Can sacrificing little goals satisfy bigger ones? In the March 2018 draft of their paper entitled “Pulling the Goalie: Hockey and Investment Implications”, Clifford Asness and Aaron Brown ponder when a losing hockey coach should pull the goalie as a metaphor for focusing on portfolio-level return and portfolio-level risk management. Based on statistical analysis of hockey scenarios and broad examples from investing, they conclude that:
- Pulling the goalie less than doubles odds of scoring, while nearly quadrupling the probability of opponent scoring. But, in terms of season point standings, a team down a goal with little time remaining has much to gain by scoring and little to lose if the other team scores. The potential short-term negative expectation is less important than the potential larger-stakes payoff. In general, hockey coaches do not pull the goalie soon enough.
- Investors make similar mistakes when they focus on: (1) risks of individual positions rather than risks of the overall portfolio including these positions; and, (2) portfolio volatilities rather than probabilities of unacceptable returns over their investment horizons.
- Investors perceive an investment manager who selects low-fee index funds and moderate-fee active funds that beat their benchmarks as an excellent manager. Sometimes this approach is not good enough, in which case the manager should consider new types of risk (leverage to boost portfolio diversification, or liquidity risk for higher expected return). More granularly, the manager should consider problematic stocks because they are cheap. Essentially, investors undervalue (overvalue) winning ugly (losing elegantly).
- However, investment managers:
- Experience a wilder environment than hockey coaches. They do not experience very similar game conditions over and over.
- Do not start fresh every season. They have performance horizons of many years, and a 5% loss this quarter means 5% less money forever.
- Can blow up their careers by losing ugly with alternative asset classes and problematic stocks.
In summary, investment managers and investors should think at the portfolio level, not the asset level, to achieve overall optimal performance.
Cautions regarding conclusions include:
- Pulling the goalie is a metaphor here for carefully examining risky assets in portfolio context, not for shifting to high-risk portfolios to compensate for poor past performance.
- Non-hockey fans may prefer swinging for the fences, suicide squeeze, going for two, Hail Mary or half court shot metaphors.
