March 12, 2019 - Lauren Digani
Lauren Digani is a product specialist across all of the firm’s investment strategies. Before joining Harris Associates in 2016, Lauren spent nine years at UBS Asset Management, most recently as an equity specialist. Prior to UBS, she worked in financial reporting at a Chicago-based bank holding company. Lauren has an MBA from the University of Chicago Booth School of Business (2011) and completed her undergraduate studies at Southern Methodist University (2005).
Americans love March Madness. In 2018, NCAA college basketball fans filled out 70 million tournament brackets, wagering approximately $10.4B – about twice as much as during the Super Bowl.1 Time spent on sports brackets at work amounts to significant productivity losses, with many employees focused on a single tournament-season mission: dominating the March Madness office pool.
But crafting a winning bracket presents challenges. There are always upsets, although they vary each year in number and significance. Sometimes there is a feel-good underdog story, like that of Harris' own hometown Loyola-Chicago Ramblers, the team that defied odds in 2018 by earning a place in the Final Four as a #11 seed. Regardless of a particular year’s details, at some point we inevitably find ourselves admiring others’ bracket picks asking, “How did they know…?!”
It’s a good question: How should we know when to make a contrarian bet? With a consensus bracket as a guide, we are essentially presented with a passive investment option for our picks. Just as markets generally go up over time,2 the consensus bracket typically serves us well on an absolute basis. However, to win the office pool – to outperform on a relative basis – we need to take some active positions.
For this task, there are a few parallels between tournament brackets and investing that can help inform when to go active:
You believe you have unique insight.
Some luck is involved every year, but active bets that pay off often represent creative thinking and solid due diligence. For example, since 2008 only 19 teams seeded #11-#13 have made the Sweet 16. However, teams in this range may have upside potential that others in your office pool overlook. Perhaps, like Loyola, they are a 25+-win conference champion from a small conference that very few have seen play. Or perhaps they underperformed due to injuries all season but are on the cusp of adding a key player back to the lineup.
Similarly, as investors, we don’t make active bets for the sake of being different, but because we believe we see something everyone else is missing. At Harris, that differentiated perspective comes from our unusually long time horizon (typically five years), an unwavering focus on identifying quality businesses and a deep level of engagement with management teams. Unlike a more quantitative or passive approach, we look beyond readily available statistics to uncover hidden value in the companies we own.
The risk-reward profile is attractive.
Undervalued teams can provide more than just the thrill of picking an opening-round upset – they may deliver valuable late-round wins, making them worth the risk. As such, how your pool rewards risk-taking is a critical consideration for any successful March Madness strategy. Prior to the 2018 tournament, #16 seeds were 0-135 against #1 seeds in opening-round matchups. Then last year the #16-seed Maryland-Baltimore County, a 20-point underdog, shocked the #1-seed University of Virginia. Nailing a pick like that may make you the office hero for a day, but assuming your pool assigns the standard two points for an opening round win, this selection will not provide significant upside versus the field. If your strategy is to choose #16s over #1s in hopes of earning two points, you’ll likely receive an open invitation to every wagering opportunity in the office.
A better strategy might be to look at undervalued teams that have potential to make deep runs in the tournament (pools typically award greater points for wins in the later rounds). Likewise, at Harris, we strive to put more capital to work in those names with the best risk-reward profiles over the long term. To achieve this goal, we rank all stocks on our Approved List (approximately 300 names globally) based on our proprietary determination of risk-adjusted upside potential. Stocks at the top of that discount ranking are typically weighted most heavily in our portfolios.
Your behavioral biases are in check.
No matter how brilliant your insight or attractive the risk-reward proposition of an active bet, benefits can be negated if behavioral biases go unchecked. In tournament context, these biases may lead us to irrationally pick our alma mater or avoid a school that burned us last season. We may actively de-select a team like Duke because we hate seeing them win. Similarly, investment analysts may fall victim to effects such as confirmation bias (seeking information that supports existing views) and anchoring (relying too heavily on a past reference point), among others.
At Harris, we do our best to counter these biases by building mitigation strategies into our investment process. Every stock under review is subject to a rigorous collective vetting exercise, during which a bear case is presented and all investment team members are held accountable for poking holes in the presenting analyst’s work. Additionally, we continuously monitor a stock’s fundamental performance relative to our initial thesis points and conduct detailed retrospective analysis on companies with performance that significantly differs from our expectations. By proactively addressing our biases, we aim to maximize the impact of our research insights and take full advantage of attractive risk-reward opportunities for our clients.
We wish you all great success in your investment portfolios – and your 2019 tournament pools.
2The annualized return of the S&P 500 was 9.07% from 12/31/93 – 12/31/18.
The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.
The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the author and Harris Associates L.P. as of the date written and are subject to change without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.