A Whole New Ballgame

Story Highlights:

• Some baseball managers are using wacky new strategies to win games.
• Investors can learn from them and also challenge historical norms, especially during bull market corrections.
• Innovative market strategies can improve long-term returns and help investors stay on track for the long run.

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Top of the 10th, tie game, two on, two out. Atlanta needs their best right-handed reliever to work out of the jam, so they turn to… the guy in the outfield? Wait, that same guy was on the mound two batters ago! Sheesh, baseball managers sure are testing some wacky ideas!

Baseball Dares to Be Different
By Darren Everson, The Wall Street Journal

The "old ballgame" is getting a facelift. "Stat-heads" like Bill James are touting newer metrics, and in addition, Wall Street heavyweights are buying teams and throwing conventional baseball wisdom out the window. It's not surprising financial titans are invading the diamond—long-term successful investors tend to be the most innovative, and Major League Baseball groupthink needed a shakeup.

Just as baseball has its standard, predictable playbook—pitchers bat ninth, walk a slugger if there's an open base—many investors use a tired approach. During bull market corrections—periods of increased volatility—groupthink teaches us to use stop losses, wait for volatility to "stop" before making moves, or protect ourselves from short-term swings with cash and bonds. But do folks stop to consider if these tactics consistently improved returns when used previously? Not in theory—but in practice? Or do they just trust the "tried and true?"

Well, "tried" doesn't necessarily mean "true," let alone "best." Innovative baseball managers crunched numbers to find undervalued players, sign them cheaply, and win more games. Studies found on-base percentage is a better indicator of offensive prowess than batting average, so the Oakland A's General Manager Billy Beane hoarded hitters with high walk totals—historically cheap players—and reached the playoffs four years straight. Use the same philosophy to develop investing strategies. Companies with low P/E ratios are like players with high batting averages—conventional wisdom says they'll perform best moving forward. But history shows this isn't the case—P/Es just aren't predictive, and if you pick stocks always expecting them to be, you're going to get beat by a more innovative thinker.

What about today? A big, gloomy majority soured on stocks when they hit lows in January and March, with many pundits preaching stop-losses could prevent such pain. That sounds fine and dandy—who doesn't want to stop losses? But history tells us stop-losses don't work: They increase fees and lead to selling at relative lows—not what most people want. (For more, read "Making Heads and Tails of Stop-Losses," 03/20/2008.) A better strategy, and one many folks may call "crazy" during these trying times, is to just ignore volatility in expectation of an overall good year for stocks. An even better strategy? Consider fundamentals others are ignoring. For example, everyone wants to call this a "credit crunch." But credit isn't crunched for the biggest, best-rated stocks. They have all the credit they need and more, so they should do very well this year. No one's talking about that—and no one's expecting the pitcher to bat eighth.

We can't count on "tried and true" tricks. First, they may not even be "true," and second, as new ideas and approaches are adopted by more people, the market prices them in and they lose their power. Just as more baseball managers are mixing up the batting order and having relievers start games, you can't rely on so-called best practices to help you win the investing game. So don't just sit in the stands with your hot dog and Coke—start thinking about the next great strategy. It's a whole new ballgame.