management as well as baseball, LaRussa was so early with his innovation —and so deficient in anticipating its corrosive effect on the karma of the players whose performance he sought to boost — that he was compelled to abandon bullpenning after a handful or so of games. 

Why did LaRussa’s strategy fail?  Because the 50-pitch limit it entailed made it nigh impossible for starting pitchers to meet MLB’s five-inning threshold for notching wins.  To be sure, as the analytics-laden execs inhabiting most MLB front offices and indeed dugouts these days would readily attest, LaRussa’s strategy indisputably enhanced his team’s odds of achieving its cardinal goal of winning as many games as possible.  But this same strategy conflicted squarely with the cardinal goal of the very people on whom its successful execution most relied: pitchers whose longer-term earnings prospects depended heavily on the number of wins they personally racked up.

Today’s Starting Pitchers Almost Never
Complete What They Begin

Why didn’t LaRussa have the As’ front office rework his pitchers’ contracts to achieve fuller if not perfect alignment of their interests with those of the ballclub for which they labored?  Prior to the sea change in labor relations in pro baseball unleashed by the de facto repeal of MLB’s so-called reserve clause in 1975, the As might have attempted if not actually executed such a paradigm shift, big leaguers being essentially beholden to the teams that employed them unless and until a team chose to trade a player for other talent and/or cash.  Since the advent of free agency for most major leaguers in 1975, however, a preponderance of such players and especially those lacking the 6+ years of MLB service on which unfettered free agency is preconditioned have focused less on dollars actually received under their current contracts than on dollars potentially received from their next contract, and the one after that (if there is one), and the one after that (ditto), ad libitum, until they hang up their cleats a final time.

It doesn’t take someone as bright as the Oakland pitcher who objected perhaps most strenuously to LaRussa’s platooning scheme, former Yale star and current MLB broadcaster Ron Darling, to understand why a preponderance of big leaguers — assumedly those below the MLB average age of 29 years plus older guys who sense their playing abilities are peaking — focus more on putting up stats that’ll impress potential future employers than on doing things that’ll merely help their current ballclubs win: in present value terms, earnings derived from contracts not yet signed typically dwarf those derived from current arrangements, an increasing fraction of which have so-called opt out provisions that enable players who perform especially well over a given interval to shift voluntarily from one team to another willing to pay them bigger bucks.

Thing 3 — Don’t Confuse Skill and Luck.  Why don’t MLB teams mitigate the misalignment of interests just described via baseball-oriented analogues to the two-part fee structures that institutional investors use so commonly to apportion financial risk between managers they employ and themselves?  Two and twenty, anyone?  C’mon now, if you owned the Red Sox (to pick a major league team at random) and could pay ace Bosox pitcher David Price $2 mill (sic) in base pay plus $20k for every strike he throws in regular season games in 2019, wouldn’t you prefer that gamble to paying Price the flat $31 mill his current contract specifies?  Inked in late 2015, that contract is the richest in baseball history for a pitcher, paying Price $217 million for seven seasons’ work, with an opt-out for Price after the 2018 playoffs wrap up.  Given Price’s generally strong but somewhat uneven performance since executing his current contract, it’s unlikely he’ll exercise his opt-out, and unlikely too that he’ll pitch well enough in 2019 to make him wish he’d negotiated the 2 and 20 scheme hypothesized above.  To be precise, if such a scheme were to be implemented for 2019, Price would have to toss 1,450 strikes to earn $31 million.  Possible?  Sure, Price having thrown 1,765 strikes in 2018.  Probable?  I’d take the under on that bet, fully aware that if our hypothetical “2 and 20” scheme were in place and Price were to throw the same number of strikes in 2019 as he did in 2018, he’d earn $37.3 million or 20% more than the $31 million the Bosox are legally obliged to pay him.     

In theory, as with contracts governing investment advisory services, there are countless ways of apportioning risks in MLB player contracts, the dollars to be paid on a guaranteed or contingent basis being infinitely adjustable and the metrics used to compute contingent bonuses being limited only by the imaginations of the parties involved or quant jocks employed by them.  In reality, however, just as parties to money management contracts are constrained by laws and regulations from apportioning risks as they might ideally wish, MLB players and teams are constrained in contract negotiations by an even thicker patchwork of constraints, including especially a Collective Bargaining Agreement (CBA) that prohibits player bonuses based on statistical measures of on-field achievements.

Interestingly and perhaps shockingly to some readers, such prohibited measures include not only traditional and familiar “stats” like a pitcher’s wins or earned run average (ERA), or a batter’s home runs or runs batted in (RBIs), but most elements of the large and growing universe of “advanced” stats that baseball wonks like yours truly enjoy tracking.  (See the table of selected stats for David Price below to get a general sense of how wonky this stuff can get.)  Why does MLB’s current CBA prohibit player bonuses based on statistical measures of on-field achievements?  It does so because bonuses of that sort would be highly susceptible to gaming — by team owners no less than players, teams being subject to salary caps that some owners sought to evade via bonus schemes so artfully drawn that MLB owners as a group adopted strict limits on such hijinks several years ago.  Of course, performance-based bonuses in money management are also highly susceptible to gaming, mostly by money managers as distinct from clients, the latter having few tools at hand to mess up incentive fee schemes outside of too-frequent calls and emails about recent returns that bring managers’ worst behavioral tendencies to the fore.

Season Team W L SV G GS IP K/9 BB/9 HR/9 BABIP LOB% GB% HR/FB ERA FIP xFIP WAR
2008 Rays (A+) 4 0 0 6 6 34.2 9.61 1.82 0.00 0.311 80.0% 49.4% 0.0% 1.82 1.67 2.26  
2008 Rays (AA) 7 0 0 9 9 57.0 8.68 2.53 1.11 0.247 93.9% 57.7% 15.9% 1.89 3.98 3.19  
2008 Rays (AAA) 1 1 0 4 4 18.0 8.50 4.50 0.00 0.393 67.7% 52.7% 0.0% 4.5 2.93 3.76  
2008 Rays 0 0 0 5 1 14.0 7.71 2.57 0.64 0.205 79.4% 50.0% 6.7% 1.93 3.42 3.9 0.2
2009 Rays (AAA) 1 4 0 8 8 34.1 9.17 4.72 1.31 0.261 67.5% 42.0% 18.5% 3.93 4.66 3.57  
2009 Rays 10 7 0 23 23 128.1 7.15 3.79 1.19 0.268 68.5% 41.5% 11.1% 4.42 4.59 4.43 1.3
2010 Rays 19 6 0 32 31 208.2 8.11 3.41 0.65 0.270 78.5% 43.7% 6.5% 2.72 3.42 3.83 4.2
2011 Rays 12 13 0 34 34 224.1 8.75 2.53 0.88 0.281 73.3% 44.3% 9.7% 3.49 3.32 3.32 4.4
2012 Rays 20 5 0 31 31 211.0 8.74 2.52 0.68 0.285 81.1% 53.1% 10.5% 2.56 3.05 3.12 5.0
2013 Rays (A+) 1 0 0 2 2 7.1 14.73 3.68 0.00 0.267 71.4% 57.1% 0.0% 1.23 1.2 1.48  
2013 Rays 10 8 0 27 27 186.2 7.28 1.30 0.77 0.298 70.0% 44.9% 8.6% 3.33 3.03 3.27 4.4
2014 2 Teams 15 12 0 34 34 248.1 9.82 1.38 0.91 0.306 72.7% 41.2% 9.7% 3.26 2.78 2.76 6.0
2015 2 Teams 18 5 0 32 32 220.1 9.19 1.92 0.69 0.290 78.6% 40.4% 7.8% 2.45 2.78 3.24 6.5
2016 Red Sox 17 9 0 35 35 230.0 8.92 1.96 1.17 0.310 73.6% 43.7% 13.5% 3.99 3.6 3.52 4.5
2017 Red Sox (AAA) 0 0 0 2 2 5.2 12.71 3.18 1.59 0.524 39.7% 23.8% 11.1% 9.53 3.87 3.52  
2017 Red Sox 6 3 0 16 11 74.2 9.16 2.89 0.96 0.278 77.0% 39.9% 9.8% 3.38 3.64 4.2 1.6
2018 Red Sox 16 7 0 30 30 176.0 9.05 2.56 1.28 0.274 77.3% 40.1% 13.2% 3.58 4.02 3.95 2.7
Total   143 75 0 299 289 1922.1 8.68 2.32 0.90 0.287 75.2% 43.6% 9.9% 3.25 3.34 3.46 40.7

Selected Advanced Stats for MLB Pitcher David Price (courtesy of FanGraphs)

Wait: with so many well-schooled pros plying their trades in the money management arena, why haven’t the best among them devised bonus schemes not susceptible of gaming to an extent intolerable to any interested parties?  They have, I’d suggest, and will discuss such schemes in later notes.  That said, I’d also suggest that even well-engineered schemes tend to do more harm than good from a principal’s or client’s perspective when the metrics on which bonuses are based are ill-conceived.  The next note in this series will focus on such misconceptions, looking at them through the prism of the ongoing and unwarranted efforts by the world’s largest educational endowment to produce returns rivaling those produced by Ron Darling’s collegiate alma mater.  As we’ll see, if the powers-that-be at Harvard want to hold their own feet as well as those of the endowment’s hired guns to the fire in a manner that’ll truly advance the university’s long-term interests, they’d adopt metrics different if not radically different from those they’ve customarily employed to assess the endowment’s evolving performance. 

Room for Improvement.  Speaking as we just were of unconventional metrics, if one were designing an optimal bonus scheme for a big league pitcher like David Price and weren’t subject to the constraints on player contracts imposed by the aforementioned CBA, one would almost surely not use an imperfect measure like pitches hitting the strike zone as the sole metric on which bonus payments depend.  (Revisit the graphic at page 2 to imagine the pounding a big league pitcher might undergo if he hurled pitches only into the sub-zone framed by dotted red lines.)  Just as there are sounder metrics for assessing the evolving performance of Harvard’s endowment and indeed most institutional funds than the metrics currently favored by such funds’ overseers, so too are there sounder metrics than such familiar stats as wins or ERAs for measuring a pitcher’s skillfulness. 

Note that our focus here is skill or the lack thereof, as distinct from results per se, the latter obviously reflecting — in baseball no less than in money management — factors beyond the control of the performer being judged.  Interestingly and perhaps unsurprisingly given plummeting IT costs and the “big data” revolution they’ve helped spawn, baseball-obsessed statisticians have worked up in recent years a host of “defense independent” measures of pitching prowess, including some shown in the accompanying table dissecting David Price’s exertions (e.g., FIP and xFIP).[3]

Could analogous metrics be devised to help allocators do a better job of distinguishing skill from luck in money management?  Some investment pros would argue that they’re already being judged and indeed compensated via such enlightened metrics, e.g., the manager of a sector-focused hedge fund whose carry or incentive fee is based on the fund’s performance relative to a sector-specific benchmark, or the CIO of an endowment whose bonus depends on her fund’s performance relative to an agreed-upon “peer” group of institutional funds.  I don’t think such arguments are entirely without merit.  But there’s almost as much room for improvement in the methods used to evaluate investment pros circa 2018as there was for improvement in the methods used to evaluate baseball pros when the Sabermetrics revolution began in the 1970s.

Open Question.  We’ll leave open here a crucial question that later notes will address, namely whether and to what extent methods of evaluating investment talent superior to those most widely employed today might usefully focus on qualitative rather than quantitative factors.  Advanced analytics like those depicted above having become table stakes for MLB franchises since the 2004 World Champion Red Sox showed the world how powerful such methods can be, baseball’s best minds including perhaps most conspicuously former Bosox general manager (2002-2011) and future Hall of Famer Theo Epstein are increasingly focused on qualitative attributes when assessing players’ bona fides.  I mention this in closing by way of encouraging readers who find baseball stats unexciting to hang in there with these notes.  As much as I enjoy diving into such stats, I enjoy the game’s unquantifiable aspects even more.  And there are plenty of the latter, just as there are in money management.  In fact, I wouldn’t have pledged to crank out 105 more of these notes if what one lover of my chief avocation said about it didn’t apply equally to my chosen profession: “Baseball,” a former Yale baseball captain named George H.W. Bush once smilingly observed, “has everything.”     

On deck: the use and abuse of peer group comparisons in money management and baseball

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Endnotes

[1] Paul and Lloyd Waner notched 3,152 and 2,459 hits, respectively, for a total of 5,611.  The Alous racked up 5,094 hits in total: 2,101 for Felipe, 1,777 for Matty and 1,216 for Jesus.  The corresponding figures for the DiMaggios were 4,853 hits in total: 2,214 for Joe, 1,660 for Dom and 959 for Vince.

[2] Later notes in this series will explore the divergent ways in which the competitive edges of skilled pros in baseball and money management tend to evolve as their active careers in each arena unfold, with superstars in money management tending to enjoy the “magic of compounding” to a more pronounced and prolonged extent than superstars in the more physically demanding domain of pro baseball.  That Williams benefited from such “compounding” to a considerable and hence logical extent is borne out anecdotally as well as statistically, no more convincingly than with the tale of what unfolded after Williams walked on four straight pitches during a game against Detroit late in his career.  “Bill,” Detroit catcher Joe Ginsberg complained to home plate ump Bill Summers.  “Don’t you think that last ball was a strike?” “Mr. Ginsberg,” Summers replied.  “Mr. Williams will let you know when it’s a strike.”

[3] FIP stands for Fielding Independent Pitching, a stat as intuitively appealing to baseball junkies like me as it is needlessly complex to casual observers of the game.  Ditto for xFIP, which is shorthand for Expected FIP.  Wanna know more about such arcana?  I didn’t think so.  But if insomnia strikes and safer cures for it aren’t available, click into the Glossary section of FanGraphs and master as many equations as you can before your game gets called due to darkness.

Notes from the Diamond #2: Until the Truth Comes Out

And somewhere men are laughing, and somewhere children shout
But there is no joy in Mudville, until the truth comes out.  
—  Thomas Davis, chair of the Committee on Government Reform of the U.S. House of Representatives, opening a 2005 hearing on steroid use in professional baseball.[1]

Trivia question #2 of 108: What was the longest pro baseball game in history measured by innings played?  Bonus points for identifying accurately (without googling) two future Hall of Famers who played in the game.  Answers in main text.

Pachyderms On The Loose

Plow too many dollars into otherwise sound forms of investing and you get problems, not only for rookie players but for accomplished veterans whose once-fecund fields of dreams become nightmarishly infecund due to overcrowding.  Plow too many performance-enhancing drugs (PEDs) into otherwise hale athletes and you create problems also — inevitably but perhaps not promptly for players who dope, and instantly and maddeningly for their competitors who don’t. Because baseball’s so-called steroid era  — a decade-long spell starting in the mid-1990s — altered the sport’s image and indeed record books so materially, it’d be feckless for this lifelong fan of the game to pen a series like this without discussing PEDs at some length.  I could initiate such discussion later in the series, of course, but with certain pachyderms at loose in capital markets at present, now seems as good a time as any to discuss the elephant in pro baseball’s room — an elephant whose tracks are depressingly evident in the data below among other indicia too numerous and grim to include here.

MLB Players with 50 or more home runs in a single season

Just The Facts

Presuming as I do that the busy and savvy capital allocators comprising ET Nation have ready access to comparable tracking data on the pachydermal investors alluded to above, I’ll burden you with little such data here.  Presuming further that readers are generally if not intimately familiar with the financiers in question, I’ll serve up few facts as distinct from opinions about them in this note, except to observe that their steadily ballooning dimensions are rooted primarily in the same causal factors underlying baseball’s ongoing PED problems: malign incentives and warped time preferences, magnified by artificially inflated results and widespread disregard of such artifice.

Where within money management circa 2018 are these mutually reinforcing traits most prevalent?  Sadly, the answer isn’t obvious, at least not to those of us whose graying noggins reflect substantial ongoing experience overseeing large-scale investment programs.  Truth be told — and Epsilon Theory exists for no reason weightier than its relentless pursuit of truth — multiple forms of investing fit the bill, including but not limited to hedge fund and venture investing.  In this note, we’ll focus on private equity (PE) — a form of investing  performed ably and honorably by many investment pros while also being done passably at best (for now) and dishonorably by other players.   Importantly, as with PEDs in pro baseball, the widespread juicing of returns and hence also incomes in the PE arena has morphed into a phenomenon not unfamiliar to ET faithful: it’s Common Knowledge — something that everyone knows that everyone knows.

Strange Things   

Did baseball cognoscenti, including Sports Illustrated’s ace journalists, NOT know that Mark McGwire was “juiced” when, in 1998, he broke major league baseball’s longstanding single season record for home runs? It strains credulity to think they didn’t, the slugger’s preternatural performance and bulging muscles being self-evident tells, to say nothing of the “andro” (androstenedione) that a reporter spotted in McGwire’s locker as his homer count approached Roger Maris’s pre-existing record of 61. That said, unethical though McGwire’s juicing may have been in some folks’ eyes (including McGwire himself, judging from his later apology to the Maris family), it —like the dodgy accounting and reporting protocols employed by some PE firms — was within the letter as distinct from spirit of applicable rules.

Andro wasn’t added to MLB’s list of banned PEDs until 2004, three years after McGwire’s playing career ended and around the time his former teammate Jose Canseco’s tell-all memoir Juiced catalyzed a Congressional hearing plus a follow-on investigation overseen by former U.S. senator George Mitchell. The hearing in question was both joyless and protracted, taking roughly 40% more time than the longest pro baseball game in history measured by innings (33, spread over roughly 8½ hours).[2] Disturbingly but importantly for our purposes here, the so-called Mitchell Report that rocked MLB in 2007, plus subsequent studies of PED use at multiple levels of organized baseball, confirm what experienced capital allocators know only too well: when potential payoffs are large enough, people do strange things, taking risks they’d otherwise shun in pursuit of riches they’re keen to seize before such hazards morph into lasting harms.

Panel testifying at March 2005 Congressional hearing on PED use in baseball

Money and Fame

What incites such risk-taking? Money, for sure, as well as fame, or more precisely a perceived insufficiency of one or both in the typical risk-seeker’s mind.  For example, Barry Bonds was already a rich man, and holder of three of his eventual seven league MVP crowns, when his heaviest if not initial use of banned substances purportedly commenced — around the time an attention-grabbing rival (McGwire) became MLB’s single season home run king in 1998.

Why risk disgrace when one is already rich and widely lauded as being among the best-ever in one’s chosen craft?  Perhaps Shakespeare answered this question best in Measure for Measure, which among other lessons teaches that most folks’ vices are simply their virtues taken to an extreme.  Hyper-competitive as they were, Bonds, Roger Clemens, and other players who purportedly doped after if not also before they became rich and famous revealed through such antics not what they were hell-bent on proving — that each was “Da Man” in his chosen craft — but rather that they couldn’t bear not being so regarded. 

Know anyone with similar insecurities in money management in general and PE investing in particular?  So do I: lots of raccoons (to use ET speak) — investment pros whose reaches exceed their grasps.  Good starting points for readers wishing to conduct their own deep dives on such practices include a paper by Harvard Business School’s Erik Stafford available here; a McKinsey study available here; and a Harvard Business Review article available here.

Dodgy Methods

If overly large egos are the single best predictor of overreaching — of determining ex ante which individuals in any field of endeavor are likeliest to cross prudential, ethical, or legal lines in order to boost their own stats, money-wise or otherwise — unduly short time horizons are surely a close second.

Among numerous examples of such myopia from pro baseball one could cite, there’s the comment a talented but undisciplined rookie tossed out after his team’s general manager gave him a much-needed lecture on personal and professional ethics in 2013.  “Where I’m from,” Yasiel Puig told Dodgers GM Ned Colletti, “we don’t worry about tomorrow.” Sadly but unsurprisingly, the incidence of illegal drug use is much higher among foreign-born baseballers than it is among US-born ones — not because the former relish rule-breaking, but rather primarily because income opportunities for them outside baseball are so vastly inferior to those within it.  (Puig himself proves the point, having risked life and limb to escape his native Cuba to play pro ball in America, something he’s done well and in all likelihood without help from PEDs, albeit not without several non-drug related dust-ups.) Similarly, PED use tends to be more widespread among aspiring pro baseballers attending junior colleges than among those enrolled at so-called four-year institutions of higher learning. The latter schools may boast more PhDs and PhDs-in-training than the former, but “jucos” as a group boast more of what Mario Gabelli among other accomplished business types claim to be seeking when making new hires: “PHDs — Poor, Hungry [and] Driven.”

Are PE pros whose net worths are lower than they deem tolerable more inclined than their peers to cut corners in efforts to enhance their incomes – to add excessive leverage to companies they control, orchestrate hurried sales (or purchases!) of such firms, manipulate fund cash flows, rig reported results, or employ other dodgy yet familiar methods to become or merely remain prominent players in the PE arena? More to the point, how can allocators determine ex ante which PE pros are inclined to do such things?

I’ll spend many a note in this series answering these questions, and I’ll introduce my answers with two baseball-related tales, both involving the MLB team to which I’d be devoted exclusively if the Bosox went belly up, and both being cautionary for allocators employing leveraged strategies executed by external managers whose true priorities may differ greatly from their stated ones.

Showtime

The first tale involves a ballplayer who recently completed his eighth season in The Show (i.e., MLB), the first four of which were on behalf of my second favorite baseball franchise, the Dodgers. [3]  In May 2016, infielder Dee Gordon of the Miami Marlins received an 80 game suspension following positive tests for two decidedly old school drugs long-banned for use by pro baseballers: testosterone and closetebol.  Given the not-insubstantial number of big leaguers who’d been caught doping since MLB’s “steroid era” supposedly ended roughly a decade earlier, Gordon’s cheating wouldn’t be especially noteworthy, except for these disturbing facts: after a generally unremarkable stint with the Dodgers (2011 – 2014) and an involuntary transfer to the Marlins at essentially no cost to them, Gordon played sensationally enough in 2015 to nab a National League batting title, a Gold Glove award, and in due course a contract to continue playing for Miami for five more seasons for pay averaging $10 million per year.  Under MLB’s Collective Bargaining Agreement, Gordon’s 2016 suspension cost him $1.35 million in foregone pay, reducing to a mere $48.65 million what he’s guaranteed to earn over the life of his current contract presuming he doesn’t dope again and get caught doing so.

To his credit, Gordon has admitted he erred by doping, and he unquestionably did so, legally and ethically.  Financially?  Not so much — not when he swapped perhaps a few more years of PED-free and likely undistinguished work as a relatively low paid journeyman player for a year of PED-fueled labors (in 2015) that carried the potential — since realized — for the Gordon family to achieve financial security for decades to come.  As for the Marlins, they clearly erred in not deducing that Gordon’s vastly improved play in 2015 was too good to be true. 

Are allocators as a group making a similar mistake by entrusting vast sums to PE managers as a group on the assumption that the boundary conditions favoring leveraged equity plays witnessed in recent times — i.e., historically low debt costs coupled with generally rising stock valuations — will persist?  Well, did the Dodgers err in granting now-retired slugger Manny Ramirez a $45 million two year contract in March 2009, five weeks before he got slapped with the first of two major PED-related suspensions?  [4]

Readers get the point, I’m sure, which has less to do with the past misallocation of capital by Dodger execs or those of other teams who’ve been duped than it does with the potential misallocation of capital by investors contributing to the funding build-up depicted in the graph below, drawn gratefully from a solid McKinsey study of the evolving PE landscape published earlier this year.

Overdue Diligence

My second and closing cautionary tale about “juicing” broadly defined also involves the Dodgers, who were purchased by a sharp-elbowed bloke named Frank McCourt for $430 million in 2004.  As the world would eventually learn, essentially all of the dough that McCourt and his then-wife (and current U.S. ambassador to France and Monaco) Jamie used to gain control of the Dodgers comprised borrowed money.  Making a long and ugly story short, McCourt sold the team to its current owners in 2012, netting an estimated $1.15 billion after adjusting for taxes, debt repayments financed by the buyer, and dollars paid in accordance with McCourt’s 2011 divorce settlement with Jamie.  Not a bad financial outcome for McCourt, I gotta admit, especially given the fact that he put one of America’s the world’s most storied sports franchises into bankruptcy along the way — a step triggered in part by the McCourts’ siphoning of an estimated $190 million from the Dodgers’ coffers to finance personal expenses and other non-baseball outlays.  Since McCourt purportedly held all of the franchise’s equity (solely or with Jamie) throughout his time at its helm, no other stockholders were left asking themselves what they’d missed when entrusting capital to him.

Not knowing personally any of McCourt’s creditors, I don’t know whether or to what extent any of them have conducted a post-mortem on their dealings with McCourt.  What I do know is that careful contemplation of McCourt’s baseball-related machinations prior to his debt-driven purchase of the Dodgers should have given his putative creditors pause.  Why?  Because such machinations included a failed effort to buy his hometown MLB team with the utterly selfish and short-sighted aim of shifting its base from an old-time stadium built 80+ years earlier to a new one McCourt proposed to build on land he owned several miles away.  The team?  You guessed it: the Boston Red Sox.  The stadium?  Fenway Park.  Talk about malign incentives and warped time preferences.

Thank goodness the Bosox were purchased not by McCourt but rather by principals with loftier aims, longer time horizons, and sounder risk management protocols — the latter reflecting in part principal owner John Henry’s verifiably successful experience trading commodities on a leveraged basis.  Who knows? If McCourt had indeed seized control of the Bosox, he might very well have run the team as well as its beguiling ballpark into the ground so to speak, leaving me no choice but to shift my allegiances to the MLB team he eventually bought and perhaps inevitably was forced to sell at a time determined by others.  Thank goodness, too, that Ben and Rusty have granted me license to pump out many more notes about pro baseball and money management, separate fields of endeavor that have much in common, including a tendency to bring out the worst — and best — in people.


On deck: the use and abuse of performance-based incentives in money management and baseball (including incentives imposed unwisely on Paul “Big Poison” Waner).

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P.S.  You won’t want to miss the endnotes below.


End Notes

[1] For the benefit of readers not previously exposed to the second-most sublime poem written in English, we’ll note that Mr. Davis was channeling Ernest Thayer’s 1888 masterpiece Casey at the BatThe poem that outshines Casey  will feature prominently in a future note, focused appropriately on couldas and shouldas in baseball and investing.

[2] The 33-inning game in question began on April 18, 1981 and involved two Triple A teams — the Pawtucket Red Sox, featuring future Hall of Famer Wade Boggs, and the Rochester Red Wings, featuring future Hall of Famer Cal Ripken.  At 4 am on April 19, with the score tied 2-2, the game was suspended after 32 innings.  Play resumed on June 23, 1981, ending 18 minutes later when a Pawsox batter hit a bases-loaded single to give his team a 3-2 win.  FWIW, the longest major league games measured by innings and time, respectively, were a 26 inning affair between the Boston Braves and Brooklyn Robins in 1920 and an 8 hour and 6 minute, 25 inning tilt between the Chicago White Sox and Milwaukee Brewers in 1984.  Amazingly, the 1920 game took just three hours and 50 minutes to play, with the starting hurlers for both Boston and Brooklyn pitching all 26 innings.  The game ended in a 1-1 tie when the umpire called it due to darkness.

[3] I’ve omitted the Dodgers’ geographic prefix because the franchise was based elsewhere than its current home when it executed a move that earned it my undying respect, breaking MLB’s color barrier by promoting Jackie Robinson to its big league team in Brooklyn in 1947 — an embarrassing dozen years before the Bosox become the last MLB team to integrate racially.

[4] Nor were the Dodgers the only team that Manny took for a ride. Are Bosox fans like me pissed that dollars which might otherwise go to active players continue to flow to Ramirez, at a rate of $2 million per year for another eight years pursuant to a $160 million contract the Bosox and Ramirez executed in 2000? YES.

Notes from the Diamond #1: Always Something New to Learn

Yazstremski waits for the bounce.

Don’t be afraid to take advice. There’s always something new to learn. — Babe Ruth

Trivia Question 1 of 108 — What baseball Hall of Fame catcher earned valedictorian honors while also posting a 75-3 record as a pitcher in high school? Answer furnished in main text. Ditto for an answer to the question, “Why 108?”

Boston Red Sox pitcher Brandon Workman at bat in the 9th inning of Game 3 of the 2013 World Series

The Wind Up.  Big differences in their physical demands aside, playing pro baseball and managing money for a living have much in common — a happy fact for those of us who find both endeavors engrossing and a godsend for money managers whose quarterly letters would be intolerably brief or dull absent baseball-related arcana.  Truth be told, the literature exploring parallels between baseball and investing is already so vast that Epsilon Theory (ET) faithful might reasonably pose the same question to ET management that Red Sox Faithful shouted at their TVs as the worst managerial miscue in living memory was unfolding before their eyes several years ago: “Why?!”  No, I’m not referring to Bosox manager Grady Little’s catastrophic act of omission in Game 7 of the 2003 American League Championship Series — acceding to star pitcher Pedro Martinez’s pleas that he continue pitching — but rather to the even dopier decision of Bosox manager John Farrell a decade later: letting pitcher Brandon Workman take his first-ever major league at-bat with the Sox and Cardinals tied 4-4 in the ninth inning of Game 3 of the 2013 World Series.  The Sox lost both games, of course, ending their season in 2003 and adding unnecessary angst to a stress-filled but ultimately triumphant season in 2013.  In due course, this series will explore both of the miscues just referenced plus other noteworthy hits, runs and errors in both money management and baseball, all with the aim of elevating readers’ investment games if not also their appreciation of America’s national pastime.[1]

Unwelcome Change.  I know, I know: in many folks’ eyes, football supplanted baseball as the national pastime long ago — a mutation as regrettable and seemingly irreversible as the shift toward extremism in American politics that Ben Hunt discusses so penetratingly in his multi-part note entitled Things Fall Apart.  Unable as I am to trump Ben (pun intended) in political punditry, I’ll generally avoid politics in this series, leaving it to Ben and other ET contributors to draw parallels if and as they see fit between the shifting fortunes of professional sports on the one hand and political factions on the other.  That said, I can’t resist quoting here the late political journalist Mary McGrory’s lament respecting mutually reinforcing trends she espied in the nation’s political and recreational proclivities long before POTUS 45 declined an invitation to throw out the ceremonial first pitch on Opening Day during his first year in office: “Baseball is what we were,” McGrory observed.  “Football is what we’ve become.”

The Pitch.  Shifting from wind up to pitch … ET faithful deserve an answer to this important question among others: why should they allocate a portion of their scarcest resource — time — to this note or indeed any of the 108 planned and presumably weekly missives comprising the series hereby commencing?  At least three reasons for doing so come to mind.  First, Babe Ruth had it right: there’s always something new to learn about any field of human endeavor, including the fun fact that, as the accompanying diagram confirms, baseballs have precisely 108 stitches.  Second, Ben Hunt has it right: sometimes the best way to replace bad habits with good ones in a chosen field is to look outside it for wisdom or inspiration — as Ben has done so effectively and entertainingly for us money management types with his Notes from the Field. Third, ET contributor par excellence Rusty Guinn has it right also: sometimes the best means of elevating one’s game is to take it on the road so to speak — to contemplate the origins and soundness of habits and beliefs outside one’s chosen profession or political persuasion with an eye toward assessing critically what Rusty refers to as an investor’s “priors”.  We all have ‘em, like it or not.

Anatomy of a baseball

No Guarantees.  I’ve put priors in quotes because I myself have never used that term in decades of writing about investing, nor do I expect to use jargon like it often if ever in this series.  But Rusty fancies the term; I like and respect Rusty (and Ben); and I’ve already learned much from Rusty’s series entitled Notes from the Road.  I won’t guarantee that readers will find these Notes from the Diamond comparably insightfulBut I will pledge that they’ll spawn chuckles on occasion, while also avoiding quotes from an overexposed baseball legend who’s understandably but unjustly remembered more for his malapropisms than for his central role in notching ten World Series titles for the Evil Empire (a/k/a New York Yankees).  After all, why subject readers to deja vus from Yogi Berra when the supply of edifying utterances from other baseballers is large and growing?

Superficial Stasis.  As skilled as Berra was behind the plate, the high school valedictorian referenced in the trivia question at page 1 was even more so, as well as a gifted philosopher in his own right.  Responding to a dinner companion’s jibe that the game he played for a living was intolerably slow, Hall of Fame catcher Johnny Bench intoned, “Baseball is a slow game — for slow minds.”  Rightly understood, investing as distinct from trading also entails prolonged periods of superficial stasis — superficial because effective investors must and do ponder more or less continuously whether newly arriving information necessitates portfolio changes, mindful that it seldom does.  Interestingly, the principle just flagged — favor inaction over action unless the latter is truly vital — is arguably the single most impactful insight spawned by the so-called Sabermetrics Revolution that’s transformed pro baseball in recent decades, i.e., the reshaping of what players, managers and — yes — umpires do or don’t do on the field based on advanced statistics not readily available before certain information technologies were developed.  Among many other insights these Notes will explore, Sabermetrics — a term derived from the acronym for Society for American Baseball Research or SABR — has confirmed decisively what baseball cognoscenti have long conjectured: that a base on balls or walk can be as good as a hit.   Indeed, for reasons to be explored in future notes, the “big data” revolution that’s transformed pro baseball no less than it’s transformed financial markets in recent decades has proven that walks can be better than hits for teams notching them under certain circumstances.

For the Love of It.  What other insights from baseball of potential utility to investors will these Notes explore?  At the risk of having Ben Hunt consign me to his necessarily large nursery of raccoons — i.e., finance types who pilfer Other People’s Money by, among other means, overpromising as habitually as Ted Williams reached base safely[2]  — I’ll answer the question just posed while also wrapping up this inaugural note by providing a sneak peek at insights I plan to explore in the 107+ notes to follow.  I’ve added “+” to 107 because, more than five decades after I first laid eyes on Fenway Park’s gorgeously green grass, and more than three decades after I sank into money management, I’m as intrigued as ever by both baseball and investing.  Whether such intrigue gives me an edge in the latter pursuit is unclear, but I like to think it does, just as I like to think that major leaguers who truly enjoy their work have an edge over those who don’t.  As in finance, which comprises a regrettably large sub-population of raccoons, professional baseball comprises numerous actors motivated primarily by money.  As in finance, it’s long been thus in baseball, as perhaps the edgiest player of all time confirmed when rebuking his fellow pros as his long and distinguished playing career (1905 – 1928) was nearing its end.  “The great trouble with baseball today,” Ty Cobb scolded, “is that most of the players are in the game for the money and that’s all. Not for the love of it, the excitement of it, the thrill of it.”

Coming Attractions.  Thrilling or not, the useful insights derivable by applying ongoing advances in baseball strategies and statistics to money management are legion.  I’m excited by the prospect of pinpointing many of them in future notes, including these:

  • Why it’s not merely useful but essential for professionals to “change their stripes” — a stubbornly enduring no-no in money management whose conscious violators include not a few investment pros as successful in their evolving endeavors as Johnny Bench was in his. Why did Bench switch from pitching to catching at a crucial point in his development as a player?  Because he and those advising him deduced correctly that his foremost physical skill — a strong throwing arm — would be optimally applied as a catcher, thus permitting Bench to use his smarts as well as his physical gifts as frequently as baseball rules permit.  We’ll explore Bench’s metamorphosis and its significance for investment pros in greater detail as this series unfolds.
  • How the metrics used to assess on-field performance condition the behavior of not only players but umpires — a phenomenon with great relevance to client-manager relations in institutional funds management. As we’ll see, the fleet-footed fellow whose most celebrated achievement as a baseballer was his breaking of Ty Cobb’s all-time stolen base record understood intuitively what many capital allocators understand dimly if at all . “Show me a guy who’s afraid to look bad,” said six-time All Star and Hall of Famer Lou Brock, “and I’ll show you a guy who can be beaten.”

Not afraid to look bad: Lou Brock (#20) in action in 1964

  • What practitioners pursuing excellence must do to maintain an edge as the information revolution advances. Quite apart from rules changes already implemented that preclude future career stats as stellar as those achieved by past outliers in each domain — e.g., Wes Crawford or Bob Gibson in baseball; Michael Steinhardt or Peter Lynch in money management — the relentless and mutually reinforcing advances of technology and transparency portend continued shrinkage in the pool of dominantly successful practitioners in professional baseball no less than in professional investing.[3]  By transparency, I mean the timely collection, compilation and dissemination of essentially all available objective data germane to the aforementioned professions.  As many readers are aware, and as future notes will discuss, enhanced transparency as just defined has reduced and will continue undermining the incomes of ballplayers as well as investment pros whose “edges” entail primarily their patrons’ imperfect understanding of their true as distinct from perceived skills.  In a baseball context, “patrons” as just used is defined broadly to include team owners and managers as well as fans — all of whom can easily and inexpensively access meaningfully large chunks of the roughly seven terabytes of data per game (including but by no means not limited to video bits and bytes) that major league baseball’s Statcast system collects via cameras and radar installed in every MLB stadium. That’s a quantum of data equivalent to the contents of 700,000 copies of Webster’s Collegiate Dictionary — and literally millions times the number of data points some of us learned how to record manually on paper scorecards back in the day.

Manual recording of Red Sox labors vs. Yankees 8/18/2006

Continuous Improvement.  Imagine if fiduciaries could evaluate investment pros as quickly, cheaply and thoroughly as baseball managements can evaluate players’ every movement  (or non-movement) using Statcast.  I’m unsure such enhanced scrutiny would produce uniformly better returns, but I’m sure that it would alter managers’ as well as clients’ behaviors, just as such scrutiny has altered how pro baseball gets played, who gets to play it, and for how much.  I’m sure too that even if investment pros’ labors remain as crudely understood as pro baseballers’ were before Statcast came along, future technological advances will compel investment pros seeking sustained excellence to change their stripes on a regular if not continuous basis.  How do I square the assertion just made with Ben’s championing of repeatable processes in Things Fall Apart? I’m not sure I can, or want to, his and Rusty’s invitation to contribute to ET being rooted in their laudable desire to foster diverse viewpoints under ET’s banner.  By my lights, choiceworthy processes in money management display the same cardinal virtue that my all-time favorite player displayed when fielding caroms off Fenway’s fabled Green Monster: such processes are less “repeatable” or static than they are adaptive and ever-changing.  The player in question, of course, was Carl Yazstremski, a Long Island native whose exceptional work ethic arguably made Puritan New England (a/k/a Red Sox Nation) a fitter venue for his sporting labors than his original home turf.  “I loved the game,” Yaz said after his 23-year career came to an end in 1983.  “But I never had any fun.  All hard work, all the time.”

Carl Yazstremski awaiting a carom off Fenway’s Green Monster in the 1967 World Series

Ernie Had It Right.  Like the best opening frame this Bosox fan has ever witnessed — a 50-minute masterpiece in which the Bosox scored 14 runs on 13 hits against the visiting Florida Marlins at Fenway in June 2003 — this initial installment of Notes from the Diamond has developed proportions more expansive than might reasonably have been expected.  As noted at page 1, readers can expect future installments to be shorter — but no less replete with pearls of wisdom from wizards of the diamond, including a gentleman who changed his stripes not once qua young Johnny Bench but multiple times en route to his own induction at Cooperstown.  Nicknamed “Mr. Sunshine” for his upbeat disposition, Ernie Banks (1931 – 2015) is forever known for his catchphrase, “It’s a beautiful day for a ballgame … Let’s play two”.  With so many useful parallels between baseball and investing to be drawn — and with so many members of ET Nation including yours truly wondering what comes next for the business of investing and their own roles within it — I’m keener than ever to craft the next note in this series … and the next.  Let’s play 108, why don’t we?

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Endnotes

[1] Workman’s first and to date only major league at bat went poorly, with a whiff plus two called strikes producing a blindingly quick out.  If the Red Sox, for whom Workman has played on-and-off since 2013, make the World Series in 2018, the odds are good that team manager Alex Cora will call on Workman to do some relief pitching.  That said, I’d bet my family’s most prized baseball-related possession — a ball inscribed for my children by Elden Auker — that Cora doesn’t let Workman bat, ever.  The last living pitcher to have faced Babe Ruth, Auker (1910 – 2006) showed his mettle early in his 10-year major league career: Ruth was the first batter Auker faced in the pitcher’s big league debut in 1933, striking out on just four pitches.

[2] Most readers know that Joe DiMaggio holds the record for consecutive games with a hit: 56 in 1941.  Some may be unaware of another seemingly unbreakable record, held by the best hitter in baseball in the 1940’s or indeed any other epoch: in 1949 Ted Williams reached base safely in an astounding 84 consecutive games.

[3] The all-time career leader in triples with 309, Crawford played before “live era” or post-1910 baseballs made home runs far more frequent than triples.  Gibson notched the all-time best single season earned run average (ERA) of 1.12 in 1968, a year before pitching mounds were lowered by a third to their current height of 10 inches.  Steinhardt made big bucks for himself and his clients during the first half of his career via block trading methods that were either illegal at the time or have since been outlawed.  And Lynch turbocharged his returns via the lawful exploitation of corporate disclosure protocols benefiting big institutions like Fidelity that post-2000 securities law reforms have rendered nugatory, including especially Regulation FD.


On Deck:

What baseball’s steroid era and private equity’s salad days have in common