You can now buy shares in an NFL running back. This is why the returns will probably be awful.

October 18, 2013

Please buy my shares! (Bill Haber/AP)

Now that's what I call financial innovation.

A company called Fantex is offering shares in Arian Foster, the running back for the Houston Texans. Or, more precisely, shares that will pay out depending on his future earnings.

The idea is that Foster will get a $10 million payment upfront from investors in the company, in exchange for handing over 20 percent of his future income both from football and endorsements. By the simple math, if the 27-year-old star makes less than $50 million in the remainder of his career, it ends up being a bad deal for investors. Much more than that and they win.

In theory this is a great idea, a model of economic efficiency. If the idea takes off, you could imagine athletes, actors and other highly visible performers who are cash-constrained early in their careers selling shares to have plenty of capital at the starts of their careers.

For example, the Washington NFL team's running back Alfred Morris has been one of the most effective rushers in the league, but he was a sixth-round draft pick who only received a $154,000 signing bonus. His future earning potential is vast; he should get a multimillion dollar contract when his rookie deal is up. But for now he drives a 1991 Mazda to practice. At the same time, it would be risky for Morris to take on millions of dollars in debt to fund a more lavish lifestyle today, because there is a risk he will get injured or his performance will dissipate and that big money contract will never arrive. By essentially selling stock in himself, he could offload some of that risk (that his future earnings don't measure up to their potential) on other investors.

For investors, these shares could be the ultimate non-correlating investment. The future earnings of Alfred Morris or Arian Foster probably don't correlate much with the overall direction of the stock market. That's not completely true — if the economy collapses, it would reduce corporate budgets for endorsement deals and reduce the revenue pie that NFL teams have to spend on players. But there's no doubt that Foster's future earnings are less correlated with the future of the economy than General Electric's.

That said, the shares would only actually be valuable if they were priced correctly relative to the risk. There is a ton of risk that Foster's future earnings will be less than the $50 million that investors would need to break even; he could suffer a career-ending knee injury on any given Sunday. He is 27 now, and few running backs have much of a career after age 30. And once they are out of the league, the endorsement earnings fall away rapidly; when did you last see a Nike ad with Priest Holmes or Curtis Martin in it?

If the market for the Fantex Arian Foster shares were inhabited solely by steely-eyed analytical investors, then the price of the shares would settle at a valuation commensurate with the risk. But this is a market that will surely include lots of buyers who are investing because they are fans of Foster or the Texans, or are intrigued by the novelty of the whole thing, or maybe just want to get their sports gambling fix through a mechanism that has a better expected return than putting money down with your neighborhood bookie.

That being the case, there's reason to suspect that investing in Arian Foster will offer a lower expected return than the risk of the investment would seem to call for. As Felix Salmon reports after plowing through the Fantex stock registration, it's actually worse than that. Rather than structuring the deal as one in which investors are buying into a simple pass-through entity that accepts a cut of Foster's earnings and distributes them (minus very small administrative costs) to shareholders, investors are actually buying a "tracking stock" that gives executives of Fantex significant power over what money gets distributed, when, and how.

There's a lesson for investing buried in all this, a guideline that anyone who is investing money should tattoo on their arm: The more fun an investment is, the less likely it is a good investment.

One of the most persistent findings across time and geography in finance is this: Value stocks outperform growth stocks.

That is, the stocks that offer the best expected return are, say, those of some down-on-the-heels, boring-as-mud industrial company that is neglected by shareholders for its stagnant or declining profits, lack of growth opportunities and general lack of flash. You get compensated for investing in boring.

Any one high-growth company — a Google or a Facebook or a Tesla, for example — may well outperform their boring, slow-growing brethren. But you pay up the nose for that expected growth, so aggregate returns end up being a shade lower. (See this 1992 paper from Eugene Fama, who won the Nobel prize this week, and Kenneth French, for example).

Why would this be? I suspect part of the reason is that it is a lot more fun to bet on the future of an innovative, fast-growing company that you can talk about at a cocktail party than it is to harvest steady or declining earnings from a boring company that nobody has ever heard of. The fact that investing in a running back's future earnings could be a fun thing to do should be an immediate red flag that it will be more like going to a casino than buying a good long-term investment.

Update: An earlier version of this story had an incorrect round in which Alfred Morris was drafted. He was a sixth-round pick.

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