Moneyball For Money Managers
Moneyball showed how picking players with the highest on-base percentage improved team success. In money management, a fund must ensure the best ideas are their largest positions to improve success.
Baseball is the birthplace of “Moneyball”. Other sports soon followed once the concept of Moneyball was proven and made public. General managers from basketball to football to soccer to hockey now employ statisticians in their front office. Drug and energy exploration companies have been playing their own form of Moneyball for years before baseball caught on. Now politics is in the game (see full LA Times article here). This recent LA Times article gives a glimpse of how the Obama campaign used their own brand of Moneyball to help win the election which will change campaign strategy for evermore.
“… the goal was to rank individual voters in the swing states based on their likelihood of voting for the president or of being persuaded to vote for him, to volunteer for his campaign and to vote early. The Obama campaign developed separate models for each.”
What strikes me about this article isn’t that politics is using Decision Theory to win elections, it’s that money management, in general, still does not use it. In baseball, Moneyball showed how picking players with the highest on-base percentage improved team success. In money management, a fund must ensure their best ideas are their largest positions to improve success. But most firms don’t effectively measure idea quality. They don’t “rank individual voters.” They don’t compare the “on-base percentage.” If they did, they would have a spreadsheet that had every investment idea ranked by Expected Return and scored by other qualitative and quantitative factors. But instead, most firms just use instincts to manage the portfolio. In fact, most firms don’t have a systematic way to size positions. I can hear the drug and energy geeks now, “and they get paid the big bucks.”
Alpha Theory is “Moneyball” for asset managers. Alpha Theory’s software captures a firm’s price targets and probabilities, then highlights the position sizes that are over or under-weighted based on those targets. It factors in liquidity, volatility, time horizon, sector exposure, etc. to give the manager a repeatable process for sizing positions. This saves the portfolio manager’s time, reduces emotional decision making, and helps you stay on top of what your analysts are thinking. Just ask the simple question: What is your 6th largest position? Is it your 6th best idea? What is your upside reward and downside risk? If you don’t know, a little Moneyball could go a long way.