David Walsh’s wisdom beats the odds

The Museum of Old and New Art (called MONA), which shocks the senses with graphic projections of birth, life, death and sex portrayed in every imaginable way, has become Tasmania’s premier tourist destination and galvanised critical acclaim.

You know you are entering into an unhinged alternative reality when you wander by Walsh’s two car spaces emblazoned with bold signs declaring they belong to God and God’s Mistress. A hedonistically enhanced AMG Mercedes sits in each spot.

Walsh says he established MONA, which he says loses millions each year, to repay a “debt for getting lucky in a way that does no one any good".

Underground caves

Its total cost is estimated to exceed $150 million once the extraordinary art that sits in its labyrinthine subsurface caverns, carved out of 250 million-year-old Triassic sandstone, is accounted for.

“When you trade derivatives or bet on horse racing, you have not actually made anything," Walsh accepts. “The world is in no way a better place because you have extracted wealth from the market and lined your own pockets. In this case, I did at least one thing that might have made me feel a ­little bit better."

He says the nexus between his abstract professional life and his emergence as an internationally recognised art collector is the pursuit of learning.

“Art can make very imprecise statements that are very profound and communicate them quickly. It overloads all the senses and emotions—not just our intellectual capacity," he says. “As someone who was a kid who struggled with emotional expression, the sort of person that many people these days describe as autistic, art was a fascinating field that was unknown to me, and the more I explored it the more I realised I did not know."

While much energy has been expended documenting Walsh’s personal history, idiosyncrasies and the story behind MONA, he has never really lifted the lid on his investment philosophy.

That is, how he has managed to continuously beat the most competitive betting markets in the world.

After several unsuccessful inquiries, Walsh agreed to engage with AFR Weekend on this subject. Asked what his advice is to any young Australian seeking to emulate his efforts, Walsh bluntly responds: “The pursuit of excellent is a load of shit."

Skewed expectations

He believes many of us get deluded by a phenomenon known as survivorship bias, where we only see the winners outputted by random life processes and do not properly observe the losers.

This skews our expectations around the likelihood of success.

“If you ask Rafael Nadal whether tennis is a good modality to explore in life, he would probably respond ‘yes, it’s fantastic and has served me well’.

“Yet at any given time there are hundreds of millions of kids trying to be tennis players. Luck and ability, and the nuanced interaction of nature and nurture, all play a part and result in maybe 100 to 200 making a living."

“The average living across tennis players is very low and most are doing things that perturb significantly their chances of succeeding in other domains."

Walsh contrasts tennis’s “high variance" outcomes, which he equates to his own improbable path, to the prospects in accountancy.

“Everyone can do a half decent job. Everyone can make a living. And the average income is greater than the mean income for tennis players and, importantly, it is a low variance, or higher probability, result."

His advice to aspirational Australians is, in short, “not to live like I did".

Ghosts of me

“It is misleading talking to me if you do not acknowledge all the ghosts of me that did similar things but ended up with shitful outcomes, to coin a phrase," he says.

“I don’t think there is a specific talent I possess other than the awareness that my success was loaded by the imposition of good fortune.

“What got me into my situation was essentially being in a town where the casino was just down the road from the university. It also helped having pretty good computer and mathematical skills, but mainly from having excellent table tennis skills."

Walsh’s proficiency at table tennis brought him to the attention of the more commercially inclined Zeljko Ranogajec, who would help him apply his mathematical talents to the gambling tables.

However, this is where luck leaves Walsh’s story.

“Once I got a winning gambling strategy, or once I had prosecuted it enough so I was not engaging too much risk, there was little luck involved. I was mathematically on a pretty rock-solid path," he says.

His providence was not about winning bets once they had been placed, but “alighting on a winning or mathematically appropriate strategy in the first place".

Limited downside

A key feature of the markets Walsh and his partners invest in is that they are characterised by randomly “independent events". Specifically, the occurrence of one event does not influence the chance of the other and they therefore have “finite variance", or limited downside risk.

“Gambling has the huge benefit of having independent events – I cannot get blown up by the black swans that plague financial markets."

He says deploying mathematics in “equities markets that may have infinite variance outcomes makes working out probabilities much harder".

“You don’t know whether you are summing a sequence of fractions that add to one or if they add to infinity, because financial markets have non-independent [or potentially related] events," he says.

The bankable independence of results in gambling markets is the “component of our strategy that gives me the most security", Walsh says.

“It is even better in games like black jack, where the events are not only independent but also negatively correlated – your chance of winning goes up if you lost the previous hand because there are an excess of cards remaining that are advantageous to you."

He is critical of the billionaires printed in financial markets who “often make money in the low-probability, high-opportunity outcomes that are essentially exhibiting ‘correlated parlays’ [where one event significantly influences the probability of another].

“Correlated parlays make people look smart and can create a whole bunch of rich folks, but there was probably nothing but pathologies in the financial data."

Wisdom of crowds

Asked about exactly what his team’s “edge" has been over the years, Walsh distils it down to embracing the wisdom of crowds.

“You can work out some complex algorithm to predict horse racing odds using multinominal logistic regression," Walsh says. “But the result would significantly underperform the public odds.

“The key is that the public odds must be included in your model. The best models are not predictive models per se, but ‘perturbation’ models that start with the assumption that the public is right and then work out what small errors they might make.

“The public odds are not just an important signal – they are a remarkably efficient signal."

He cites the example of the former Russian chess grandmaster Boris Spassky, who played and lost to the Russian public in a game of chess.

He describes the public’s ability to make accurate collective decisions as an “emergent strategy", like birds flocking or democracies (which form not in the mind of one individual, but through the interactions of many).

“I am saying there is wisdom in crowds beyond the point you can model without explicitly incorporating it."

How does this system work in practice? “Let’s talk about Sydney race night on Saturday," Walsh explains.

“We might have a model of what we think the probabilities should be that includes the public odds.

“We essentially wager on those events that have better chances than the public thinks, which gives us a positive return expectation."

Efficient markets

There are echoes of Walsh’s thinking found in the more bounded forms of the “rational expectations" and “efficient markets" hypotheses, which landed Robert Lucas and Eugene Fama, respectively, Nobel prizes. Many astute investors accept that market prices are right most of the time and focus their attentions on more difficult-to-find exceptions.

Walsh says that if he had his time again knowing what he does today, and he had no money, he would prefer to start off in financial markets rather than casinos.

“If someone wants to assume high risk with very little cash, financial markets, with their correlated parlays, are probably the right place to be."

In this context he argues that if investors ignore the information signals in public market prices, like those on stock exchanges, they are “going to eventually blow up".

Harnessing these insights, the Bank Roll hunted for distortions in gaming markets in the same way hedge funds do.

While Walsh says technology and the globalisation of gaming rendered the strategies used in the 1980s and 1990s redundant, and have made it harder to outperform, he believes you can still win consistently.

“Nowadays the opportunities are better in smaller markets because there is more statistical dispersal and perhaps because smart people don’t bother playing, and the back-end technology they need to get access to the market’s data does not exist."

The biggest impact of technology is also not what you might think.

“Technology can certainly help you place bets more accurately and rapidly, build more models, think about opportunities in new ways, and tap into research from around the world."

But Walsh says the “most important change has been the increase in pool sizes".

Expanding markets

“Technology has allowed betting venues to provide more sophisticated services more often and thus the market size has grown faster than its organic rate, which we benefited from."

Asked what gaming risks get most frequently mispriced, Walsh says there are “hundreds".

Much to his surprise he finds people underestimate the utility of a good jockey. “I would have thought they would overestimate a jockey’s capacity." Walsh also believes punters place too much emphasis on the “weight a horse is carrying".

Some have speculated that the “rebates" the Bank Roll receives from gaming venues in exchange for the billions of dollars it transacts each year have been essential to their profitability.

Walsh says this is incorrect because they do not get rebates in most of the gambling they undertake.

And even when they do, the “profitability of our system is statistically significant in their absence".

So can lay punters win regularly? ­“Absolutely yes," Walsh confidently exclaims. “There are punters that watch horse races that have insights that nobody else has.

“It is bloody amazing to me, but is a fact."

He highlights a Betfair disclosure several years ago that among its 800,000 customers there were 30,000 consistent winners. “I was surprised by how large that number was – I would have probably been surprised if it was just 5000.

“We are talking about statistically significant volumes of regular winners that are far higher than the law of large numbers would suggest."

“The upshot is that there are ways to win that I am not privy to and that don’t require the sort of expertise I have."

Intellect and insight are great levellers.