Pari-Mutuel Betting - How it Works and Different Types of

Charlie Munger: "And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple."

The Art of Stockpicking is one of the more seminal works regarding value investing in my opinion. It's a fairly short essay/speech - concise and to the point, filled with lots of invaluable investing wisdom. Most of it seems like common sense - but as Munger points out, the professional investment managers prefer complicated solutions rather than simple ones.
I've extracted a portion of the essay speaking about value investing, specifically the way Munger describes the stock market as a pari-mutuel betting system, and how to make the most of this you should bet infrequently and bet big.
Read the full essay here: http://www.grahamanddoddsville.net/wordpress/Files/Gurus/Charlie%20MungeCharlie%20Munger%20_%20Art%20of%20Stock%20Picking.pdf
The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what's bet. That's what happens in the stock market.
Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2.Then it's not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it's very hard to beat the system.
And then the track is taking 17% off the top. So not only do you have to outwit all the other betters, but you've got to outwit them by such a big margin that on average, you can afford to take 17% of your gross bets off the top and give it to the house before the rest of your money can be put to work.
Given those mathematics, is it possible to beat the horses only using one's intelligence? Intelligence should give some edge, because lots of people who don't know anything go out and bet lucky numbers and so forth. Therefore, somebody who really thinks about nothing but horse performance and is shrewd and mathematical could have a very considerable edge, in the absence of the frictional cost caused by the house take.
Unfortunately, what a shrewd horseplayer's edge does in most cases is to reduce his average loss over a season of betting from the 17% that he would lose if he got the average result to maybe 10%.However, there are actually a few people who can beat the game after paying the full 17%.
I used to play poker when I was young with a guy who made a substantial living doing nothing but bet harness races.... Now, harness racing is a relatively inefficient market. You don't have the depth of intelligence betting on harness races that you do on regular races. What my poker pal would do was to think about harness races as his main profession. And he would bet only occasionally when he saw some mispriced bet available. And by doing that, after paying the full handle to the house ‑ which I presume was around 17% ‑ he made a substantial living.
You have to say that's rare. However, the market was not perfectly efficient. And if it weren't for that big 17% handle, lots of people would regularly be beating lots of other people at the horse races. It's efficient, yes. But it's not perfectly efficient. And with enough shrewdness and fanaticism, some people will get better results than others. The stock market is the same way except that the house handle is so much lower. If you take transaction costs ‑ the spread between the bid and the ask plus the commissions and if you don't trade too actively, you're talking about fairly low transaction costs. So that with enough fanaticism and enough discipline, some of the shrewd people are going to get way better results than average in the nature of things.
It is not a bit easy. And, of course, 50% will end up in the bottom half and 70% will end up in the bottom 70%.But some people will have an advantage. And in a fairly low transaction cost operation, they will get better than average results in stock picking.
How do you get to be one of those who is a winner ‑ in a relative sense ‑ instead of a loser? Here again, look at the pari-mutuel system. I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They're sending money out net after the full handle a lot of it to Las Vegas, by the way to people who are actually winning slightly, net, after paying the full handle. They're that shrewd about something with as much unpredictability as horse racing.
And the one thing that all those winning betters in the whole history of people who've beaten the pari-mutuel system have is quite simple. They bet very seldom.
It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it ‑ who look and sift the world for a mispriced be that they can occasionally find one.
And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple. That is a very simple concept. And to me it's obviously right based on experience not only from the pari-mutuel system, but everywhere else.
And yet, in investment management, practically nobody operates that way. We operate that way ‑ I'm talking about Buffett and Munger. And we're not alone in the world. But a huge majority of people have some other crazy construct in their heads And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they'll come to know everything about everything all the time.
To me, that's totally insane. The way to win is to work, work, work, work and hope to have a few insights.
How many insights do you need? Well, I'd argue: that you don't need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that's with a very brilliant man Warren's a lot more able than I am and very disciplined devoting his lifetime to it. I don't mean to say that he's only had ten insights. I'm just saying, that most of the money came from ten insights.
So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you're probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It's just that simple.
When Warren lectures at business schools, he says, "I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches ‑ representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all."
He says, "Under those rules, you'd really think carefully about what you did and you'd be forced to load up on what you'd really thought about. So you'd do so much better." Again, this is a concept that seems perfectly obvious to me. And to Warren, it seems perfectly obvious. But this is one of the very few business classes in the U.S. where anybody will be saying so. It just isn't the conventional wisdom.
To me, it's obvious that the winner has to bet very selectively. It's been obvious to me since very early in life. I don't know why it's not obvious to very many other people.
submitted by learner1314 to investing [link] [comments]

Pari-mutuel definition, a form of betting and of handling the betting on horse races at racetracks, in which those holding winning tickets divide the total amount bet in proportion to their wagers, less a percentage for the management, taxes, etc. The pari-mutuel system means handicappers are betting against each other, not against the house. For example, say 90% of the money on a given race were bet on the same horse and only 10% percent of the cash was distributed among the rest of the field. Pari-mutuel betting is the most common form of horse racing betting. The term actually originated in France, and literally translates “to wager amongst ourselves”. Unlike most other forms of betting, the odds are not fixed. Exacta horse racing betting is a popular form of pari-mutuel wagering that can be quite lucrative for experienced horse racing bettors. Winning an Exacta bet isn’t the easiest thing to do by far, but for seasoned handicappers, the profit margin can be remarkable. The name pari-mutuel originates from the French phrase “pari mutual,” which means “mutual betting.” After becoming frustrated with the bookmakers for making such large profits off of innocent bettors, it’s believed that Oller came up with an ingenious idea to solve this problem.

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