What if I told you I held the secret to creating a better than average NCAA bracket?
It’s March which means one thing – March Madness – and 2021 has left us no shortage of excitement or upsets. After 2 rounds of the NCAA Tournament, we approach the Sweet 16 which this year includes a 15 seed (Oral Roberts), a 12 seed (Oregon State), two 11 seeds (UCLA and Syracuse) an 8 seed (Loyola Chicago once again riding the magic of 101 year old team chaplain Sister Jean), a 7 seed (Oregon), a 6 seed (USC), and two 5 seeds (Creighton and Villanova). These are all teams that according their seeding were not expected to make it this far.
Every year like ~40 million others I’ll not only complete a traditional bracket (with the hopes of winning $5 from each of my coworkers), but I’ll also complete a “benchmark bracket” in order to compare my performance to that of an all-favorites (aka “chalk”) bracket where the higher seed team always beats the lower seed team.
Let’s call all chalk the “passive” approach and choosing upsets the “active” approach to bracket management.
According to Sports Illustrated, the current Sweet 16 is the least chalky of all time, yet right now an all-chalk bracket has been outperformed by only 27% of ESPN’s 14.7 million total bracket submissions, and therein lies my secret to a better than average bracket: simply choose all favorites.
Simply looking at the first round of the tournament we can see why it’s so difficult to beat a passive benchmark:
- Higher seeds tend to beat lower seeds
- In order to “outperform” the passive all chalk benchmark, over 50% of your upset picks must be correct
Before you throw your arms up in disgust, I’d like to do a very quick thought experiment – what if rather than being judged on your 2021 bracket, you were judged on the aggregate success of all of your brackets for the next 30 years – would your approach to bracket management change? The passive all-chalk approach might rarely win your pool, but you’d be much more likely to consistently finish in the top half of competitors – and if you were able to compound this advantage over decades you’d be in great shape.
Is this starting to sound familiar?
Naturally, the parallels between bracket management and investing are uncanny:
Results: Just like a more active approach to bracket management typically results in worse overall performance, actively managed investment funds tend to experience the same kind of struggles against their benchmarks. According to SPIVA 60.3% of Large Cap US Equity Funds underperformed the S&P 500 in 2020, a year with so much volatility it should have been ripe for active management! Expand this data set out to 20 years and 94% of Large Cap US Equity Funds have underperformed the S&P 500.
Sex Appeal: Passive investing is not sexy. It means you don’t get to brag about your shares of GameStop going “to the moon”. Similarly bragging about picking Gonzaga to advance to the Sweet 16 will garner you no accolades, but you might get kudos for picking 15 seed Oral Roberts to make it this this far. With that said, long term investing is NOT SUPPOSED TO BE SEXY just like 15 seeds are NOT SUPPOSED TO MAKE IT THIS FAR. Since the tournament expanded to 64 teams in 1985, Oral Roberts is only the 2nd 15 seed to advance to the Sweet 16 (1.4% chance). In other words, GameStop and Oral Roberts are both gambles.
Costs: Passive investing is low cost and requires little mental effort. Similarly creating a passive all chalk bracket takes no time at all. Active investing is much more expensive. Likewise, doing expansive research to try to pick NCAA upsets can take hours.
Luck Vs. Skill: If your friend correctly predicted Oral Roberts would make it to the Sweet 16 this year, would you trust them to make a bracket for you next year? Does this pick make them an incredibly skilled NCAA bracket manager, or did they just get lucky? In my eyes this pick seems indicative of someone willing to take on huge levels on unnecessary risk, and I’d predict their bracket in subsequent years would struggle because of it. Similarly, there are actively managed funds that have outperformed their passive benchmarks, but is this primarily due to skill, or due to luck? Would you trust their past performance to be indicative of future returns? I wouldn’t.
Evidence Based: My belief in passive investment management stems from my belief in evidence. The numbers speak for themselves. Similarly – since the field expanded to 64 teams in 1985, 1 seeds have won the title 63% of the time, and 1, 2, or 3 seeds have won the title a whopping 89% of the time.
In conclusion, while it may be a hated strategy, if you’re looking to consistently finish in the top half of your bracket, chalk is the way to go. With that said, I’m also well aware that if you’re looking to win your bracket (particularly a bracket with many participants), you’re going to have to come up with some wild picks – you’re hoping for volatility and a bracket that exhibits extreme positive skew. This level of risk taking is valid because a busted bracket has no real-life consequences. A “busted portfolio” on the other hand that takes on unnecessary risk, high costs, and seeks short term volatility to try and hit a home run (I’m looking at you GameStop), is more than likely to struggle in the long term, and certainly does come with real life consequences. When it comes to investing, trust the evidence, keep it simple, keep it passive – and until next year, Go Zags!