Faith in figures proves to be a big hit
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Billy Beane is an unlikely speaker at an investment conference. The general manager of baseball’s Oakland Athletics looks, and speaks, like the professional athlete he once was – he is 6ft 4in tall, is still in excellent physical shape, boasts a healthy tan and speaks in relaxed tones.
But at T. Rowe Price’s annual investment symposium in Baltimore last month, he took top billing over an array of investment analysts and historians, and kept his audience – mostly of fund managers and their clients – rapt with attention.
Beane’s great contribution to baseball – he is quick to admit – has been to apply to it techniques that were first honed by investors on Wall Street. Now, to his evident enjoyment, Wall Street is interested by the lessons it can learn from the world of professional sports. Beane’s decisions on hiring players – and those of an increasing number of his competitors – are based on quantitative evaluation techniques, aimed at finding market mispricing. He freely admits that he has borrowed liberally from the techniques of value investing and arbitrage. To the extent that they work, people such as the fund managers at T. Rowe Price want to know about them.
His celebrity dates back to Moneyball, an unlikely bestseller from 2003 by Michael Lewis, a writer who made his name with Liar’s Poker, arguably the funniest book ever written about Wall Street, in which he chronicled the excesses of the trading culture at Salomon Brothers in the 1980s.
Lewis was fascinated by Oakland’s consistent success in spite of having one of the lowest payrolls in the sport. In recent years the A’s have become one of the poorest teams in Major League Baseball as they lack their own stadium – they share a football stadium with the Oakland Raiders – and do not have revenues from a cable network to fall back on.
Yet Oakland have been to the play-offs five times under Beane’s management. Under his tenure, he proudly shows the conference in a presentation, his wins have on average cost less in terms of players’ wages than for any other team in the league.
Moneyball, when it came out, suggested that Beane had done this by understanding that the rest of the league was mistaken in its traditional emphasis on
batting average – which measures the percentage of times a player makes it to first base by way of a hit, and strips walks out of the equation. Walks were traditionally held to be the fault of bad pitching, and so were not credited to the batter.
Beane was himself an unsuccessful major league hitter, in spite of his great athleticism. He happily admitted this to his T. Rowe Price – very few of whom could ever even have dreamt of playing in the big leagues – and said his problem was his lack of discipline. By the time he took over as a general manager, baseball statisticians had worked out that on-base percentage – measuring the amount of the time a hitter avoids making an out and gets on base, including walks – was much more relevant to the number of runs that would be scored.
Hence, there was a mispricing in the market. Players with a gaudy batting average, who hit strongly for power, were over-priced. Patient hitters who walked a lot were undervalued. So he filled his team with under-priced patient hitters. Rather than trust the observations of scouts sent out to watch youngsters playing, he would trust the numbers.
This formula worked for Beane’s first few Oakland teams, which were full of patient, soft-hitting hitters who often did not play very good defence. However, the rest of the league soon caught up with these notions.
Beane says on-base percentage (OBP) is now one of the best rewarded statistics on the free agent market. Last year Oakland ranked only 10th in the major leagues in on-base percentage. But this does not mean that Beane’s strategy has changed, or failed. Rather than always looking for patient hitters, his aim is to look for whatever abilities are under-priced by the market. “Basically, when everyone is zigging, we have to zag. We have to be contrarian on everything that’s in vogue,” he explains.
Thus he has stopped bidding for on-base percentage “only because we can’t own it”. He adds: “If it’s in vogue, then people are paying for it. Right now [Barry] Bonds and [Jason] Giambi and [Manny] Ramirez are playing for high-barrel dollars. They are high OBP guys. We have a finite market. It’s a finite market in a zero-sum game.”
So Beane and his statisticians invested their energy in analysing defence, which is still by far the hardest aspect of the game to categorise numerically. Their efforts resulted last year in what was by common consent the best fielding team in the league. Fielding was under-priced, so once Beane and his team could find a way to measure it, they went out and bought it. “If I can’t measure it, I’m not going to invest in it. The intangibles – personally I don’t believe in it, but that’s just my opinion.”
The baseball community reacted ferociously to the book, which many interpreted as saying that computers and “stats geeks” could beat trained professionals. But the book caught on in Wall Street, where many recognised the parallels with the rise of passive investment at the expense of star stockpickers.
The success of the players mentioned in the book has been mixed. Kevin Youkilis, the obscure player in the Boston Red Sox farm system whom Beane idolised as the “Greek God of Walks” (he is in fact of Romanian Jewish origin), made it to the 25-man Boston squad that won the World Series in 2004, without seeing any action.
During his first full season of action last year Youkilis established himself as a solid player. His ability to leave the ball was as forecast; he came 15th in the league in OBP, seventh in walks and first in the number of pitches he saw each time he came to the plate. A balding, slightly pudgy player, he does not look like a classic baseball player. Beane spotted his potential.
Nick Swisher, who Moneyball shows as Beane’s coveted prime target in the 2002 draft, has now established himself in Oakland’s line-up. Primarily known as a power hitter, he finished one place ahead of Youkilis in walks. He has a lot of power, finishing in the top 10 for the league in home runs, but his performance in the play-offs was disappointing.
The play-offs are the greatest flaw in Beane’s resumé. For four years, starting in 2000, the A’s reached the post-season. Each year they fell in the first round, and each time they did so after losing the decisive fifth game. This was such a consistent record of futility that many believed there was a common cause.
Beane’s explanation in Moneyball was that the post-season was a “crap shoot”. As with investment decisions, his hiring decisions depend on the concept of “reversion to the mean” – over the long run, players tend to revert to their historic performance, just as stocks do. This happens over a 162-game season. There is no time for mean reversion over a five-game series.
This year, Oakland finally won a post-season series, sweeping the favoured Minnesota Twins in three games. But they promptly were swept themselves by the Detroit Tigers in the next round. Beane is still happy to call the entire post-season a “crap shoot”. “This year proved it,” he says.
“The thing about baseball is that the eight best teams get there. But you have only got a 15 per cent chance of winning it if you are the best. If you are the worst, you only have a 10 per cent chance. One event during the season usually won’t make much difference. In the post-season, everything can swing on one event.”
If Beane is frustrated by running the most consistent team in baseball of this decade (outside of the vastly wealthier New York Yankees), and watching several obviously weaker teams take the title over that span, he does not show it.
But he does admit, with relish, that his job is getting harder. Several teams now have their own young general managers, trained at elite universities, who are devoting resources to statistical analysis and the hunt for mispriced assets.
Most notably, the Red Sox, who almost hired Beane in 2002, before Moneyball came out, put his ideas into practise when they won the World Series in 2004. Theo Epstein, the general manager – who Beane deeply respects – is a Yale graduate, and was only 28 when he was hired.
As for his own investing, Beane says that he certainly tries to be a value investor. He is a follower of Warren Buffett and Charlie Munger, but he is not as successful as they are. But Buffett – who owns a minor league baseball team himself – would doubtless approve of what Beane is doing.