A Conversation with Joe Peta on Baseball, Stocks and Performance Analysis by Elliot Turner, Compounding My Interests
I’m very excited to share my interview with Joe Peta here. Joe is the author of Trading Bases: A Story About Wall Street, Gambling and Baseball and Managing Director at Novus. As you may realize from the title, Trading Bases combines (compounds) a bunch of my interests. In his work at Novus, Joe Peta has been doing some groundbreaking research on performance attribution by dissecting volumes of individual fund and investment manager performance records in order to gain deep insight into how to identify the true drivers of alpha. His insights for traders and investors alike from years of experience on trading desks, running his own hedge fund, and now studying some of the best alpha-makers in the world are incredibly valuable for anyone looking to make money in the stock market. Plus Joe Peta’s outlook on life, whereby he took a challenging physical injury and turned it into an intellectually stimulating and ultimately rewarding experience in baseball betting is both inspiring and a great lesson for all in critical thinking. I’m very thankful that Joe Peta took the time to discuss some of these topics with me here! Enjoy:
Elliot: Novus has been putting out some great stuff, particularly on the Julian Robertson and his Tiger Cub progeny, as well as European short interest. Can you talk a little about your role in Novus and your effort to build out the investing equivalent of baseball’s WAR–the WAGEs?
Joe Peta: Novus was founded by ex-Fund of Fund investors who were dismayed at the lack of use of analytics in evaluating fund managers. Despite the fact that study after study has shown that today’s fund winners correlate poorly with tomorrow’s winners, in 2007, our founders wondered why the entire industry of allocators (endowments, state and corporate pension plans, sovereign wealth funds, fund of funds, etc.) all based their allocation decisions on the same process: Review the 1-, 3-, and 5-year track record and have a face-to-face interview with the fund manager to see if “he gets it.”
With data and analytic tools available that didn’t exist in the years prior when the “track record/interview” process was the only way to evaluate managers, Novus was founded with the idea of augmenting that process with analytics. Since our founding nearly seven years ago, the firm counts as clients not just allocators but asset managers (hedge funds, for the most part) as well. Allocators use us to manage their data and provide portfolio analytics while managers, thanks to the possession of daily data, can use Novus as an invaluable self-analysis tool.
Novus found me after reading my book Trading Bases. The first time I saw their analytics platform for hedge fund managers I nearly slapped myself in the head, thinking: “these guys have commercialized the exact stuff I tried to build on Excel at my hedge fund.” The whole goal of this type of analysis is to find out what you or your firm are good at and then leverage those skills. It’s a simple concept really rooted in the division of labor – if you want your hedge fund to be successful, find out what you do that persistently creates alpha and then leverage those skills. Leveraging alpha is smart; leveraging beta is risky; and, undertaking activities that you’re not good at is stupid.
These are exactly the management concepts that have arisen out of the sabermetric revolution in baseball. Buster Posey doesn’t try to steal bases, because he’s slow-footed. Getting thrown out stealing would erode his other highly-coveted skills that make him more valuable than his peers. Yet, I see PM’s who specialize in tech consistently losing money trading bonds or oil. If confronted, they’ll spin some sort of crap about correlations, but it’s just another form of behavioral finance weakness. They either don’t know what they are good at, and therefore don’t stick to it, or they simply cannot help themselves from trying to be something they are not. (I used to tell a fabulous semiconductor PM I knew who consistently lost money trading oil that he would laugh his ass off if T. Boone Pickens dabbled in SOX trading. My friend would laugh knowingly – and then go right back to trading the USO.)
Novus, at its core, is designed to detect those skills and weaknesses. It can help an allocator invest more intelligently and it can help managers improve returns. Baseball, sadly, is way more advanced at separating skill from luck when examining results than the financial industry is.
Elliot: Are you still running the baseball hedge fund while at Novus?
Joe Peta: My complete immersion in the world of model-based baseball betting covered the 2011 and 2012 baseball seasons. The entire 2011 experience is chronicled in my book and that led to the 2012 adventure of raising a $1million fund and moving to Vegas for the majority of the season. Other than some personal season-long futures bets that I made this year and last, I have made virtually no single game bets. It’s a time consuming venture that really ended when my book came out last year and I started to look for the next step in my career.
Two questions that arise from those that read the book are 1) if the model returned 41% and 14% in ’11 and ’12 respectively why don’t you raise a bigger fund, and 2) why would you disclose virtually your entire process in the book? The answer is that my experience in Vegas convinced me the returns aren’t scalable. I estimated my true edge to be somewhere in the low teens (based on my model’s slightly better Least Mean Squared forecasting error over more than 4,800 regular season games and my allocation schedule which produced daily volatility roughly akin to the QQQs.) I learned that my $1mm fund could only be 2 to 2.5x bigger (at the most) before the returns would have diminished due to the inability to size my bets up to reflect a larger fund. You might protest that 13% a year on say, $2mm is still $260,000 in returns a year and I would agree that’s a very material amount of money, but it’s money that would belong to my investors; managers typically get 20% of the profits. So at the most optimistic, you could say I had a business model that had an annual expected value of $50,000. The 23-year old me would have jumped at that, but as a married forty-something financial industry professional with young children, it’s just not a viable business model. I love that I had a two-year experience that resulted from a horrible accident, but I’ve essentially removed myself from that world..
Elliot: While WAGEs is a comparative stat, how can I use it to my advantage as an individual and an investor to better assess my own performance? How can I use WAGEs to think critically and smartly about myself in the quest for constant improvement?
Joe Peta: I have 100% confidence that a WAGEs (Worth of Actively Generated skills) type analysis of every single active trader/investor can yield extremely valuable insights that can lead to self-improvement