I liked Moneyball the book better than Moneyball the movie. They were both pretty good (Chris Pratt did a serviceable Hatteberg), but I found the book (as I do most of Michael Lewis’ work) to be a good narrative on the evolution of an industry (in this case baseball) due to the advent of technology. The ability to process, compare and analyze vast sums of data is a relatively new phenomena. The ability to speculate about stuff that is going to happen in the future, on the other hand, is not. The point of Moneyball wasn’t that sabermetrics made traditional scouting irrelevant nor was it that math had “broken the code” of future player performance. It was just that some of the “stuff” that we intuitively knew was important could now, to an extent, be measured and could be used as an advantage over those reluctant to embrace the value of this increased level of information in decision making. I find this story very akin to what is taking place in the ETF industry.
Factor investing has become the sabermetrics of the investment industry. This is a positive leap forward because it allows investors to make more informed decisions and has opened up the ability to be more dynamic (both aggressively and defensively) in one’s approach to investing. By using analysis of past data, we can now better understand the historical relationship between certain factors (revenue, dividends, size, growth, customer satisfaction, etc) and the markets. With that said, it is important to put these relationships in context. The world, like baseball, has many outside (normally exogenous) factors that contribute to the outcome as well and can’t possibly be modeled in any simulation. This doesn’t mean factor investing is useless but rather it will have varying degrees of success. These degrees of success will be determined by how well your simulated relationships held and how much of your targeted “factor” you were able to harvest. I’m of the belief that given this scenario the best path is the one that makes the least “assumptions” and attempts to systematically capture intuitive and well researched factors.
Size premium is among the best researched and identified phenomena in the marketplace. Customer satisfaction leading to better financial results is among the most intuitive. The goal of the exercise is to consistently create alpha above the benchmark through systematically taking advantage of factors that show a consistent positive relationship with the market. I still feel like the ETF market is missing the joke in that their takeaway, like the erroneous take many had with Moneyball, is that even more complex math will eventually “solve the equation”. This leads to more complicated product rather than innovation. I look forward to the market “catching up” to simplicity….and Moneyball.
Posted by: Kevin Quigg 04/04/2018