In 1896 Thomas Burke from the USA won the 100 metre Olympic final in a time of 12.0 seconds beating the bronze medal winner by 0.6 seconds. In 1936 in Berlin Jesse Owens slayed the Olympic record and won gold with a time of 10.3 seconds but only managed to beat the Dutch bronze medalist by 0.2 seconds – the spread between first and last in the final was 0.6 seconds. Fast forward to the most recent summer Olympics when we all watched in awe as Usain Bolt won his second straight 100 metre gold with a time of 9.63. It wasn’t easy though – bronze medalist Justin Gatlin was hot on his heels 0.16 seconds behind at 9.79. There are two interesting dynamics at play here that present a bit of a paradox. On one side, the winning time has come down substantially over time as training techniques have evolved, nutrition is better understood, equipment and track conditions have improved (Jesse Owens ran on a track made from the ashes of burnt wood), and as the sport has broadened to more people around the world (in 1896 8 nations competed vs 92 in 2012). On the other side, the spread between winning and losing athletes has decreased just as dramatically. Everyone’s getting better but everyone’s getting more and more average.
In baseball, it’s hard to argue that players aren’t getting better. Just looking at photos of some of the old time players leaves you with no doubt! And again, better training, better nutrition, better equipment and a larger pool of athletes have all lead to far superior ball players. And yet no MLB player has batted better than .400 for a season since Ted Williams did it in 1941 and the league average batting average seems stuck in a tight range of about .250 to .270. If batters are getting better and better why can’t you see it in the numbers? At least with the 100 metre race the record came down significantly over time. Perhaps that’s because in the 100 metres there isn’t an adversary trying their best to trip you, block your path, or use every trick up their sleeve to stop you from crossing the finish line. In baseball they’re called pitchers and it’s hard to argue looking at today’s aces that they haven’t improved at least as much as hitters over the years.
In both sports, you have higher skills today than in the past yet it’s getting more difficult to stand out. When skills are so refined and so common and competition so fierce, the factor that can most often distinguish between winners and losers becomes….luck.
This week we attended a Morningstar panel discussion where the topic was, “Is Alpha Shrinking” or in plain language, “Is it getting harder for fund managers to outperform the market?” The panelists were very experienced, very smart and didn’t come to the event with a particular axe to grind – how refreshing! They all agreed that it’s becoming harder and harder to beat the market, partly because of the proliferation of highly skilled investment managers. According to the MAR database there were 95 hedge funds in 1990. There are more than 10,000 today. And that’s just hedge funds – it’s hard to believe it’s getting any easier to compete. Even more so because now everyone has a great education from a top business school where they study the same thing, everyone has the same investment tools and computing speed and the internet means that known information is incorporated into market prices almost instantaneously. Trying to “out-skill” the market is perhaps even more difficult than winning the 100 metre dash or batting .400. Investors will beat the market, it’s just most likely due to luck.
The application of this “paradox of skill” to the investment world is best explored in strategist and author Michael Mauboussin’s 2012 book “The Success Equation”. The baseball analogy above is from the book. It’s hard to look at the evidence and believe that paying someone high fees to try to beat the market makes a lot of sense. Active investment management is a zero sum game – the winners win at the expense of the losers and active managers underperform the market in total by the amount of their fees – so what can you do? Charles Ellis wrote The Losers Game in 1975 but the takeaway is even truer today than it was then.
The winning strategy in a losers game is not to play.