Sorry, but I couldn't post the secure link so, I cut and paste instead.
Byron is so well written that I couldn't resist posting this here:
US Investment Perspectives – August 27, 2003
Perhaps There’s a Better Way
Byron R. Wien (Byron.Wien@morganstanley.com)
Every once in a while, when I’m in a melancholy mood, I
think of how little the craft of portfolio management has
changed during my 40-year career. Sure we have computers
now instead of Quotrons, and programs to determine value at
risk and volatility, but if you analyze how money managers
spend their days, it isn’t all that different from what is was in
the 1960s.
Salespeople file into conference rooms early each morning to
listen to analysts’ comments on earnings, new products, and
meetings they attended. The sales force then calls portfolio
managers who are soon off to their own meetings to discuss
what should be bought and sold. Every so often a macro
concept like legislation, currency, or interest rates is assessed,
and asset and sector allocations occasionally come into play,
but portfolio managers spend their time relentlessly in pursuit
of a group of perfect stocks. Everyone is so busy talking
on the telephone, reading emails and research reports, and
attending meetings, when do they have time to think? Why
don’t salespeople call in the afternoon when portfolio managers
are more relaxed? Is the information that urgent? Or
will the portfolio manager wonder who got called in the
morning?
For the buy-side, performance, as elusive as it seems to be, is
everything. The highest compliment you can pay a portfolio
manager is he or she is a great stock picker. Nobody points
someone out in a crowd and says, “That guy really knows
how to construct a sound portfolio.” The heroes beat their
benchmarks if they are long only, or they earn satisfactory
absolute returns with low volatility if they’re hedge funds.
They do that by picking winners and, if they are hedged,
shorting losers.
I have often thought that one reason so many managers have
trouble beating the market is because building a portfolio one
stock at a time may not be the best way to manage money.
Even if you make judgments on the relative attractiveness of
sectors based on the fundamental outlook and quantitative
values and then pick the individual stocks afterwards, your
effectiveness does not seem to improve all that much. There
is so much data on stocks, I thought there must be a way to
determine the quantitative characteristics of winners and
losers and to build portfolios accordingly. Some portfolio
managers pay attention to quantitative analysis, and some
firms run money using that approach, but most money is still
managed the old-fashioned way.
It was perhaps because of my thinking about an alternative
approach to investment management that I responded so
enthusiastically to Michael Lewis’ new book Moneyball (see
Steve Galbraith’s essay, “Searching for the Financial
Equivalent of a Walk,” US Investment Perspectives, 8/06/03).
As many of you know by now, this book is ostensibly about
baseball, but almost from the first page it sang out to me
about money management.
For those of you don’t know the story, Moneyball is about
the Oakland A’s and its general manager Billy Beane. This
team, which had a poor record and limited funds for signing
top players, dramatically changed the way it identified talent.
They employed a young Harvard-trained computer whiz who
studied the statistics relating to player performance and
identified a series of factors that were likely to determine
whether a college player would succeed in the major leagues.
Until then the selection of players was highly influenced by
the team’s scouts. Experienced baseball professionals, often
ex-players, would travel through their assigned regions
watching players day after day. Here is how Lewis describes
it.
In the scouts’ view, you found a big league ballplayer by
driving sixty thousand miles, staying in a hundred crappy
motels, and eating god knows how many meals at Denny’s,
all so you could watch 200 high school and college baseball
games inside of four months, 199 of which were
completely meaningless to you. Most of your worth de-
Strategy and Economics
US Investment Perspectives – August 27, 2003
Please see analyst certification and other important disclosures starting on page 4.
Page 2
rived from your membership in the fraternity of old scouts
who did this for a living. The other little part came from
the one time out of two hundred when you would walk into
the ballpark, find a seat on the aluminum plank in the
fourth row directly behind the catcher, and see something
no one else had seen — at least no one who knew the
meaning of it. You only had to see him once. “If you see
it once, it’s there,” say Eric. “There’s always been that
belief in scouting.” And if you saw it once, you, and only
you, would know the meaning of what you saw. You had
found the boy who was going to make you famous.
The scouts were looking for certain “tools.” “These were the
ability to run, throw, field, hit and hit with power,” according
to Lewis. “A guy who could run had ‘wheels,’ a boy with a
strong arm had a ‘hose.’” But for Billy Beane, there seemed
to be a better way. “He’d flirted with the idea of firing all the
scouts and just drafting kids straight from Paul’s (Paul
DePodesta, the computer whiz) laptop. Paul’s laptop didn’t
have a tiny red bell on top that whirled and whistled whenever
a college player’s on base percentage climbed
above .450, but it might as well have.”
As I sat through some portfolio manager stock-picking dinners
during the past month I wondered whether we were all
like the scouts. Although investment management literature
is filled with evidence of how hard it is to beat the indexes,
we all keep trying in the belief that our combination of
knowledge and skills will enable us to outperform our
benchmarks consistently. Even long-short equity hedge
funds that delivered outstanding performance during the
1990s are having a hard time of it this year. They did relatively
well during the difficult 2000-2002 period, but are
underperforming now because their short positions are offsetting
the appreciation of their longs. Some argue that you
should expect hedge funds to underperform in strong rallies
because they are “defensive,” but I never heard that argument
during the 1990s when hedge funds were shooting the lights
out. I worry that many of these funds are giving up performance
points to achieve low volatility.
The investment lesson of Moneyball is that the way portfolio
managers pick stocks is too subjective. There is ample data
on stocks to enable a skilled quantitative analyst to determine
the statistical pattern of winners and losers. Critics will
argue that the data are historical and not particularly useful in
forecasting future performance, just as the scouts would
argue that baseball data are no substitute for watching a
player on the field. But the Oakland A’s built a succession of
playoff teams with lower budgets than their competition by
analyzing the data on past performance. I wonder if portfolio
managers couldn’t learn from their example. A few people I
know who have read the book say it may be useful for value
investors, but I think the discipline could help growth stock
buyers as well.
The Moneyball metaphor extends beyond stock picking and
toward a holistic idea of portfolio construction. Think, for
example, of how many basis points you might gain over your
benchmark if you could just modestly reduce the number of
losers or increase the winners. Here is a description of how
Paul looked at the whole baseball season quantitatively
rather than a player or a game at a time:
Before the 2002 season, Paul DePodesta had reduced the
coming six months to a math problem. He judged how
many wins it would take to make the play-offs: 95. He
then calculated how many more runs the Oakland A’s
would need to score than they allowed to win 95 games:
135. ... Then, using the A’s players’ past performance as a
guide, he made reasoned arguments about how many runs
they would actually score and allow. If they didn’t suffer
an abnormally large number of injuries, he said, the team
would score between 800 and 820 runs and give up between
650 and 670 runs.* From that he predicted the team
would win between 93 and 97 games and probably wind
up in the play-offs. “There aren’t a lot of teams that win
95 games and don’t make it to the play-offs,” he said. “If
we win 95 games and don’t make the play-offs, we’re fine
with that.”
I thought about my experience as a buy-side analyst. Although
I went to broker-sponsored conferences, I always
thought there was something especially useful about visiting
a company in its home office and touring a plant. Most
portfolio managers I know still believe face-to-face meetings
with top executives are especially useful. Our clients tell us
they reward brokers who set up company meetings for them.
Looking back I can think of instances where those meetings
were useful, but many others where an investor would have
been misled and come to the wrong conclusion.
*They wound up scoring 800 and allowing 653.
Strategy and Economics
Page 3
Identifying undervalued sectors using quantitative data may
be more useful than many believe. As for individual stocks,
price-to-sales and price-to-book (we will be doing more
work on this) may be to portfolio managers what on-base
percentage and walks were to the Oakland A’s. Perhaps
Paul’s careful work in baseball will have an impact in areas
beyond what he originally envisioned. Lewis observes:
And so, surely for the first time since the dead ball era, the
Harvard Old Boys’ network came to baseball. Paul himself
sat at the desk on the other end of the room. I ask them
if it ever troubled them to devote their lives, and expensive
educations, to a trivial game. They look at me as if I’ve
lost my mind, and Paul actually laughed. “Oh, you mean
as opposed to working in some deeply meaningful job on
Wall Street?” he said. |
