Whenever I am getting my sports information from the Wall Street Journal I know I am too busy. There have to be more informed sources like ESPN, Bill James Baseball Abstracts or even Topps baseball cards? But I got an inspiration from the Friday July 17 WSJ article on baseball “The Underdogs: Are These Teams For Real?” by Matthew Futterman.
Mr. Futterman’s thesis is that analytics have leveled the playing field in major league baseball to a point where the Houston Astros, New York Mets, Minnesota Twins and Pittsburgh Pirates have a better chance at the 2015 playoffs than the Red Sox or Yankees. While I agree that all baseball managers possess the tools today to slice and dice statistics like Billy Beane, the star manager of the Oakland Athletics who was popularized by “Moneyball”, I think Mr. Futterman has missed a nuance. The managers of these “small market” teams have small budgets so they must choose their players wisely and with inspiration about achievement potential beyond statistics. Clearly the Yankees and the Red Sox have all the statistical and financial resources to get any player they want. So the Yankees have expensive players in their line-ups like Mark Texiera, Carlos Beltan and Alex Rodriguez and the Twins, Astros Mets and Pirates have low salary unknown hitters and pitchers like Brian Dozier, Trevor Plouffe, George Springer, Evan Gattis, Jacob deGrom, Josh Harrison, Neil Walker and Starling Marte.
I would argue that it is all about the money. When you have lots of it to spread around you have to buy big names to appease the ego of your owner, put fans in the seats and grab the national limelight for TV revenues. When you are in short supply of money and you want to be successful you have to choose your few stars wisely and your high potential players even more wisely because you have to win to put fans in the seats and grab important TV revenues. So for the big market teams it seems to be all about the entertainment value of their teams and for the rest of the MLB it is about proving yourself by winning.
I believe there are striking similarities between large and small market PE managers. The large market managers have venerable names like Blackstone, KKR, Apollo, impressive roman numerals in their fund history, and highly reputable managers who are the founders and true “rock stars” of our industry. They have a lot of money to pass around because their public shareholders are often buying on reputation, and pension fund, endowment and public retirement system owners have career risk in manager selection and gravitate to proven stars. So just like the Yankees with “AROD “the Tigers with “Miggy”, the Red Sox with “Pappy” and the Dodgers with Clayton Kershaw, the large fund manager roster is based on historic track record and iconic stature. In fact, 10 private equity firms account for 55% of the money managed by all PE firms and 7 of those 10 are publicly traded. Appollo Fund VIII alone has $17.5 billion.
The resurgence of the small market baseball teams is based, principally, on smart managers who are largely unknown and want to establish their pedigree. So you find GM Terry Ryan and Coach Paul Molitor turning around the moribund Twins, and Neal Huntington and Clint Hurdle leading the Pirates, and Jeff Luhnow and A.J. Hinch leading the Astros and Sandy Alderson and Terry Collins directing the Mets. These are not household names even for veterans of fantasy baseball like me and certainly not the kind of managers who are going to direct $200 million dollar payrolls. They can only afford a few established stars like Andrew McCuthcheon, Jose Altuve, and Joe Mauer and fill their rosters with many unknown players like Dallas Keuchel, Brian Dozier, Gerrit Cole and Carlos Correria. In fact the Twins are #18, the Mets #21, the Pirates #25 and the Astros # 29 in 2015 payroll and the Mets, Pirates and Astros combined have a smaller 2015 payroll than the Los Angeles Dodgers.
If you need support for my small market, small fund manager bias you need to go no further than Clayton Kershaw who is the ace of the Los Angeles Dodgers. Mr. Kershaw is getting $31 million in 2015 under a five year arrangement. If he doesn’t opt out he can earn $65 million over the two remaining years of a seven year $215 million contract. He is currently 6-6. By contrast, Gerrit Cole who is the ace for Pittsburg is getting paid $510,000 under a one year contract (no mistake with the decimal point- that is $510 THOUSAND!!!!). So who has the incentive? And who has the entertainment value? Gerrit Cole is a free agent and he is proving his worth with a performance for the ages. He is 13-3 at the All Star break. Kershaw is also doing his job by putting fans in the seats and getting national TV attention; he is an All Star and solid entertainer. But the real question for the owner and management is who would you bet on?
If I was motivated by career risk and track record and had the money to pay up I would take Kershaw. However, if I had something to prove like a recovering alcoholic (Clint Hurdle) and a graduate of a tiny liberal arts college in New England (Neal Huntington) I would take Gerrit Cole.
So should you choose your PE managers like small market owners? It probably depends on whose money you are investing. If it is your own, I would look for mangers with good credentials that have something to prove through performance. The PE Fund with $10 Billion under management is like Clayton Kershaw. The partners start each year of a 10 year contract with a range of $100 million of $200 million to cover annual salaries and overhead. The small fund team starts with $2.0 million in a $100 million fund and is much more motivated to produce aligning returns upon exit. It is also particularly gratifying for the small PE Fund manager to find a few Gerrit Coles in his portfolio even though long term Mr. Cole will probably end up in a larger market (larger fund).
Either way you are probably a winner unless your fund manager has the kind of luck you find with the Chicago Cubs or the Cleveland Indians both of which have been cursed and defy any normal thesis about business, life or baseball.
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