Underestimating the Density of the Fog

The story has essentially attained the level of holy writ, at least to those committed to data and evidence, such that it now seems almost too good to be true. The quick-and-dirty version of the tale is that stats geeks with computers, like those former player and broadcaster Tim McCarver called “drooling eggheads,” outsmarted and outmaneuvered the stupid yet arrogant “traditional baseball men” who ran our most traditional sport at the professional level and who thought they knew all there was to know about the game. Thus, it is said, everything the old-time baseball men thought they knew about evaluating players and teams has been found wanting, not that those whose day has passed, committed to wizardry and witchcraft as they are, have recognized it.

This revolution – as shocking as it has been comprehensive – is said to have brought about the ultimate revenge of the nerds. The geeks now run the baseball show, having moved the level of analytical precision involved in running teams and evaluating players from zero-to-sixty in a flash. The new breed of “baseball men” aren’t grizzled scouts looking for “five tool guys” but, rather, Ivy League educated experts in computer modelling and statistical analysis who use those skills to determine who to scout, who to sign, who to play and how to play. The prevailing narrative describes this new contingent as dominating professional baseball at every level, down to the depths of the independent minor leagues.

Is the analytics overhaul of baseball proper as complete and comprehensive as the telling claims? No. The real story is much more interesting and enlightening than that.

Baseball is particularly amenable to the use of statistical analysis because it offers large sample sizes, discrete individual-performance measures (such as plate appearances, pitches, and the like), and ease of identifying positive results (such as winning, home runs, and the like). However, when humans are involved – and baseball is as human as can be – interpretation of the underlying data is highly complicated.

Great interpretation of difficult data sets, especially those involving human behavior, involves more sculpting than tracing. It requires great skill, imagination and even a bit of whimsy as well as collaboration as to whether the various interpretive choices are acceptable (not to say the right) ones. That’s why we understand reality better with respect to the natural sciences than in the social sciences. As ever, information is cheap but meaning is expensive.

To lead off, let’s recall that if it seems too good to be true, it usually is. To see what I mean by that in the context of our story will require some in-depth analysis of its own, starting with more than a bit of background information and history. 

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You Can’t Outrun the Boulder

The idea behind tactical asset management is to make tactical shifts in asset allocation in order to take advantage of what is doing well and to escape what is doing poorly. The standard benchmark is a classic 60:40 allocation, of which VBINX is an excellent proxy. Had the whole concept of market-timing not been so utterly discredited (the latest data is here), it would probably still be called that. Such funds have broad discretion to move among stocks, bonds and cash and to move in and out of various sectors of the equity and fixed income markets in order (allegedly) to take advantage of market opportunities and to avoid market pitfalls.

From a marketing standpoint, the thrust of tactical management is to avoid market downturns (at least the significant ones) and to provide a lower volatility experience. That’s why, after almost disappearing, tactical managers returned with a vengeance after the 2008-2009 financial crisis. Visually, the idea is essentially that, like Indiana Jones, tactical managers can outrun the onrushing boulder of negative returns.

In reality, we can’t outrun the boulder, as the following video (using a plastic “boulder” – it looks like a blast) demonstrates clearly.

A Morningstar study from 2010, updated in 2012 and updated again in 2014 should put the matter to rest. During the pre-2010 period, tactical management underperformance averaged 2.6 percent per year. And over the three years through July of 2014, tactically managed funds underperformed a classic 60:40 portfolio by 3.8 percentage points per year.

The great William Bernstein states the key to that underperformance well as follows.

“There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.”

Another reason for the underperformance is fees, which are the best indicator we have of performance success. Tactical funds on average charge an annual management fee of 1.48 percent as of 2014, according to Morningstar. That’s nearly double the mutual fund industry average of 0.77 percent, according to ICI.

Tactical management is yet another sort of “cargo cult” investing “solution” (thank you, Dr. Feynman) — an approach, model or system that is said to work somehow without adequate analysis, testing and safeguards. A data-mined but insufficiently authenticated “solution” will almost surely be a disaster for everyone but those collecting fees for it. Some of these “solutions” seem like a joke. Most are deadly serious. But there’s no reason to expect them to work.

You aren’t Indiana Jones. You’re not going to outrun the boulder.

Hot Pants Investing

I watched Mike Krzyzewski’s first Duke win from the stands in Cameron Indoor Stadium as a student in 1980 and his fifth national championship victory earlier this month at home, on television, with my grandchildren. I’ve probably seen a majority of the games in-between one way or another. Coach K is an icon, and widely regarded as perhaps the best college basketball coach of all-time. He is the winningest college basketball coach of all-time. But when has hired 35 years ago, he wasn’t even generally considered to be in the running for the job. During the entire month-long coaching search, Krzyzewski’s name never appeared in any North Carolina newspaper as even a long-shot candidate for the job. No radio station nor any television station suggested him as a possibility.

Then Duke Athletic Director Tom Butters insisted that he was getting the “brightest young coaching talent in America” to lead his basketball program (video from the hiring news conference here – notice how “Krzyzewski” is repeatedly mispronounced in the report) when he hired Coach K. There was no live coverage of any kind. The local morning paper had reported that one of “three Ws” – Bob Weltlich of Ole Miss, Old Dominion’s Paul Webb or then top Duke assistant Bob Wenzel – was going to get the job. But Butters hired the West Point graduate, then just 33 years old and coming off a losing season at his alma mater. Butters had ultimately listened to Bob Knight, who told him that Krzyzewski had his own good attributes without the bad.  The headline in The Chronicle (Duke’s student newspaper) was “Krzyzewski: This is Not a Typo.” Ironically, the local afternoon newspaper got the scoop several hours before the press conference, but it was after deadline and there was nowhere to report it.

This story seems quaint today, with the idea that a major college basketball hiring could remain unreported and largely secret until the press conference and that the coach hired had not even been considered a candidate is appropriately presumed to be impossible in this digital age. Obviously, times have changed. To get at what that sort of change means to our culture and to the financial services business, we have to go back into ancient history, even before 1980.

Signing Day and the Investment Process

Yesterday – the first Wednesday in February and thus the so-called National Signing Day – was the first day that high school seniors could sign letters of intent to accept an athletic scholarship to play Division I college football in the fall. It’s the culmination of a long recruiting process and crucial to the success of teams and coaches. It can get more than a bit ridiculous.

Some players announced their intentions using live animal props, or worse. One recruit picked Texas over Washington based on a coin flip. At least it wasn’t for the gear, officially anyway. And Snoop Dogg will be giving up his support for USC to cross-town rival UCLA because his son picked the Bruins, where he’ll join P. Diddy’s kid on the team. Cornerback Iman Marshall, a big-time USC signee, has a self-styled “commitment video” that’s particularly absurd.

But the coaches and the media outlets that cover college football recruiting (of which there are an astonishingly high number) take it all very seriously indeed. As the parent of a DI player (at Cal, see above), *I* took it very seriously.

These various publications generally rate high school players being recruited via a “star system” of from two to five stars, with five stars being reserved for top 50 players, four stars for the next 250 (numbers 51-300), three stars for the next 500, and two stars for players who are considered “mid-major” and thus not good enough for the top conferences and teams. Alabama’s current recruiting class is usually reputed to be the nation’s best, for the fifth straight year, averaging out to 4.08 stars. And while it’s not much ado about nothing, it’s much ado about a lot less than you’d think, and in a different way than you probably think.

Whole Foods Quackery

Source: The Quackometer

Fortune has a puff piece out on Whole Foods Market (WFM, a stock in which I have no interest and no intended interest), the up-scale purveyor of excellent prepared food, overpriced groceries with multiple claimed but unsubstantiated benefits, phony health remedies, and the oxymoronic concept of “healthy indulgence.” It made its reputation by pushing healthier living and selling food that doesn’t contain the pesticides and additives that are often staples of “regular” food.

The Whole Foods approach has worked in that its share price is up about 12-fold since its November 2008 recession-era low versus 130 percent for the S&P 500 index. “Great brands impose a view on you,” WFM consultant Kevin Kelley says, and Whole Foods is no exception. “One of the faults that traditional groceries have is they believe the customer is always right.” Today, Whole Foods has a list of 78 banned ingredients, ranging from aspartame to foie gras to high-fructose corn syrup. You may want a Coke, but you can’t get one at Whole Foods.

However, when I took a look at the ingredients that provided Whole Foods its success, the whole thing became far less appetizing. The Whole Foods emphasis on “natural” foods is obviously silly. There is no such thing as non-natural food. Moreover, at least in the United States, it has no consistent meaning. Indeed, the federal Food and Drug Administration explicitly discourages the food industry from using the term. But that doesn’t stop Whole Foods. After all, it’s working.

Oh that a bit of silliness were the only problem. Despite broad scientific consensus that genetically modified food poses no greater health risks than other types of food, Whole Foods says it will require all its vendors to label products with GMOs by 2018 and suggests (at least by inference) that such food isn’t really good for you. Whole Foods would also have you believe that organic produce (which is, not so coincidentally, much more expensive than “regular” produce) will help you stay healthier, even though a major study published in the Annals of Internal Medicine (nicely summarized here) examining hundreds of scientific studies over many years found no evidence of health benefits from organic foods. “There’s a definite lack of evidence,” emphasizes Crystal Smith-Spangler of the Stanford University School of Medicine and an author of the study.

But these issues aren’t all that much to be really upset about. If people want to overpay for something they think will make them healthier, the fact that it doesn’t isn’t too big of a deal. Nobody’s getting hurt and people are stupid all the time. However, the Whole Foods story gets still worse – much worse.

As reported by Michael Schulson in The Daily Beast, Whole Foods pitches homeopathic remedies (such as homeopathic remedies for allergies, homeopathic remedies for colds and flu, Boiron homeopathic medicines and even cures for cancer) as well as other foods and “drugs” that make medical claims that are simply false. Homeopathy is, after all, pure quackery. Whole Foods also sells probiotics — live bacteria given to (allegedly) treat and prevent disease – but it’s a total scam: “If you are a normal human, with a normal diet, save your money. Probiotics have nothing to offer but an increased cost.”

Phony claims such as these are far more damaging than simply pushing “natural” and organic foods. That’s because such fake remedies often cause people to forego substantive medical care that might actually help. For example, such an approach may well have cost Steve Jobs his life, to his obvious regret.

Sadly, it isn’t just customers who have fallen for the Whole Foods hype. “They’re a leading national authority on health and nutrition,” says BB&T Capital Markets analyst Andrew Wolf, “and unequivocally the leading retailer on the link between food and health.” As if.

My friend Josh Brown even fell for the WFM nonsense: “There’s a lesson in the Whole Foods brand that I think carries a great example for my organization and possibly yours as well: The customers are not always right and, more importantly, they sometimes wants [sic] to be told what’s best for them and to have harmful options taken away from within their grasp.” Unfortunately, what customers are told is all too frequently in error and obviously bad for them, as Whole Foods so aptly demonstrates.

Happily, I have every confidence that Josh is doing right by his clients. And I completely agree with Josh’s conclusion: “Zealous advocacy is not fascism, and steering a customer away from something they don’t need or shouldn’t want is just as important as the actual suggestions you are making.” But Whole Foods is far from a good example of “doing [what] is superior and in the clients’ best interest.” In fact, Whole Foods should be a cautionary tale rather than an exemplar.

Maybe there really is a sucker born every minute and Whole Foods will continue to survive and even thrive despite its bogus marketing. But I’d like to think that truth will out, at least eventually.

Bringing the Stupid

Earlier this week I wrote about the growth of the sports analytics movement, particularly in baseball, as an inevitable outgrowth of trying to make one’s beliefs data-driven and thus reality-based. “Arguments and beliefs that are not reality-based are bound to fail, and to fail sooner rather than later.” I also noted that the investment world needs similar growth and development.

But despite the exponential growth in the use of analytics (earlier this year the Phillies became the last Major League Baseball team to hire a full-blown stats guy), not everyone in baseball (as with investing) has gotten the message. For example, The Book goes into great detail about the percentages and when it makes sense to execute a sacrifice bunt and finds — conclusively — that sacrifice bunts are grossly overused and rarely make sense. Simply going back over previous games so as (a) to calculate how many runs each team scored when it had a runner on first and nobody out, and (b) to compare those results to when teams had a runner on second and one out, makes the general point pretty well. In fact, Baseball Prospectus has a report that shows that sacrifice bunting reduced a team’s run expectancy for innings that played out that way from .83 runs to .64 runs in 2013. The same is generally true in previous years.

Note too that we’re not talking here about difficult concepts or high-level math. It’s just a simple calculation — more teams scored and scored more with runners on first and nobody out by not-bunting than by bunting. Easy.

But not to Texas Rangers manager Ron Washington. Washington likes to sacrifice bunt. In response to a question about the dubious nature of that strategy based upon the math, Washington took offense.

“I think if they try to do that, they’re going to be telling me how to [bleep] manage,” Washington said. “That’s the way I answer that [bleep] question. They can take the analytics on that and shove it up their [bleep][bleep].”

Wow. He even went third person.

“I do it when I feel it’s necessary, not when the analytics feel it’s necessary, not when you guys feel it’s necessary, and not when somebody else feels it’s necessary. It’s when Ron Washington feels it’s necessary. Bottom line.”

Double wow. No matter one’s chosen ideology, if the data doesn’t support it, the risks of continuing on that path are enormous. It’s not the percentage play (by definition). And it’s not the smart play.

Insisting upon a course of action that is shown to be wrong is, quite simply, a recipe for disaster. A good investment strategy, like good baseball strategy, will be – must be – supported by the data. Reality must rule. When it doesn’t, we’re simply bringing the stupid.

Get Real

Investment Belief #2: Smart Investing is Reality-Based

Anytime is a good time to talk baseball. I’ve done it pretty much my whole life. If you’re watching a game, its pace is perfectly conducive to discussing (arguing about) players, managers, strategy, tactics, the standings, the pennant races, the quality of ballpark peanuts, and pretty much anything else. In the off-season, the “hot stove league” allows for myriad possible conversations (arguments) about how to make one’s favorite team better. And now that spring training camps have opened, baseball talk about the upcoming season and its prospects has officially begun again in earnest.  The coming of Spring means the return of hope — maybe this will finally be the year (Go Padres!) — which of course means talking (arguing) about it.

Our neighborhood quarrels about the National Pastime when I was a kid were incessant and invigorating, and didn’t have to include the vagaries of team revenues and revenue-sharing, player contracts, free agency and the luxury tax, as they do now. We could focus on more important stuff. Who should be the new catcher? Who should we trade for? Do we have any hot phenoms? Who’s the best player? The best pitcher? The best hitter? The best third baseman? Who belongs in the Hall of Fame? Which team will win at all this year? How do the new baseball cards look? Is the new Strat-O-Matic edition out yet?

Early on, my arguments were rudimentary and, truth be told, plenty stupid. They were ideological (the players on my team were always better than those on your team), authority-laden (“The guy in the paper says…”), narrative-driven (“Remember that time…”), overly influenced by the recent (“Did you see what Jim Northrup did last night?”) and loaded with confirmation bias.

Quickly I came to realize that it’s really hard to change an entrenched opinion, and not just because I was arguing with dopes. Slowly it became clear that if I wanted to have at least a chance of winning my arguments, I needed to argue for a position that was reality-based. I needed to bring facts, data and just-plain solid evidence to the table if I wanted to make a reasonable claim to being right, much less of convincing anyone. Arguments and beliefs that are not reality-based are bound to fail, and to fail sooner rather than later.