March Madness Confirms Humans Don’t Add Much Alpha

First let me tell you why I love the annual NCAA men’s Division I basketball tournament (aka March Madness). It’s the ultimate reality show. Where else can little known universities such as St. Peters, Loyola of Chicago, Murray State, Weber State, Florida Gulf Coast and Valparaiso suddenly jump into the national limelight with upset wins over perennial powerhouses.

If you don’t think March Madness success has much to do with a school’s brand recognition or athletic recruiting, think again. I know it’s hard to believe but 20 years ago, no one outside of eastern Washington had heard of Gonzaga University. Now the Zags are a national powerhouse. In fact, they’re the No.1 ranked team in the entire country ahead of Kentucky, UCLA, Kansas, Duke, North Carolina and all the Big Ten universities.

Don’t think that helps a school’s brand? Since 1999 applications to Gonzaga have increased 300 percent and enrollment has increased by  more than 86 percent. Hmm.

This year’s “Cinderella” team has been tiny St. Peter’s University of Jersey City, NJ (undergrad enrollment 2,200), The Peacocks upset mighty Kentucky (31,000 undergraduates) in the first round and then defeated former Cinderella Murray State in the second round to remain one of only 16 teams left in the tournament. Only 1.5 percent of brackets had the “Peacocks” advancing to the “Sweet 16.” St. Peters head coach Shaheen Holloway earns a fraction of what the lowest paid assistant in the Kentucky program earns.

What’s not to like?

St. Peter’s president, Eugene Cornacchia, told the North Jersey media “For our whole community, this is a seminal moment in our history. We can’t put $8-10 million into the (basketball) program,” [referring to Kentucky?] “but nonetheless you see what we can do if you have a great coach and players who are hard-working and committed. This is truly a miracle story.”

Not only did the St. Peters website crash after the win over Kentucky, but Cornacchia said the school has already seen increased applications from students. “There’s just been an outpouring of media attention across the country that has been unbelievable. Now I know why they call it March Madness… We’ve been hearing from people around the country about our T-shirts. We ran out real fast.”

Bracketology is not an exact science

Feel good stories aside, I love filling out the tournament brackets as do 20 million other sports fans, office workers, lodge buddies, fraternity brothers and millions of other people who never watch college hoops the rest of the year. Filling out brackets can be great for office morale, despite the drop in productivity. Plus, the tourney is a great reality show. It’s got heroes and villains, alliances and backstabbing. There’s no best of seven. It’s single-elimination win or go home. Just pick which team you think will win each game and each round. It couldn’t be easier. But it’s not -- at least for humans.

There’s no shortage of information to make an informed decision and you don’t have to be an “accredited” gambler to play. It’s almost impossible NOT to find a free printable bracket on the web. You get the official NCAA seeding number for each team (ranked 1 through 16). You get their season record. The Vegas odds for each game are everywhere on the web. You can even get injury reports, stats for each player, and each team’s national ranking on two-dozen common metrics. It’s all publicly available and free of charge.

Yet nobody – NOBODY -- seems able to fill out a perfect or even near-perfect bracket. This year, not a single one of the 20 million brackets filled out on the Yahoo, Capital One or CBS Sportline bracket challenges were correct after the first two rounds of the tournament. In fact, only one of the 20 million brackets had even 15 of the remaining “Sweet 16” correct and only .001 percent had even 14 out of 16 teams remaining.

As with stock picking, humans are just lousy identifiers of winners, even when you have a wealth of information, years of experience and high-powered computers at your disposal. Here’s another dirty secret. Despite all the upsets every year, you can do darn well just by picking the favored teams (i.e., the higher seeded ones). It’s like investing in index funds – unmanaged and emotion-free.

You’ll consistently finish in the 75^th percentile of your office pool just by picking the large cap favorites. This year that unmanaged “set it and forget it” strategy would put you in the 91^st percentile as we enter the Sweet 16. Sure, you need a few low-ranked small caps and under-valued “value picks” to score some bonus points in the early rounds, but by the time we got to the Elite 8 and Final Four, the big boys tend to rise to the top.

Going back to 1985, #1 Seeds have won the national title about two-thirds of the time (23 out of 36). That’s more than all the other seeds combined. Teams seeded #2 have won the title five times, #3 seeds have won four times and then just a smattering of one-offs for the remaining years. No team seeded 9^th or lower has ever won the tournament.

So how much alpha are human bracketologists adding? Not much. Just like active managers. That’s what makes March Madness fun – especially for behavioral finance observers like me. Just don’t put real money into your March Madness wagers.

Conclusion

Even with perfect information and a level playing field, humans just can’t override their emotions when it comes to March Madness. Same goes for the markets. I’m okay with that and so is my wallet.

Don’t agree? Tell me why.

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