The Quant Approach of Jeopardy Champ James Holzhauer

Recently, I was doing one of my favorite weekend activities, walking my dog and listening to podcasts (I like a simple life). A recent episode of an NPR podcast came on and it was a very charming piece about James (uncle Jamie) Holzhauer and his incredible Jeopardy! run. I was listening to this story unfold and was surprised when a few topics connected the story to the investment world—which I suppose I should have expected given the title of the podcast is “Planet Money”!

The podcast talks about how the approach used by James during his 20+ game winning streak has some different elements than past winners; mainly that he approaches the game as a data problem versus simply having to be amazing at trivia (which he is). It introduced listeners to the Jeopardy! Archive which is a website loyal fans have created that includes the clues, answers and game boards for every game spanning multiple years. As with seemingly everything these days, a computer scientist downloaded all of this data and analyzed it for information including: what topics are often covered (history, geography and literature), within these topics what is asked the most (U.S. History and U.S. Presidents) and which topics aren’t worth studying at all (types of cheese). Another data analyst and past contestant noticed the non-random patterns around Daily Doubles (i.e., that they are never in the top row and typically appear in rows three and four). James then uses this data to increase his chances of success in the game. He focuses his preparation on the most likely topics, and used the Daily Double patterns to give him an edge in finding them on the board (of which he has found an extraordinary number).

Investment Management

So, what does this have to do with investing? You’ve no doubt heard of the growth of quantitative investing as a way to use the now widely available amounts of current and historical data to select securities as opposed to more traditional, fundamental methods. Strategies with this approach are seeking to exploit observed and persistent patterns, or anomalies, and then design a disciplined, rules-based approach to implement a strategy that will give them the best likelihood to succeed over time.

But there is still a part of it that takes some smarts—James actually has to know the answers to the questions, right? It’s fine if you see a pattern, but if you don’t know how or why it exists, it may not make sense to exploit. The way we think about it in investing is by questioning if there is a logical/academic reason as to why a certain relationship exists.

Maybe there is a correlation between the weather in Nairobi and the price of Apple stock, but there isn’t a logical reason as to why there should be. (For the record, I just made that up.) There IS a reason for a value approach to investing (i.e., something underpriced will eventually reach its intrinsic value), for the size premium to exist (i.e., smaller stocks are riskier, so you should get paid for that risk over time) and for the observation that markets have ‘sped up’ since the late ’90s (e.g., 24/7 news, cheaper trading). Although an approach that is designed to take advantage of these observed anomalies doesn’t have a payoff that comes in a linear and consistent fashion (James hasn’t found every Daily Double), adhering to a disciplined process during the inevitable ebbs and flows can result in premiums over time for quantitative strategies.

Retirement Planning

While the second observation discussed in the podcast is well known, it’s always worth revisiting. The question was, when should an investor take the most risk? During his current winning streak, James tends to go for the high dollar questions earlier (upsetting many long-time viewers) and make large bets on Daily Doubles early in the game. He does this because he knows he has plenty of time to make up for it should he get a question wrong. His bets become more conservative as the game nears the end because he knows it will be more difficult to recover. (This does not apply to his Final Jeopardy betting—which is funny and something I won’t spoil here). The same is true for our clients, when you are young it makes sense to take more risks, invest heavier in stocks—maybe in emerging market stocks or highly volatile companies with big growth prospects. If you take a loss early in your working years, you still have time in the market and plenty of earning years left to make up for it. However, as you get closer to retirement, it is often prudent to dial back risk since recovering from larger losses can take longer than you may expect or plan for.

One way we talk about doing this is by incorporating hedged equity strategies which can provide clients with some exposure to equities but does so in a more risk-averse way. These strategies seek to deliver returns not by outperforming on the upside, but rather by losing less on the downside and letting compounding work in its favor over time. While investing in hedging strategies has been tough the last few years, you can see in the chart below how even while lagging on the upside, by minimizing the downside, you have the potential to outperform a long-only approach—and can significantly reduce your volatility on the way.

Past performance is not indicative of future results. Source: Morningstar. Data from 1/1998 – 12/2018. The blue line represents a hypothetical $10,000 investment in the S&P 500 Index (100% invested). The orange line represents a portfolio that participated in 60% of the S&P 500’s gains, but experienced only 40% of the S&P 500’s downside during market declines. Volatility as measured by standard deviation.

Investing, game shows, and probably every facet of modern life, will continue to change given the proliferation of data and the continued improvement of computing power and techniques used to analyze it. Within the investment world, some approaches should be met with healthy skepticism, but others are founded on well-documented research and implement well-designed approaches to add value. Even so, the benefits do not come in tight, consistent packages. Results can be lumpy and will evade many investors who, for a myriad of reasons, do not maintain patience. But for those that do, these quantitative approaches that seek a specific edge have the potential to benefit investors over time and may even make you the James Holzhauer of your investment portfolio!

Read more in The Pitfalls of Bias in Betting and Investing >