Thursday, February 11, 2010

Chasing recent winners



By Dr. Jason White
Director of Investments
Family Investment Center

For those of us in a haze of emptiness now that the National Football League season has come to an end, I wanted to share a fun summary I ran across in my research activities entitled “NFL Alphas 2009-2010” from Analytic Investors.

Dr. Steve Sapra and Lisa Bosley authored this study which defines a positive-alpha NFL team as one that exceeds market expectations by winning games which most folks think they should lose. Thus, the teams with the highest positive alphas are those who record the most upset victories based on measured legal wagering activity.

During the regular season, 14 of the NFL’s 32 teams earned positive alpha returns, led surprisingly by the hated Oakland Raiders. The Raiders were only favored in one game this year, the epic Futility Bowl against the beloved Kansas City Chiefs – and the Chiefs won! Oakland recorded 5 unpredicted upset wins on the year, earning the highest alpha ever recorded in the history study.

Disappointing fans and earning the lowest negative alpha returns were the underachieving Redskins, Lions and Rams.

Historically consistent winning squads, like the Patriots, Giants and Ravens, ended the regular season with negative alpha returns as they lost to several teams they were heavily favored to beat.

We can learn some important financial lessons from human behavior in this study.

People have a tendency to chase last-year’s winners, much like in investing. It appears that even in football prognostication, past performance is no guarantee of future result. Behavioral finance has proven that the one of the biggest barriers to reliable long-run investing strategy is our own psyche. Investors tend to run in the same direction at the same time, like a stampeding herd of cattle spooked by a coyote or lightening strike. The herd has no idea where they are headed, or even why they are running, but they all fear being isolated from the herd.

Successful investors have learned to stick to their proven game plan despite the peer pressure of emulating what the herd is doing. A good team needs a good coach to properly devise and execute a winning strategy, just as serious family wealth grows best under the watchful eye of a skilled advisor.

Reversion to the mean is a predictable phenomenon. With so many closely matched teams in the NFL, parity if you will, the days of the perennial dynasty are over. While we may fondly recall the great Cowboys, 49ers, Steelers or Packers teams of decades gone by, today’s league is characterized by annual unpredictable winners and losers. Last year’s loser is this year’s champion, and vice-versa. If you look closely at the long-term records of many hall of fame coaches, they often are not that far above .500.

Investments typically revert to their long-run mean as well. When oil, gold, bonds or stocks have a stellar year or two, you can bet that below average returns are coming soon. The problem is these changes of fortune are not reliably predictable, despite the siren’s song any number of experts may sing.

So where does that leave us? Are we to just “place our bets” and hope for a lucky streak? Of course not! There is a science to long-run investing. Asset allocation, the mix of commodities, stocks and bonds in your portfolio, must be strategically managed, diversified, and rebalanced with emotional detachment, discipline and professional judgment. This is the only long-run success strategy that is a proven winner.

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