I'm sure that you heard about one of the players in the Final Four on the women's side - Caitlin Clark, who has been described as a generational talent. She certainly brought a lot of viewers to women's Final Four basketball this year. Caitlin Clark plays for the Iowa Hawkeyes, and she is projected to be the number one pick in the upcoming WNBA draft. She is the all-time leading scorer in women's NCAA history - and she holds a ton of records.
The game leading up to the championship game, Caitlin Clark scored 41 points in a rematch against LSU which was the rematch from last year's championship game. That's a lot of points. The Iowa Hawkeyes made it to the championship game, which is a pretty remarkable feat in itself. What's even more remarkable is it's the second year in a row that they've been in the championship game.
She scored 18 points in the first quarter of the championship game, which is another record for Caitlin Clark. Nobody's ever done that before in women's NCAA Final Four history. She ended the game with 30 points, eight rebounds and five assists.
Now, spoiler alert - it's not much of a spoiler because it's happened weeks ago - but if you weren't paying attention, they LOST. The all-time leading scorer in NCAA history takes her team to back to back championship games and loses both of them.
So I guess the question is, why didn't they win the game?
The problem was not necessarily Caitlyn Clark. The REAL problem may have been - what did the rest of the Iowa Hawkeyes team contribute?
The team they played against was South Carolina. Every single player on the South Carolina team, the starters, and all the players on the bench have scored at least two points. ALL OF THEM.
Do you know how many points the players on the bench for Iowa State? Zero. Not a single point was scored by any player that came off the bench. Some of Caitlin’s teammates played almost a third of the game and scored zero points - whereas the South Carolina team, everybody contributed.
This championship game is actually quite an appropriate analogy to understanding investing and portfolio creation. When you're talking about a sports team, the expectation is that every player will contribute. Obviously, you're going to have some star players - players that are just so much different or better than the average. But you also expect the average player to contribute. Whether it's two points a game, like South Carolina bench scored, or what have you.
The outcome of this game for Caitlin Clark’s team is, in our world, what we would call concentration risk and lack of diversification. Another term for it is idiosyncratic risk. Idiosyncratic risk is another term we use to describe something called nonsystematic risk. All it really means is that there's a difference between systematic risk and nonsystematic risk.
When investing most people have some stocks, bonds, and cash. When you look at the historic volatility of the stock market, it is typically more volatile than the bond market, which is one of the reasons why you expect to receive higher rates of return when you take on stock market risk compared to taking on bond market risk. The actual return of a portfolio is going to tie to the systematic risk of each of those asset classes.
The other side of that is what we talked about with regards to lack of diversification, which is called idiosyncratic risk. And that really addresses the risks of being in either a particular group of securities like a specific sector of the market or being in an individual security. We use this to describe something called nonsystematic risk. All it really means is that there's a difference between systematic risk and nonsystematic risk. It's totally relevant to when we build portfolios, and how we build portfolios, and why we do what we do.
In this basketball example, the expected return for Caitlin Clark was higher than any other individual player on either team, and she did score more points than any other player on either team. Unfortunately, the outcome of the game was sort of dependent on all of the players as it turned out, and not just a single player.
To understand more about how we build portfolios to avoid taking on more risk, check out any of The CM Group's Free Lunch Podcast!