Like many followers of the Cleveland Browns I watched the some of the NFL Draft recently. I will admit I am not a die-hard fan as the Browns have been so lousy for so many years. However, I do still want them to do well as strong local sports teams are good for the greater Cleveland area. Most people are in a better mood on a Monday after a Browns victory. While following the draft I noticed some themes consistent with investing.
I believe it was toward the end of the second day, so the end of the third round, when I flipped on ESPN and some of the analysts were getting a bit fired up about why teams were making the choices they were. This continued on the final day of the draft when the “expert” picks were still around well past where these experts felt they should be selected. Mel Kiper was really upset with some of the choices. Maybe he does this every year, but his anger at team’s choices was baffling to me. I started to feel as though I was watching CNBC instead of ESPN.
A few years ago some economists did an analysis of NFL draft data and the conclusions were pretty interesting. I’ll jump to the final chapter and let you know their conclusion: Those teams that did poorly failed to follow the rule of risk diversification. Their study went much deeper though and let’s dig into more of their findings.
First, trading up really is not worth the price a team pays. For years teams have used a Chart to put a numerical value on all the positions in the draft. This Chart was used to determine how much teams had to exchange in value to move from say the 12th choice to the 2nd choice. In the study they looked at over 1,000 trades and most times the probability the higher pick was a starter more frequently than the next player picked at the same position was not that high. Basically, you would pay a king’s ransom to move up from 12 to 2 for a DE, but there may only be a 2% higher chance the 2nd pick was a starter and the 12th pick wasn’t. Reminds me that there is more opportunity for gain in a value stock versus a growth one.
They next discovered teams who moved down to gather more picks and more players did better. Specifically, if a team traded down and then selected two players the results were the team ended up with five more starts per season and they slightly increased their number of Pro Bowl appearances. This result wasn’t due to simply having more players either. Their analysis showed if the teams only kept one of the two players they would still get slightly more starts and the same number of Pro Bowls. Again, diversification at play. Also, a reminder about dumping losers and keeping your winners.
Next, lower picked players are cheaper and this allows a team to spend more money in free agency. It has always been said that successful teams build their foundation through the draft and then supplement through free agency. Their findings showed the best value actually came from picking players from the start of Round 2 and down. These picks provided more value in terms of statistical performance than players drafted higher or more expensive free agents. The successful teams spent efficiently in free agency. Again, a focus on value versus the flash of the next hot stock as well as controlling your fees. Their final conclusion was teams who had more draft picks ended up with more wins per season, however, their data set was pretty small.
So, how does this tie into investing? Well, making a bunch of picks in the second, third, and fourth rounds is sure less exciting than all the excitement that happens in the first round or even the first five picks. Buying a low-cost mutual fund or ETF sure is not as exciting as putting money into a Hedge Fund, but the performance data is much better for ETFs than Hedge Funds as a whole. Warren Buffett touched on this recently at his annual meeting when he reminded everyone of a wager he tried to place in 2008 where he would buy a simple S&P500 index and he thought he would outperform a group of Hedge Funds. No one took him up on the wager and his choice crushed the performance of the Hedge Funds.
Next, investors and football executives all suffer from Overconfidence Bias. Studies show the more information we are given the more confident we are in our decisions. The problem is the accuracy of our decisions hits a ceiling while this confidence still rises. We all fall in love with a stock or a player because we are so confident in our abilities. Teams that have done the best take the approach they will improve their odds by having more picks than locking in on one player.
Hopefully the Browns have finally picked a drafting process that is more consistent with the empirical evidence than what someone’s gut tells them. If this is classified as Money-Ball, so be it. Let’s just get the team some wins and improve the mood of the region on Monday mornings. And when you flip on ESPN remember the E stands for Entertainment. I wonder if CNBC would throw an E in the front of their call sign?