The NCAA College Basketball Tournament has begun. There will undoubtedly be heartbreak and victories; but among the blood, sweat, and tears, there is also a valuable lesson in the importance of reliable ranking systems; a lesson that can also be applied to investing. The tournament begins in earnest with 64 teams and operates in a single elimination format, which means that 63 games will be played to determine the ultimate champion. While personal college affiliations are of course important, participants simply need to pick which teams will win each of those 63 games, which is no easy task. Fortunately, the NCAA brought March Madness into the casual fans’ wheelhouse by including “seedings” for each team, helping us all move one step closer to being “bracketologists.”
The seeding process of teams began in 1979 as a way for the NCAA to make sure that the strongest teams didn’t end up meeting each other too early in the tournament, which would be a threat to TV ratings and the overall fan experience. The seeding also provides the uninitiated in basketball a basis from which to make decisions; everyone intuitively understands that picking a number 16 seed (the lowest ranked teams) to beat a number 1 seed (the highest ranked) is not a statistically good bet. In fact, 2018 is the first year that there has been a number 16 seed to beat a number 1 seed in the history of the tournament. A team with a high ranking is, after all, the stronger team based upon qualitative and quantitative evaluation. They often possess more talent and better coaching than the lower-ranked teams. While past performance has certainly not guaranteed future success for all of the high-seeded teams, it is certainly a good starting point for the average fan’s tournament bracket.
When using data compiled from CBS Sports and ESPN regarding the success of each of the 16 seeds advancing through the NCAA tournament, the seeding process has largely worked out as the NCAA intended it to. Higher ranked teams typically advance well into the tournament, leading to exciting clashes of talented teams late in the tournament. Top-seeded teams don’t always survive the test to the Final Four, but historically these teams win about 80% of the games they play. The #13 – #16 seeds combine to win just roughly 11% of the games they play.
Many NCAA “bracketeers” spend an awful lot of time slicing and dicing the differences between the point guards of #15 seeds, which have only ever won 8 games out of 124 played. Yes, you may be the one to predict that tenth win in history for a #15 seed; however, you are also predicting the elimination of a seed that wins 94% of its 1st round games, and roughly 71% of all its NCAA tournament games. So, while the potential of being able to claim “victory” in picking a #15 seed over a #2 seed might seem alluring, the fact is such picks have been correct just 6% of the time in NCAA Tournament history. Which side would you rather be on?
In the investment world, “Relative Strength” portfolio management does not differ too much from what we have described above, and the NCAA tournament is a perfect analogy to use in describing that process. In Relative Strength, we are simply “seeding” teams, and like the NCAA experts, we are seeding them based upon recent trends of success against their peers. The more Relative Strength generated by a team/security, the stronger the ranking or the “seeding” of that investment. Similar to the NCAA tournament, we know that history shows those top seeds perform better as a universe than the lower seeds. There are upsets, of course, but the trend generally favors the higher seeds and so that is where we focus our investment selection. While the NCAA committee has their own proprietary ways of ranking teams, the input is based upon head-to-head games earlier in the season and overall recent performance. The manner by which relative strength is used to rank stocks, sectors, countries, and even asset classes is not particularly different. Our relative strength rankings are a way to identify the strongest performance trends within a given universe, using head-to-head comparisons to build a database of information. Equally as important, our relative strength rankings can be used to track the deterioration of a positive performance trend, allowing us an opportunity to potentially exit a position before earning that potential # 16 seed next year.
**This article was written and provided to you by Charles Tumlin, Managing Director, TLS Wealth Management of Raymond James. Charles Tumlin is a Financial Advisor with Raymond James & Associates, Inc., Member New York Stock Exchange/SIPC located at 305 Carteret Street, Beaufort SC 29902. He can be contacted at 843-379-6100 or email@example.com or visit our website at: www.tlswealthmanagement.com
Any opinions are those of Charles Tumlin and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
Note: The online version is the correct version of ‘What NCAA basketball teaches us about investing’.