April 12, 2017

Lessons Learned from Sports Investing

Wee Willie Keeler was one of the greatest contact hitters in baseball. One year, 30 of Keeler’s 33 home runs were inside the park. Keeler’s motto was, “Keep your eye clear, and hit ‘em where they ain’t.”

I have always tried to do that by focusing on underexploited investment opportunities. In the 1970s that meant stock options. In the 1980s I had success with managed futures.

Also in the 1980s I had a family member who bet on football games. He knew I invested using data-driven quantitative methods, so he asked me to take a look at betting NFL home underdogs. I was reluctant at first but then obliged him. I was surprised to discover profit opportunities there.

I became intrigued with the possibility of exploiting inefficiencies in that market. There were no computer-based sports databases back then and almost no published sports research. So I hired a few UC Berkeley students to go through the data and help me test betting strategies.

After we had a stable of successful angles, I put one of these students on a bus to Reno each weekend. Encouraged by our early results, I expanded this research to include all sports, both pro and college.

I focused on areas where the linemakers were not paying enough attention, such as game time weather conditions or mean reversion in team stats. My wife never understood why I was always so interested in the wind direction at Wrigley Field.

We even came up with a player stat based Monte Carlo simulator that predicted the outcome of every baseball game. It gave us an edge early in the season before others figured out the impact of all the off-season player trades.

One of my research assistants continued to analyze sports after graduation. He became Vice President of Basketball Operations for an NBA championship team. He is now VP of Basketball Strategy and Data Analysis with another NBA team.

Our biggest edge came from betting against public biases. For example, teams that showed poor performance in their last game were often under bet in their next game. As with stock market investing, mean reversion and public myopia were rampant in sports wagering. (My best indicator of positive future results has always been when investors overreact to short-term losses or underperformance and close out their accounts.)

Issues with Doing Well

As we continued to do well, some bookmakers would no longer take our action. One let us bet early so he could use that information to move their lines. Another became very friendly and would bring us other bookmakers’ lines as soon as they were available. This way he could know most of our plays and bet right along with us.

Afternoons we would hang large marking boards on the walls of our investment office and write down the betting lines from all our outs. Fortunately, we had very few office visitors!

I had a 12-foot BUD (Big Ugly Dish to get all the satellite feeds) installed at my house and would watch as many games as I could. That was the problem. Sports wagering was causing me to neglect my family, so I set it aside. (I won’t say I gave it up, since it would be a great out-of-sample test to sometime see how those angles have held up since then.)

 Looking back on my sports activities, I realize now that I learned valuable lessons that helped make me a better researcher and investor. Here are some of them:

Always Have an Edge

When I went to Nevada with friends, I would never play casino games. When they asked why, and I said, “I don’t gamble,” they would laugh. They knew I was betting tens of thousands of dollars every week on sporting events. I always wanted a positive expectation of profit before assuming any risk. To me, this is what distinguished what I was doing from gambling.

Most of those who invest actively have little or no edge. You cannot have an advantage doing what everyone is doing. You would generally be better off investing in low-cost passive index funds. As I indicated in my last blog post, factor-based investing may soon pose the same problem. My need for a positive expectation led me instead to the little exploited niche of dual momentum investing.

Do Your Homework

Betting lines, like financial markets, are mostly efficient. The only way to be confident you have an edge is through thorough research using plenty of data. Doing your homework gives you confidence. It helps you stay with your approach despite short-term fluctuations in the value of your investments.

For investors, this can mean not doing what everyone else is doing. Herding is a powerful behavioral instinct, but it can lead to mediocre or worse investment returns.  You need to have a healthy dose of skepticism about all strategies that differ from the market portfolio. This also means looking beyond academic studies. You need to be aware of how strategies actually perform real time in light of scalability and liquidity issues. And you need to consider how they will perform in the future as they attract more capital. [1]

Keep Things Simple

Selection bias, over optimization, and model overfitting are serious problems in both sports and non-sports research. If you keep tweaking a strategy, it isn’t difficult to find betting angles that look like they have over 60% winners. But these almost never hold up in real time.

With sports wagering you need 52.4% winners to break even after costs. Sports betting legend Lem Banker became wealthy with an overall winning percentage of around 57%.

Sports research taught me the importance of having a simple strategy with intuitive logic behind it. You also need plenty of backtest data across different markets. This is what led me to momentum investing. It is simple, logical, and supported by over 200 years of backtest validation across nearly all markets.

Have Realistic Expectations

If you win 57% of your sports bets, you are still going to have some serious losing streaks. You just have to accept this. Warren Buffett is often quoted as saying the # 1 rule of investing is to not lose money, and the # 2 rule is to never forget rule #1. That is nonsense. Buffett’s Berkshire Hathaway was down more than 50% twice during the past 15 years. Yet Buffett has still done well. Confidence in your approach and emotional discipline are really what you need once you have a proven edge.

Expecting to consistently win at sports much more than 60% of the time is unrealistic. Expecting to beat the markets most of the time on a short-term basis is also unrealistic. Here is the percentage of time that Global Equities Momentum (GEM) featured in my book outperformed the S&P 500 index over various periods since 1971:

Time horizon
% of time GEM outperformed the S&P 500
3 months
1 year
3 years
5 years
10 years
Results are hypothetical, are NOT an indicator of future results, and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Please see our Disclaimer page for more information.

Over one year or less, GEM did not do much better than a coin flip. But over 5 or more years, those results change considerably. Patience is important whether you are a traditional investor or have a 57%-win rate from sports. Warren Buffett did have the right idea when he said the stock market is a mechanism for transferring wealth from the impatient to the patient.

Leave Your Opinions at the Door

You need to forget your likes or dislikes and go where the data takes you to be an effective sports bettor.  The same is true for investing. I have seen many investors disregard or override their strategies when these conflicted with their hopes or cherished beliefs. Some close their accounts or decline to open new accounts because of their behavioral biases or fears. To be a winner over the long run, you need to be a good loser over the short run. You can do this if you have a proven edge with a simple approach, have done your homework, and have realistic expectations. Go Patriots!

[1] For more on this, see my blog post "Factor Zoo or Unicorn Ranch" and Research Affiliates' "The Incredible Shrinking Factor Return".