September 2, 2022
“Moneyball,” by Michael Lewis, was published in 2003. It documents the 2002 season of the Oakland Athletics (or, as most fans refer to them, “the A’s”) and their General Manager, Billy Beane. The A’s had one of the lowest payrolls in Major League baseball, which conventional wisdom said would doom them to a season of losing to their richer counterparts. Yet 2002 marked the third consecutive season that the A’s had reached the playoffs. Over those three years, the team won more than 60% of the games it played.
How did a team with little money and low expectations buck the trend and become one of the great success stories in pro sports? The A’s completely re-thought the approach to constructing a baseball team. They replaced emotion with logic and subjectivity with objectivity. In doing so, they permanently changed the way the game is played, managed and discussed. They also provided some valuable lessons that can be ported to other endeavors, including investing. We explore one of those lessons here.
One of Moneyball’s central storylines revolves around the playing career of Billy Beane, the team’s General Manager, and how that playing career shaped his approach to building the A’s roster two decades later.
In the late 1970s, Billy Beane had come out of his California high school as one of the most touted prospects in the sport. He was what scouts referred to as a “5 Tool Player.” He could hit for average, hit for power, run, throw and field. He possessed all of the physical characteristics scouts associated with star players.
Yet, after being selected by the New York Mets in the first round of the 1980 amateur draft, Billy Beane spent the next decade bouncing between the high minor leagues and the back end of major league rosters. By the time his career ended after the 1989 season, he had appeared in just 148 major league games. His lackluster .219 batting average was accompanied by a grand total of 3 home runs.
As Billy Beane transitioned to the role of a front-office executive, his own experience as a player contributed to his growing skepticism about traditional scouting methods. Why was it that “can’t miss” prospects often missed by so much?
Most talent scouts were ex-players whose views were shaped by the sport’s conventional wisdom. While statistics were certainly used to filter prospects, scouts valued the player’s ability to pass the “eye test” at least as much. Factors such as height, weight, sprint speed, throwing velocity, and overall physical presence were critical in a scout’s determination of how highly a young player was rated. These biases extended to the evaluation of major league players as well.
It wasn’t that Billy Beane thought those traditional physical metrics were completely irrelevant. Clearly, raw athletic ability has some real value. His concern was that physical tools were being assigned more value than what they were worth in terms of what really mattered to a baseball team: winning games. Further, he believed that overvaluation stemmed from the mostly subjective nature by which scouts evaluated players. Necessity also played a role. Because the A’s had little money to work with, they could not afford to pay huge salaries to acquire the prototypical “perfect” players.
As discussed in Part 1 of this series, the A’s understood that patient hitters who reached base frequently helped a team generate more runs, which led to more wins. There were many players who didn’t check every prototypical scouting box but who were consistently able to find their way onto base. Often, these players were largely ignored by most teams. There were other players, like Billy Beane himself, whose physical talent masked a much less disciplined approach to hitting.
Traditional baseball scouting methods allowed any number of subjective biases to seep into the evaluation of a player, regardless of what an unbiased assessment of the player’s actual on-field production might reveal. By using a more objective approach to player evaluation, the A’s sought to obtain better value for each dollar they spent, thereby allowing them to remain competitive against teams with much larger budgets.
Investors are prone to many of the same subjective biases that influenced old school baseball scouts. The first step in mitigating the impact of those biases is to acknowledge their existence and to understand that no one is completely immune from them. The second is to counterbalance them by being as calm and objective as possible in making investment decisions. What are some of the biases to be aware of?
Just as scouts can become overconfident in their own ability to identify talented players, investors can become overconfident in their ability to choose the correct stock, sector or theme. This can be an especially dangerous bias during bull markets, which may fool investors into thinking that their success is due more to their skill and prescience than to the market tailwind. False confidence can encourage risky behavior such as ignoring high valuations, investing excessive amounts in a small number of positions, and utilizing borrowed funds.
When evaluating Billy Beane, many scouts were so mesmerized by his natural talent that they ignored certain warning signs, including somewhat diminished performance during the final season before he was drafted.
Once an opinion has been developed, no one relishes the idea of it being proven wrong. Therefore, we often overweight evidence that supports our opinion and may be dismissive of evidence that contradicts it.
This is a dangerous bias for an investor. We may think we are being measured and rational when in fact we are subconsciously seeking out only corroborating evidence. In most cases, if one tries hard enough, it is possible to find “evidence” to support almost any position. The result may be a stubborn reluctance to adjust strategies even in the face of mounting losses and a changing fact pattern.
At times, front office personnel overweight recent results at the expense of a longer and more reliable track record. Free agents who are coming off of a career-best season may sign huge contracts only to disappoint when their performance reverts to its historical average.
The investing equivalent is to chase the hot stock, the top performing mutual fund, or the latest market fad. When market participants see outsized returns being generated, they may have a fear of missing out and pile in at the exact point where the fundamental investment case is at its least compelling. This works in the opposite direction as well, where poor recent performance is extrapolated into the future, leading people to abandon the market at the exact time they should want to buy more.
As the saying goes, “There is safety in numbers.” Scouts may disagree on their exact rankings for top prospects, but the list of those top prospects is generally fairly consistent from team to team. Choosing one of those players does not subject a team to ridicule if the player doesn’t work out. After all, every other team had the player ranked highly as well.
Investing confers similar risk onto the decision-maker. Piling into the same trade idea or having the same opinion as the majority of other investors provides a sense of security and a degree of cover. Being a contrarian, on the other hand, exposes an individual to negative feedback in the event their actions prove incorrect.
This mentality has some relationship with recency bias. Often, the crowd follows recent momentum, chasing prices ever higher or selling into a declining market. Seeing many others do the same thing is a form of confirmation bias as well, providing validation through the actions of other smart people. This is one reason that the old adage of “buy low and sell high” is so much harder to achieve in practice than it is in theory.
Anchoring occurs when one becomes focused on a certain past condition and holds onto that condition as a barometer for future performance even if circumstances have changed. In the case of athletes, scouts may anchor their views about a player to the level of potential they envisioned when the player was first drafted. This may explain why some players with consistently below-average results continue to receive opportunities from professional teams.
Investors often anchor their view of an investment to the price at which it was originally purchased as opposed to objectively assessing it based upon its current merits. An investment which has declined in value due to deteriorating fundamentals may have difficulty recovering to the original purchase price or to some other arbitrary target level like a previous high. Anchoring prevents the holder from fully acknowledging the changing circumstances, perhaps preventing them from biting the bullet, realizing a loss, and allocating the capital more efficiently elsewhere.
The Oakland A’s added objectivity into their player evaluation and game management by relying more on hard evidence. A player’s actual performance in the most important statistical categories drove their opinion of that player more than the subjectivity and potential biases inherent in human judgment.
They were also not afraid to risk looking bad by choosing players that other teams shunned. The A’s drafted or signed players who were broadly considered too old, too slow, too overweight or otherwise physically defective. Many of those players provided valuable production to a playoff-bound team. They were also signed for bargain prices because other teams could not get past their engrained biases.
For an investor, human error caused by subjective biases can have a material negative impact on the achievement of long-term goals. A lack of objectivity can lead to poorly timed entry and exit points, irrational adherence to a particular investment strategy, and missed opportunities.
The biases mentioned here are only a subset of those to which investors may be subject. Although avoiding bias sounds easy, it can be hard in reality. In many cases, bias is subconscious, making it difficult to acknowledge and correct.
Objectivity can be increased by consistently challenging one’s own assumptions and actively looking for contradicting evidence. This includes being especially cognizant of the possibility that greed or fear might be driving a decision instead of facts and fundamentals.
Having an appropriate long-term asset allocation plan and sticking to that plan is another good way to inject discipline into the investment process and to discourage emotional responses. A well-diversified portfolio reduces the risk of a bias-induced mistake having an outsized impact on performance, and activities like dollar-cost averaging help reduce the subjectivity involved in market timing decisions.
There is no way to entirely remove the human element from sports or investing, nor would that even be desirable. Because neither endeavor is an exact science, there will always be a need for some amount of judgment. The challenge is to make that judgment as objective and fact-based as possible.
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