What Baseball Can Teach Us About Managing a Portfolio
Spring is here bringing with it melting snow, warmer days and…. baseball! Watching a game the other night got me thinking, we all know sports can teach us lessons about life but can they teach us anything about investing? Of course!
Take baseball for example, when you break the game down to its most basic concepts it appears quite simple: hit the ball, get on base, move the runner along, score, repeat. Portfolio management in its most basic form is simple too: buy low, sell high. How hard is that? So how come the outcomes vary so greatly from person to person and game to game? Well, the simple answer is it’s not so simple!
Like many things that appear simple at first blush, there is actually a lot of strategy and skill at play behind the scenes in order for the game plan to be executed correctly and successfully. If the execution goes off without a hitch the illusion of simplicity holds up.
So, what can we apply from baseball to managing a portfolio?
Training and Preparation – Baseball players, as with all athletes, spend more time doing weights, cardio and practicing (hitting, fielding, pitching) than they do on the field of play. ‘Don’t practice until you get it right, practice until you never get it wrong’ is a quote heard in many locker rooms over the years.
Once the game begins there is no time to think. Athletes use the term ‘muscle memory’. Because of the time put in practicing, when it comes time to execute a swing or pitch the body kicks in and takes over so the mind doesn’t have to think about the mechanics. If the player over thinks, he forces the swing or pitch and it doesn’t end well. It takes 0.4 seconds for the ball to leave the pitcher’s hand and arrive at the plate. In that amount of time the batter has to register what type of pitch it is, how fast it is traveling, where it will cross the plate and whether or not he should swing. With all that going through his mind he can’t be worrying about the mechanics of how to swing…he has to rely on his training and preparation to kick in.
How does this relate to portfolio management? Well luckily a PM doesn’t have to make a decision to invest in a company in 0.4 seconds, but, that aside, training and preparation are just as critical. In this situation, training refers to the education a PM has. There are a whole variety of industry courses and designations a person takes to qualify as a Portfolio Manager. Some are mandatory, others voluntary. The most important one of all (which is voluntary) is the Chartered Financial Analyst (CFA) designation. Beware, not all PM’s have the CFA so choose to work with one who does. The CFA charter represents the highest level of education in the investment industry and charter holders are held to the most rigorous standards.
Preparation refers to the amount of time a PM puts into researching and analyzing investments. This work lays out what companies to invest in and at what price to buy and subsequently sell. A lot of time should go into this step. Without that work, it’s just throwing darts. Muscle memory for a PM is his/her experience. Experience brings wisdom. I once heard a PM say ‘I’ve seen this movie before and I know how it ends.’ That’s his experience kicking in.
No time limit/game clock – Baseball is one of the few sports where this is no set time to complete the game. There are 9 innings (maybe more if the game is tied after 9) and those innings must be completed for the game to end, however long that takes. Sometimes you have a pitching duel where the game flies by, other times it’s a barnburner where the hits keep coming and the game could take 4 hours. Either way, the game isn’t over until 9 innings are in the books.
Investing is the same way. Markets go through different cycles and a manager can only take what the markets give. Sometimes markets are frothy and ‘running’ – as in an upward trending bull market. Sometimes everything is going down in a bear market. Other times markets are bouncing along in a sideways trend with no clear direction either way. Each cycle will result in a much different approach to the ‘trading timeline’.Given that, there is no set time limit as to how long you will end up holding a stock. A PM relies on the fundamental research he/she has done to determine when to buy and when to sell. That sell price could come 3 months after the initial buy or 3 years after.
Patience – Patience is a virtue. This couldn’t be truer than in baseball and investing. A batter who is patient at the plate will be far more successful than one who is always trying to hit a homerun every at bat. A smart player knows that sometimes you have to sacrifice yourself in order to move the runner along. Yes a homerun may be more exciting and gets the adrenaline pumping, but, a sac fly or sac bunt has its place chipping away slowly to get the men on base across home plate. Momentum stocks can be exciting but boring names with solid earnings and a good dividend will help you reach your goals in the long run.
Watch the approach a veteran hitter takes at the plate versus a nervous rookie. The veteran knows how to sit back and wait for his pitch and many times works the count for a walk. His goal is to just get on base. A less experienced batter will chase pitches out of the zone. Patience in investing is a key determinant of success. Once the PM has determined the price he/she is comfortable paying for a company they must be disciplined to wait for that entry point. And the same holds true for the exit strategy.
Defence – There are two components to winning a game. Offence is exciting but defence wins games. Solid pitching and excellent fielding keep runs off the board. You increase your chances of winning if you limit the damage from the other side. When managing a portfolio downside protection is critical. A good PM utilizes cash as a tool. Some PM’s insist you have to be fully invested at all times. But take a close look at their performance numbers over the last decade versus a PM that takes money off the table and moves into cash for periods of time. The fully invested Portfolio Manager has had three or four negative calendar years in the last ten. On the other hand, Exponent Investment Management has had ten consecutive calendar years of positive performance. Exponent is not afraid to proactively move some money into cash if we see headwinds coming. It’s much easier to make money if you’re not losing money!
Building a batting rotation – Not everyone is a power hitter. You do not build a team of only homerun hitters. A homerun hitter can dazzle and excite but he also strikes out more. Build a team of diverse hitters, each playing a role. In your portfolio, diversification is critical. Don’t overweight one position, sector or geographic region. Beware the Portfolio Manager who is grossly overweight the financial services sector stating ‘banks never lose money’. Not true!! Every sector goes through cycles; work with a PM who prepares a client for the possibility that certain sectors can go out of favour and prepares ahead of time for that.
Leadoff hitter – The leadoff hitter is your fastest player with the best ‘on base percentage’. This person gets on base better than anyone else on the team either via a hit or working the count for a walk. He is strong and reliable. When it comes to stocks, think of the global, multinational powerhouses. J. M. Smucker is a great example. Smuckers has experienced more than a century of success that has led to a powerful position in the consumer staples market. The company combines a healthy balance sheet with a wide variety of highly recognizable strong brands. High customer loyalty creates a barrier to entry for competitors and consistent double digit dividend growth rewards the shareholder.
#2 hitter – makes contact to move the runner along.
#3 hitter – drives in runs. Your number 2 and 3 would be represented by the pharmaceutical stocks. GlaxoSmithKline (GSK) is a great example. Global demographic trends tend to favour healthcare and pharmaceutical stocks. More countries around the world are adopting vaccination policies and let’s face it, the population is aging. Pharmas tend to invest a lot of money and time into research so they can be innovative and create new products.
Cleanup – This person has ‘pop in their bat’, hitting the ball hard. This doesn’t necessarily mean hitting homeruns, it just means getting the ball through the infield.Disney is a great stock that represents this category. The company seems to make smart acquisitions, while always building on its core business. If anyone knows branding, it’s Disney! The company knows how to make money and rarely makes mistakes.
#5 – The fifth spot in the rotation is reserved for the player that although he isn’t the best overall he steps up and seems to have a knack for getting extra bases when making contact. This can help to clear the bases if the cleanup hitter didn’t connect. This would be where you would slot in the bank stocks. Financials have a place in every portfolio but you wouldn’t want to build your entire portfolio around them. Banks pay a consistent, growing dividend but they aren’t immune to cyclical pressures.
The bottom half of the rotation is where the players with the lower batting averages sit. This doesn’t mean that they are deadweight. They still contribute via bunts, sac flies, and hits as well. Telecommunication companies, rails and pipelines fit in well here.
Bear in mind, just like in a batting rotation, things can change and there comes a time when it becomes necessary to take profits and trade out of these names. But in time, with patience, a dip in price will present a new buying opportunity.
So, in summary, if your PM does the hard work behind the scenes, relying on their experience and training when times become difficult, success will come. Discipline and patience are key contributors to that success. Protecting your capital should be a primary goal and he/she should proactively take money off the table from time to time. And, although it sounds boring, holding a diverse mix of companies from a variety of sectors that provide slow and steady growth with reliable cash flow is the most consistent path to achieving your goals. Just get on base!
* Any stocks mentioned are for illustration purposes only and are not to be construed as a solicitation to buy.