Buffett's March Madness Bracket

April 1, 2016

In honor of March Madness, here's a re-play of one of my favorite notes.  It explains important parallels between your bracket strategy and investing.  (I’ve made a couple of edits to improve/update last year’s original.)

 

How Buffett and Bogle Would Have Played Your Office Bracket

 

Imagine that investment legends Warren Buffett and John Bogle were your co-workers and participated in your office March Madness pool.  What strategy would they have employed, and how would it have differed from your typical co-worker’s approach?

 

First, let’s take a look at your co-workers’ approach.  Chances are most filled out their brackets based on what they heard from the “experts” in your office or on TV.   Some might even have spent money to sign up for tips from an expert online.

 

Bogle would have scoffed at wasting money with experts, since he believes that markets are perfectly efficient, making it pointless to try to beat them.  He would have simply consulted the National Bracket, which aggregates all the brackets submitted to ESPN’s website.  This is the indexing version of placing your March Madness bets.  Assuming your office is large enough and sufficiently diverse, its bracket would have been roughly in line with the National Bracket.  As a result, Bogle likely finished in the middle of the pack somewhere.  Though he surely wouldn't have won the pool, he wouldn't have been shamed finishing dead last in the office.

 

Buffett, on the other hand, would have taken a totally different approach.  He knows that markets, whether they’re sports betting markets or securities markets, are highly efficient, but not perfectly so.  While they often reflect the madness of crowds, they occasionally reflect the madness of crowds.  Like Bogle, Buffett would have consulted the National Bracket as a gauge for the crowd’s view and accordingly how the office’s odds were likely to be priced.  He would then have cited a statistical service like Ken Pomeroy's, which ranks teams based on purely quantitative factors such as shooting, turnover, and rebounding efficiency.  Next, Buffett would have hunted for wide gaps between the crowd’s appraisal of the odds (the National Bracket) and his calculation of the intrinsic odds derived from the stats.  He’d have looked for situations like Syracuse, which began the tournament with the crowd pricing its odds of winning at just 1 in 300.  If Buffet, using certain quantitative statistics, had calculated the odds as being far better than 1 in 300, then he’d consider Syracuse’s odds potentially mis-priced.

 

If Buffett were a pure quant, he’d have merely built his bracket with a purely numeric approach.  This would have been the “smart indexing” approach.  But Buffett is much more than a quant.  He would thus have taken it a step further and performed some old fashioned investigative research, or “scuttlebutt” as he calls it.  He’d have watched interviews with players and coaches, attended some live practices, and learned about recent injuries.  He’d have gone above and beyond to gain insight on the teams he was investigating (legally and ethically, of course).

 

Taking all this into account, Buffett would have built his bracket tilting toward teams that had the widest gaps between the crowd’s opinion and his own appraisal derived from his quantitative analysis and scuttlebutt.  Buffett will not win every year with this strategy, but over time, he’ll win more than his officemates – perhaps a lot more. At least that’s how it’s worked out for him applying the same approach to investing.

 

Now here’s the ironic part.  The office receptionist, who knows nothing about basketball, will surely one day ask her skilled colleague Buffett how she should fill out her own bracket.  If you were Buffett, what would you tell her?  Probably the same thing that he’s suggested to average investors for years:  just do what Bogle does. At least his indexing approach guarantees she won’t end up falling prey to the advice of the office blowhard or some expensive online tip service, which could doom her to finish at the bottom of the office rankings.  The downside, at least from the perspective of the true sports fan, is that applying this “finish in the middle” automatic system will never ignite this receptionist’s interest or passion in the sport of basketball.  At least the “smart indexing” method helps her understand that sometimes the game doesn’t turn out like the crowd expects.  Now that’s exciting, and it offers hope of engaging her interest to learn more – and maybe even take control of her own bracket.

 

In time, a National Bracket composed of more independent, educated bets and fewer “follow the crowd” bets will result in more efficiently calculated odds, and a far more engaged and informed crowd of fans.  That’s good for the fans and good for the sport.

 

It’s too bad that no one in the office has the time or inclination to teach the novice receptionist how to follow Buffett’s approach to completing her bracket – even if just the first step (“smart index”).  Fielder’s novel ambition is to do just that in the world of investing, helping real people beat the odds by engaging them more deeply with their money and showing them how to build a winning bracket they understand and excites them.

 

Yours in the Field,

 

 

 


Frank Byrd, CFA

 

Disclaimer:

While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities.  It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein. This information is intended only for the recipient of this email.  Under no circumstances should this report be shared with or forwarded to anyone else without the express permission of Fielder. 

 

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