They looked for value, focused on the future, and kept things simple.
The football (or soccer, depending on the brand of English you speak) version of a Black Swan event unfolded in the English Premier professional football league this season when Leicester City, a 5,000-1 bet at the beginning season, won the championship. Odds makers had thought there was a greater chance that Bono, the lead singer of the rock group U2, would be named the next Pope, than that Leicester City – largely unknown outside of England – would win the season. (As a result, bookmakers lost US$36 million to people who picked Leicester – the biggest gambling loss on a single sporting event in British history.)
Leicester City isn’t a company, or a stock. But the way that the team achieved the all-but-impossible holds a number of lessons for investors.
Look for value and be contrarian
Leicester City was a collection of assets – talent – that turned out to be deeply undervalued and contrarian.
All of the players on the team earned a combined £48 million (S$95 million) – less than the annual earnings of one particularly pricey star at Manchester City, one of the better-heeled teams of the league. Leicester City’s total payroll was one-fifth that of some of its competitors. Two of the starting forwards for Leicester City started the season earning the football equivalent of chickenfeed, at a combined £2.5 million.
Some investors, like Jim Rogers, buy out-of-favor assets that no one else is interested in for pennies on the dollar. Leicester City is an example of this approach.
The team was not anchored to the price of its squad. It’s easy to judge players by their salary – and assume that players who aren’t paid much, aren’t worth much.
When we assess the value of something, we seek a reference point for comparison. Unfortunately, we often choose insignificant, or even random, reference points – or we use one that we’re given. Anchoring bias causes us to rely too much on the first or most prominent piece of information as an anchor to determine value. This is true for the salaries of football players too, when we assume that an inexpensive team will wind up in the cellar.
It’s also true for stocks, where investors often anchor share prices incorrectly – for example, when they look for signs that a stock will stop dropping. What you pay for something doesn’t mean it’s worth that much.
Try to – but fail – to plan for the unexpected
Leicester City’s win was what analysts call a black swan event; it was totally unpredictable and no one thought it would ever happen.
The team’s manager, Claudio Ranieri, had an uneventful 28-year career, and it did not seem like that would change any time soon. He had lost his last job as coach of the Greek national team after they lost to Faroe Islands – a penny stock of a football team – at home.
Leicester had fallen out of, and made its way back into, the Premier League for years (every year, the worst 3 teams in the English Premier League (EPL) drop down to a lower league called the Championship, and are replaced with the top teams from that league). It seemed to be a matter of time before Leicester City would fall out of the Premier League forever. No one foresaw Leicester as a threat until they went on a massive winning streak, ultimately taking the title.
The lesson? Planning for the unexpected doesn’t do any good… because the unexpected, by definition, is something that you can’t plan for.
There’s another lesson here. Leicester City winning the EPL was a long-shot, black swan event… just like the highly speculative penny stock that winds up being the next Google. Either could happen again tomorrow… or neither might happen again for many years. Expecting a black swan isn’t a good investment strategy.
Don’t get stuck in the recent past
Before this season, the same four teams had won the English Premier League for the previous 20 years. No other teams have even come close. So no one saw Leicester City coming in part because nothing like it had happened recently.
Recency bias suggests that people have the tendency to assume that the recent past will repeat itself. But this often isn’t true. Each situation – or market dynamic – is unique. Just because the market fell yesterday, and the day before, and last week, doesn’t mean it will fall today.
Keep it simple
Leicester was good at a few things – quick counter-attacks, solid defence and regular interceptions. The manager previously had a reputation as a tinkerer, making adjustments all the time to try and improve the team. But at Leicester he resisted that urge, and had the team stick to what it knew best.
It’s the same for an investment portfolio. There’s no need to over-complicate things. A good rule of thumb is the “crayon test.” If you can’t explain a company, or investment strategy, using nothing more than crayons and a piece of paper, then you don’t understand it – and probably shouldn’t invest in it.
By following these five guidelines, investors can build better portfolios. They could also help bump your returns into Premier League status.