Wait…is this another article comparing markets to a sport? Well, sometimes there is no better way to drive the message home than to use analogies, right? Most avid cricket supporters thought that Australia would reach the final of the T20 World Cup. Also, some typical South African fans thought that South Africa would lose to the Netherlands and catch the early flight home. These were said to be as sure a thing as it is having four seasons on the same day in Cape Town. But lo and behold, Australia got knocked out before the semi-finals, and South Africa went to the finals. Over-exposure to a particular stock isn’t always the best approach, sometimes the favourites just don’t win. Well, the reality is that markets, just like we’ve seen in the cricket World Cup, are uncertain and risky. As the phrases go “Don’t put all eggs in one basket” and “Past performance isn’t an indication of future performance”. But let us unpack this a little bit more.

Australia got knocked out before the semi-finals, after losing to Afghanistan and India, and then Afghanistan went on to beat Bangladesh. But that would be a poor summary of the World Cup. That would be as bad as saying ‘teams played the sport, some won, others lost’. In many respects, this World Cup has been strange. As a start, it was played in the US and West Indies. New York, Dallas and Miami are not traditional cricketing venues, with some stadiums only being built for this tournament and some pitches being imported from Australia. We don’t know the logistics of how they transport a strip of manicured land across continents, but we do know that it doesn’t result in interesting cricket. In addition to new venues, we saw new teams like Papua New Guinea and Uganda play on an international stage. The T20 format is supposed to be fast-paced, high scoring and unfairly favouring the batsmen. But this World Cup has been anything but high-scoring. The New York pitch was more of a trampoline than solid ground and batsmen looked like they were playing the wrong sport at times. Low-scoring games have made for some exciting cricket, with bowlers finally having some advantages. Pitches not only misbehaved but also did so unpredictably. The weather gave us everything from tropical storms and gusty winds, which made fielding difficult, to rain bringing the infamous duo Duckworth and Lewis back in action. It felt like England played with rain more than with bats or balls and watched weather forecasts more than cricket scorecards. Two teams who were never supposed to win the final, but were unbeaten in the tournament, ended up fighting it out in the finals. India won in the end but with the narrowest of margins.

Let’s bring it back to the markets, investments and constructing portfolios. Estimating the playing conditions in cricket and building a team best suited for them, is like constructing a portfolio based on estimated risk and return characteristics. Diversification inside a portfolio means that the portfolio can still do well even if parts of it don’t. Some of the big names in cricket have underperformed in this tournament, but their teams have still done well because they are well-balanced. It can be difficult to know what to expect from drop-in cricket pitches. Same as portfolio managers can’t fully know what to expect when constructing portfolios in different economic cycles. Certain sectors doing better than others can be akin to certain types of bowling like spin or swing doing better than others. In short, we live in an ever-changing and unpredictable world, where winning at a sport or constructing robust portfolios is a difficult task. Estimated and unforeseen risks can ruin well-laid plans and can make experienced teams and portfolio managers have bad periods.

The World Cup, just like the markets, comes with media, data, and news overload. What a captain or coach says in a press release is like what a CEO says while reporting results. If the news from the teams or companies is firsthand information, there is no shortage of second or third-hand information and speculation. There are opinions, articles, and analyst reports dissecting every aspect of a company and a team through text, audio, video and every other medium we can think of. If we think about the returns from assets as the results of cricket games, there is a lot of speculation and noise around predicting them. Forecasting markets is as futile an exercise as predicting which team will win, especially in T20 cricket. If we were to stretch the analogy a bit more, the shorter format of the game is just as uncertain or unpredictable as the shorter-term forecasts. Predicting which teams will do well in Test cricket is easier than in T20 cricket.

Markets, just like cricket, are about stories. Stories about whether a CEO or a top executive can turn a company around, or about whether two companies merging will go as planned and boost revenues. Stories lead to biases like the recency bias, where investors put more weight on recent events or viewers look for teams that have performed well recently. Hard numbers can and do tell stories too, and sometimes the stories can also be misleading. Hard numbers will say that Australia and Afghanistan won the same number of games so far, but the latter is going through to the semi-finals and the former not. This is because Afghanistan has won the games that have mattered more. Another example of misleading numbers is Sri Lanka, which on paper has performed poorly. But what the numbers don’t show is that they have had a horrendous travel schedule and played games at different times, with few breaks in between. In contrast, India played all their games at the same time and travelled a lot less. Numbers can say which companies have performed well and are likely to continue to perform well, but they may hide other things like market liquidity. The liquidity or trade volume numbers may look good, but unforeseen circumstances like wars or pandemics might affect what happens going forward.

In conclusion, the unexpected outcome of this year's T20 serves as a powerful reminder that even the most well-researched markets can surprise us. Fundamental analysis, while crucial, can't always predict the element of luck, or the unforeseen circumstances that can swing outcomes. Same as quantitative analysis, with its reliance on historical data, can struggle to account for everything influencing the market.

The key takeaway isn't to abandon either of these approaches, but rather to view them as a compass and a map, not a crystal ball. By combining fundamental analysis with a healthy dose of scepticism and an openness to quantitative insights, investors can navigate the ever-changing market landscape with a greater chance of success. Remember, even in the face of calculated risks, sometimes black swan events can get us out for a golden duck!