The holy grail of hedge fund investing is to capture alpha: returns based on selection and timing rather than market correlation. Alpha equals skill – the more alpha you capture, the greater the return in excess of average market returns. You can earn alpha by recognizing and exploiting mispriced assets, which supposedly don’t exist in efficient markets. Ask a successful alpha trader, and they will tell you differently.
Alpha returns are not limited to a particular market. You can earn it through stocks, bonds, commodities and …. sports bets! Talk about diversification – here is a “market” that is unrelated to the economy or socio-political news. You can easily make a case for increasing the efficiency of your investment portfolio by including sports bets in it. It may be that someday you will be able to make sports bets through a prime brokerage account. But we can easily foresee offshore sports hedge funds in which sports gurus use their superior knowledge to earn excess returns. Sports arbitrage could be implemented by laying off the same bet in both directions in two different locales; if the odds are different in the two locations, an arbitrageur can earn risk-free returns. As a matter of fact, such arbitrage will soon enforce price discipline in the sports bets markets, which would become more efficient in the process.
Now, some financial investors may bristle when we lump sports betting together with the stock market. After all, isn’t the stock market more than just betting? Well, you tell us. Frankly, we cannot see much of a difference between the two. In both cases, individuals with superior information (not to mention inside information) will always do better than the average investor or gambler. We happen to think that there is a real difference in the talent of different teams, and that one can make superior estimations of results by understanding the dynamics of that talent. And that is alpha.
A sports hedge fund could take multiple approaches to sports betting. In addition to a fundamental appraisal of a sports match-up, the fund may also use quantitative analysis to use previous performance to predict the future. This applies to teams, individual athletes, even horses and dogs. A sports hedge fund would be required to build up an extensive database of sports facts to support decisions. By closely evaluating the information at hand, you can make a prediction that is superior to a “random walk”. So be on the lookout for the appearance of sports hedge funds. How confident are we that they will appear before too long? It’s a sure bet!