Monday, February 23, 2004

Revenge of the Scout?

Dave Pinto has a post on what will happen when other teams start to use Sabermetrics to identify undervalued players. Of course, once these players are identified, they will no longer be undervalued as more teams will be willing to pay for their services. But Pinto argues that many clubs will actually not follow through with a complete sabermetric strategy, but will probably just identify players with high OBA. He believes Beane will be able to identify undervalued players that other clubs, who only follow the perceived strategy, will continue to overlook.

I’m not so sure. There are a lot of uses for sabermetrics that go beyond the importance of OBA. But I would argue that OBA is the one aspect that gave Beane and others their biggest advantage. So while there are other players with certain characteristics that will remain undervalued, I don’t think they will have the impact that OBA advantage does. I’m also not so sure that they will be able to keep finding new types of undervalued players that will go unnoticed by other ballclubs.

I think it is informative to look at how undervalued assets are found in other markets. You can either look for market inefficiencies on a macro level or meticulously analyze individual assets looking for market mispricings.

Lets say an investment manager is able to earn significant abnormal returns (higher than a market model would suggest) by investing in small cap stocks. This manager wouldn’t even need to hire many analysts, as he would just need to put his money into a diversified portfolio of small cap stocks to beat the market. His hardest work will be in trying to keep this market inefficiency a secret from his competitors (I guess Joe Morgan was write – Billy Beane shouldn’t have written Moneyball).

But once this market inefficiency is discovered by the public the advantage will disappear. Everyone gets in on the game and the price goes up. So what does the investment manager do? Well its real hard to find new market inefficiencies. It is tautological that this would be very hard to accomplish, because for the market inefficiency to exist, it would have to go unnoticed by all other investors. How often can you realistically expect find a new one? And when you do, how long will the advantage last until the rest of the market picks up on it?

It’s more likely that the investment manager will need to increase the number of analysts to try and find individual assets that are being mispriced. Unfortunately, this is a lot harder and quite more expensive (and the returns aren’t nearly as fantastic).

So what does this mean for baseball. Well as the basic logic of sabermetrics is used by more teams, the advantage from using it will disappear. The next step would probably to do more research to try and find the type players who can develop into the desired profile. In other words, don’t be surprised if big scouting budgets return in the near future.