Playing the odds

While markets continue their remarkable rebound, the most important event for many people this month will be the return of the Premier League, something that cannot come soon enough for loyal fans (particularly Liverpool supporters). The resumption of top flight football provides a welcome distraction during these trying times as the German Bundesliga has already shown, even if the atmosphere is somewhat diminished by empty stadiums. The great thing about professional sport is that so much is captured by data, the quality and depth of which is extremely rich. This is something it has in common with financial markets and – like financial markets – reveals interesting insights into the nature of human decision making which can be instructive for investors.

Perhaps the most undisputed statistical phenomenon in sport is the concept of home team advantage. This has been present across different sports over long time periods, and in the Premier League specifically it is estimated to increase the chances of winning by around 16%. The reasons for this are debated by statisticians and laymen alike, but empirical evidence points to social pressure exerted by home crowds on referees as a contributing factor1. Recent results in the Bundesliga seem to support this theory, as the home win rate has dropped from 40% to 21% since teams have started to play so-called “ghost games” without supporters physically present.

Looking at betting data provides another interesting perspective. Rather than dispassionately weighing up statistical data to make decisions, many bettors are influenced by all sorts of often irrational factors. Studies have shown that gamblers are more inclined to back favourites over underdogs, as well as beloved local or otherwise glamorous teams, despite being offered relatively poor odds. Bookmakers of course are well aware of this fact, and through accurate assessment of the odds as well as a strong understanding of customer behaviour, they are able to generate healthy profits.

The behavioural and emotional biases present in sports and betting markets are examples of the sort of thinking that influences all human decision making, and behavioural finance theory has been successful in describing how this also applies to investment decisions. Markets are after all a social construct where fair price is determined by the assessment of independent buyers and sellers. Investors can find irrational comforts in their favourite stocks, overpaying for recent winners or familiar names they know well from their domestic market. They can also be swayed by the power of crowds, following popular opinion rather than making difficult decisions on their own merits.

Making correct investment decisions is inherently more complex and consequential than predicting the outcome of a sporting fixture, and so it is important that investors are well informed and aware of the potential for emotional biases to impact decision making. There is no shortage of historical data and academic theory to inform decisions, but such information needs to be understood in a contemporary context and applied appropriately.

Our goal as active managers is to apply this knowledge correctly to help our clients achieve their investment goals. Inefficient markets provide specialist managers with the opportunity to generate excess profits in their areas of expertise, while our diversified approach to portfolio construction targets factors that have been shown to generate long term returns while limiting risk. We believe this is the best way to maximise the odds of success, and over the long term is certainly preferable to betting against the bookmakers!