What Are The Core Principles Of
The Moneyball Investing Methodology?
We build our stocks portfolio pretty much the same way a football manager builds his team. Constructing an investment portfolio and putting together a soccer team are in fact pretty similar. By having the right type of players deployed in the right positions and doing what they need to do, we will be able to build the winning team.
In this article, you will gain a personal insight into our investing approach that enabled us to beat all the 3 markets (US, China, Singapore) consistently by a good margin for the last 6 years to achieve an annualized return of at least 40% over the past 5 years with over a million dollars at work now.
The Moneyball Approach
Before we go on to explain our investing methodology, perhaps we should first share what the Moneyball approach is about. It originated from Billy Beane, the general manager of the Oakland Athletics, who turned their fortune around to build a winning baseball team using statistics despite the constraint of a limited payroll. Such principles can well be applied to portfolio management too. While Billy Beane is looking to buy runs, as investors we are looking to make a good return on our capital.
The thesis is simple. By employing simple statistical analysis on the stock charts, we are able to invest in companies that are undervalued by other market participants and sell the ones that are overvalued to other market participants. The first part of the trick is to find the right companies to do so by assessing which factors are the most significant for future outperformance. The second part is to know when to buy or sell them. In short, we exploit the market inefficiencies of such companies through stocks investing or its derivatives.
Scouting For The Right Players
Firstly, it is about picking up the right data to curate a watchlist of stocks that are high-quality, large and poised to outperform their peers dramatically. Past performance, while may not be a guarantee of future performance, is still a reasonably good predictor of future success.
When looking at information, we prefer to look at non-narrative ones such as market share or sales growth. Not the brand stories that are meant to entertain or to inspire investors. We want to be making an accurate assessment of what things are, and not what they want to appear to be. We will also not go to the extent of constructing a DCF model that projects the next 10 years of cash flow which to us, are just based on too many assumptions to be meaningful. Instead, we challenge our investment thesis with well-thought qualitative reasonings. Sometimes, the simplest and most obvious ideas are the best ones.
By having the strongest conviction in such stocks, we will have the discipline to stay the course and ignore the market noises that are bound to come along. It would mean that we never ever have to engage in panic selling or even having to put any stop losses.
Form Your Line-Ups
You choose who plays and who doesn’t. In investing, we call this asset allocation. Every sector rotation happening in the financial markets is akin to a new match. You would want to plan out the team sheet that gives you the best chance of winning for the upcoming game. The ideal player for the coming game may not necessarily be so for the next one. We manage our portfolio and make substitutions based on how well a particular stock will fit into the current game plan. Let us now touch on our line ups starting from the backline.
Every team first needs a goalkeeper. Similar to the goalkeeper of the team, we want to have someone (by holding cash) who is going to bail us out of trouble during a market turmoil.
But a portfolio is not just meant for capital preservation. Other than the goalkeepers, we need our defenders, midfielders and forwards. Based on our methodology, defenders will be in the form of REITs, midfielders being financial derivatives such as options and forwards being growth stocks.
Defenders will typically be REITs that will be able to provide us with some kind of reliability and stability in our portfolio. This is especially so when the attacking players (growth stocks or options) are not pulling their weight. These high quality REITs that generate good dividends forms the backbone of our solid defensive lineup after the goalkeeper. They can help us to ride our dips in the market.
Next up, we would imagine having options positions to be our midfielders. Options like midfielders in a team, would help to strengthen our attacking or defensive needs. The options strategies can be directionally biased or non directionally, depending on what we need. But it does require pacey responses and the ability to read the game well in order for them to be at their best.
Up front, we would have growth stocks as our forwards. They would help to accelerate our portfolio growth with high capital gains and bring in the goals just like in a soccer team. They must have a great track record and have the drive to continue to perform even better.
Such a line-up is not cast in stone but serves as a mental model of the way asset allocation is done for our Moneyball investing approach. As for the exact number of players deployed for attacking half or defending half, it will vary according to what the situation calls for, similarly to a soccer game. This will be elaborated further in the tactical plan.
Bear in mind that the journey of investing is an infinite game though. There is no clear endpoint and the objective is not just to get the best possible returns you can just for this year by buying extremely speculative stocks. Extremely outsized gains are hardly sustainable overtime. It is sufficiently rewarding enough to be performing above the average and being able to stay in the game year after year.
In our soccer context, this could mean deploying tactics that ensure us qualifying for the Champions League every other year, rather than an unsustainable one that gets us either the Championship this year but may face relegation the next. Hence when it comes to asset allocation, we have no qualms rotating into sectors that may play out only in a couple of quarters later. In the short term, it may be a drag on our performance but overtime, we find ourselves duly rewarded.
Having a suitable formation and getting good players playing for your team is just half the story. A portfolio manager similar to how a football manager is, has to provide directions that will ultimately impact the scoreline as the game progresses. Should you now play defensive, balanced or all out attack?
A portfolio or football manager will always have to decide if it is more important to score a goal or not to concede one. We rely on our proprietary technical analysis methods to read the state of play. We take advantage when pockets of opportunities present themselves or become defensive when things appear to be taking a turn. A good manager will know how to position his pieces at the right places at the right time, for most of the time. And for every position, there must be individual clarity. The moment something happens for the better or worse, the manager knows what is expected of each player immediately. As investors it means that we have a clear idea of how to deal with each position if it is making money, going sideways, or have drawdowns.
What makes a portfolio or team great isn’t just the tactics alone. It is about how the whole can be greater than the sum of its parts. With all the different moving parts or several positions working hand in hand, the goal is to reduce downside volatility (conceding goals) while gaining excess returns (scoring goals).
The type of style often refers to the risk taking approach of the manager. Most football managers’ philosophies are about producing goals on offense. For our Moneyball investing philosophy, it is pretty much the opposite. We believe that if we manage the downside, the upside will take care of itself.
We mitigate our risks by diversifying our portfolio across three different markets, namely the US, China and Singapore in search of attractive investment opportunities and to get less correlated returns but have a positive expectancy. We also invest in different time frames within the same market or industry as part of risk management. As the market conditions evolve, we scale in or scale out our positions accordingly. Such are examples of our mean reversion strategies which are confidence weighted based on the attractiveness of the opportunity.
More importantly, we believe that the whole point is to reduce drawdown risks. Diversification is just one common way of doing so traditionally. But we believe that if we know what we are doing, we do not always have to be spreading our bets across all the different asset classes or into many different sectors of the stock market at any point in time. We seek ways that allow your portfolio to achieve a much lower beta and derive more alpha or excess returns.
Risk should be understood as the opportunity cost of not growing your capital within a given time. If you can generate meaningful returns even if the stock prices do not go higher, you have actually reduced your risk accordingly as well.
In the context of football, the closest resemblance to our investing style would be that of the Italian word “Catenaccio”. It focuses its tenets on relentless defending and the art of precise counter-attack.
In football, the idea of the counter-attack is to embrace the opponent’s advances with tight defence and then go on the offensive all of a sudden. This takes advantage of the fact that the opponent needs time to transit from an attacking to defending structure. They tend to be disorganized and have less defensive pressure/ less in numbers at the back, giving the counter attacking side the numerical and positional advantage.
Bringing this idea to Moneyball investing, it is about making good and quick margins during irrational selloffs, pricing anomalies or temporary inefficiencies. The way to do this is to look for specific setups on the real-time charts that will fit our purpose and not on dated information such as P/E ratio. We want to buy solid companies at a point in time where they are unloved by the crowd. When they are beaten down by temporary negative news or industry related reasons, but not those that will affect them on a fundamental level.
In order to be able to exploit ongoing or upcoming opportunities, it is important to keep a portion of our funds liquid so that when a good investment opportunity comes along, we are in a position to take advantage of it. This can come from taking profits off the table from time to time. The time to raise cash is when we don’t have to.
Most retail investors are usually in a loaded up condition, meaning fully invested all the time, at all times. This means they will also have maximum exposure to market drawdowns that happen from time to time that erode their gains for a period of time. And this is something that prevents the compounding effect to work in your favour. And sometimes, they may be sitting on paper losses which mean that in order not to realize the losses, they have to commit the cash on those existing positions and forgo other upcoming opportunities. And this may take a pretty long time which we are not in favour of.
We believe the ability to turn over our working capital many times over and grow it sustainably is one of the secrets to our portfolio performance in TJI. And this is only made possible of course by minimizing the risk and time taken for our investing trades to play out. We operate like the casino. Our high turnover combined with the statistical edge allows our advantage to work its magic. In our Moneyball Investing methodology, we treat our investing capital just like the way merchandising works.
Antifragility: Leveraging Adversity To Enhance Performance
Antifragility is a concept by Nassim Nicholas Taleb which describes people or organizations who eventually thrive from disorder or setbacks. No football team wins every single year nor any portfolio can consistently beat its benchmark every time. Due to our specific investment philosophies, we cannot expect outperformance consistently, especially during shorter time frames, just like any other actively managed fund.
An antifragile portfolio does not mean that it will not be subjected to huge drawdowns as well. In fact it may at times lead to more swings for the same reason it can result in more home runs. The fact is that just like football strategy, no investment strategy can ever be foolproof and no matter how good the data looks or how high our conviction is, we can be wrong at a certain point in time. The bigger question is what happens after the Black Swans? Is the portfolio garnering tremendous gains or ends up with irreparable damages? Can your team bounce back from defeat when it happens eventually? It may not hurt to lose a few games occasionally as long as you can still be the champion of the season.
One important trait that we have built into our portfolio with our Moneyball investing methodology is the concept of antifragility. It not only survives, but thrives when exposed to volatility and disorder. Our systematic approach to investing seeks high-upside and low-downside outcomes. Our strategies tend to be either less mutually independent with a large number of less correlated individual positions or even mutually exclusive which means it is impossible to lose on all fronts at a given time. This screenshot below from one of our brokerage accounts speaks for itself. Each time a crisis presents itself, the portfolio recovers eventually and becomes even better.
If we can agree that the markets are uncertain and will continue to do so in the many years to come, we will be in a good position to sustain a strong performance over the long term.
Year-On-Year performance of the Moneyball Portfolio