In baseball, narrow wins and large losses reflect a manager’s efficiency and skill. The opposite is true in investing and finance.
The most efficiently managed baseball team is one that generates the highest number of wins for a given number of runs scored and allowed. Bill James created the Pythagorean Winning Percentage formula which calculates the number of games a team should win based on the number of runs they score and allow. The chart below uses a version of James’ formula to show which major league teams’ win total are outperforming or underperforming their run differential so far this year. If a team has won more games than projected by the formula, such as the Blue Jays, it indicates that they have efficiently managed their game day decision, especially relating to their relief pitchers.
As an example, if a baseball manager handles his pitching staff well, his team may win five games by one or two runs and then lose the next game by a wide margin. This would be an efficient use of a pitching staff, as the narrow wins and one large loss creates a 5 win / 1 loss record. In baseball, performance is additive, and each result is measurable in binary units of 1 win or 1 loss.
In finance, outcomes are multiplicative (returns compound over time) with unspecified units. Narrow wins and large losses work well in baseball, but it is terrible for investing. If a portfolio has a 5% annual return for 5 years and then loses 25% in year 6, the total return is -4%. A single large drawdown can erase years of steady gains and leave the investor worse off than when they started. While it is improper to judge baseball managers on their worst days, for investment managers their worst days are often the most important days to analyze.