Swedroe: Why Alpha’s Getting More Elusive

November 21, 2014

Beating the market was always hard, but who knew it’s literally becoming harder?

Editor’s Note: This article is an excerpt from The Incredible Shrinking Alpha, an upcoming investment book co-authored by Larry Swedroe and Andrew Berkin. Its expected publication is in early 2015. Also, Swedroe will deliver a keynote address by the same name at the Inside ETFs conference Hollywood, Florida in January 2015.

Baseball’s “modern era” began in 1903. Prior to that time, foul balls that weren’t caught weren’t considered strikes, giving hitters a major advantage. From 1903 through 1941, seven different players achieved a batting average of over .400 a total of 12 times—Ty Cobb and Rogers Hornsby each did it three times, and George Sisler did it twice.

The last National League player to hit .400 was Bill Terry of the New York Giants, who hit .401 in 1930. The last American League player to do so was Ted Williams, who was known as the Splendid Splinter, of the Boston Red Sox. He hit .406 in 1941. So it’s been more than 70 years since anyone has hit .400.

What Gives?

Today’s baseball players are superior athletes. They are bigger, faster, stronger, use improved training techniques and have better diets. That presents us with an apparent anomaly. Why have superior athletes been unable to achieve once in the last 73 years what was accomplished 12 times in just 39 years?

Part of the explanation is that on defense, today’s players are also superior and have better equipment. On the other hand, the strike zone is much smaller today, giving hitters a major advantage. Statistical analysis, however, provides us with the answer.

It has to do with what is known as the “paradox of skill.”

The Paradox of Skill

In many forms of competition, such as chess, poker or investing, it’s the relative level of skill that plays the more important role in determining outcomes, not the absolute level. The “paradox of skill” means that even as skill level rises, luck can become more important in determining outcomes if the level of competition is also rising.

The result is that, as the average skill increases, it becomes more difficult to outperform by large margins. In other words, the standard deviation of outcomes narrows.

And, by definition, there’s no tendency for luck (either good or bad) to persist. In baseball, that means players are likely to have “hot” and “cold” months purely as result of lucky (or unlucky) outcomes, but that isn’t likely to be the case over a full year. That’s why you don’t see .400 hitters any more. Let’s look at the statistical evidence.

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