Notes from the Diamond #4: Less Is More

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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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Comments welcome on Notes from the Diamond!

Contact David directly at:
     Email: david.salem@epsilontheory.com
     Twitter: @dsaleminvestor


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.

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Hi David, have you spent any time reviewing FI360 or CEFEX’s IPS practices and guidelines? In case you aren’t familiar with those organizations, they are marketing themselves as the leaders in the fiduciary standard-setting space. In my limited time helping clients implement those standards, I get the feeling they would find your IPS grossly inadequate. Thoughts?

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