Tonight is the Major League Baseball All Star Game. The Midsummer Classic. A game of marquee match-ups that features some of the best athletes to ever play the sport. But even the best hitters among them will likely never finish a season with a batting average above .400.
If Ted Williams were playing baseball in his prime alongside today’s players, he would still be an All Star. But, like today's stars, he wouldn’t hit .400 either. According to Michael Mauboussin, this week’s guest on Intelligent Investing with Steve Forbes, Williams – the last hitter to bat over .400, with a .406 average in 1941 – would fall victim to the Paradox of Skill. As participants in any given activity improve across the board, says Mauboussin, the standard deviation shrinks. In other words, outstanding performance stands out less.
According to this article, Williams’ 1941 performance was 4.21 standard deviations above the mean batting average in the league that season. Using the numbers derived here, that level of outperformance in 2010 would have ended in a batting title, but would have fallen a good deal short of .400.
So what does this have to do with investing? Investing, like baseball, is a blend of luck and skill, meaning it too falls captive to the Paradox of Skill. As money managers and individual investors become more universally skilled, the distance between the best investor and the average investor shrinks. Today’s investing All Stars might theoretically be smarter than ever, but the team will perform closer to the benchmark average than in decades past.
As Mauboussin points out, the Paradox of Skill is a concrete way to describe the efficient market hypothesis. “If it's a very competitive world out there – there are low barriers to entry, everybody's got the same information, the same computers and reading the same academic research – it's going to be very, very competitive. And then luck is going to become very important.”
Watch a clip of Mauboussin’s discussion with Steve Forbes below for more about Ted Williams, All Star fund managers, and the Paradox of Skill:
- standard deviations
- batting average
- Major League Baseball All Star Game
- efficient market hypothesis
- barriers to entry