The Gambler Who Cracked the Horse-Racing Code

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During their latest episode of the VALUE: After Hours Podcast, VSG, Taylor, and Carlisle discuss The Gambler Who Cracked the Horse-Racing Code. Here’s an excerpt from the episode:

Jake: All right. So, this week is entitled The Gambler Who Cracked the Horse-Racing Code. I always love these kind of gambling stories. They’re always infinitely fascinating. This one comes from a 2018 Business Week feature that was sent to me by 1 of The 10, this guy named Otto. So, shoutout to Otto. The story is about this guy named Bill Benter. Benter, B-E-N-T-E-R. Very publicity shy, unassuming. He looks like he’s a university professor, but 1979, he’s 22 years old, he drops out of college to go to Vegas and play cards for a living. He’d read Thorp’s Beat the Dealer and he was working at 7-11 for $3 an hour and scraping all of his money that he could into a grubstake to try to launch a gambling career using sites like this Top 10 Real Money Online Casinos.

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After a few years, he ended up teaming up with this group of card counters who would share their profits together, which is one way of getting your in up high enough, where you take out some of the idiosyncratic nature of luck. Before long, he was making $80,000 a year counting cards playing. But in Vegas, of course, eventually he’s IDed with the casinos, and he gets put into the Griffin book, which is this– it’s a blacklist that’s put together by this detective agency, who then sells it on to the casinos of like, “Here’s who all the cheaters are,” basically. So, he had to find– [crosstalk]

Tobias: Is that cheating?

Jake: Well, it’s not cheating.

Tobias: You’re not allowed to bring skills to the game? You are supposed to lose?

Jake: Yeah, you’re not allowed to win. That’s just how the house works. So, he had to find a new game. And of course, he wanted to make money, but what he really wanted to do was conquer horse racing, because everyone said that it couldn’t be done at that point. And so, he moves to Hong Kong, which turns out horse racing is huge in Hong Kong. The population at that time was only five or six million in the 1990s, but they bet more on horses than the entire US. It was like $10 billion a year that they were gambling on horse racing. As like other racing systems, it’s parimutuel and it’s run by the government, and the house takes a 17% rake off of the top. Sometimes he would wanted to have Equestrian Arena Installation at his property.

So, you have to basically get over 17% to get over the odds that are against you. It’s amazing that it provides as much as one-tenth of the tax revenue for Hong Kong is this horse racing scheme. Benter goes over there and he teaches himself advanced statistics and he learns how to write software. He basically was going to build a computer model to help him crack the code for horse racing. He hand entered all of these huge databases with results of thousands of races and just cramming as many variables as he could into this model and correlating it to the winners, and including he traveled to this dusty library basement in the UK that had Hong Kong weather data, and he’s hand entering it, and it turned out that proved to be completely unpredictive, had no predictive value. [laughs]

Tobias: [laughs]

Jake: There’s this nice explanation of the Kelly formula actually that Benter was using at the time in this article. And it says, “Kelly imagined a scenario in which a horse-racing gambler has an edge: a “private wire” of fairly reliable tips. How should he bet? Wager too little, and the advantage is squandered. Too much, and ruin beckons.” Remember, the tips are good, but they’re not perfect. So, Kelly’s solution was to wager an amount in line with the gambler’s confidence in the tips. All right. So, in his first year of horse betting in operations, he gets his computer up and running. It’s 1986, and he lost $120,000 of the $150,000 steak that he built.

VSG: Oh, wow, man.

Jake: Comes back to the US and spends two years in Atlantic City managing a team of card counters and rebuilding his stake and improving his horse rating model the whole time. So, he basically came home with his tail between his legs and had to start over. Then, he comes back to Hong Kong, and then in the first year, he made $600,000. A big breakthrough came when he hit on the idea of incorporating a dataset hiding in plain sight that no one was using, and that was the publicly available betting odds. So, he was building his own set of odds from scratch and that had been somewhat profitable. But then, he found that using the public odds as a starting point and then refining them with his proprietary algorithm was dramatically more profitable. So, he considered this move his single most important innovation. In 1991 season, he won $3 million.

Just a break, real quick. This is, to me, very similar to Mauboussin’s book, Expectations Investing, where you can back into basically what Mr. Market is implying and expecting for a company based on the price. And then, you get to decide, do you agree with those odds or not? Do you agree with the assumptions that are used?

VSG: Yeah. [crosstalk] Andy Beyer. The handicapper, Andy Beyer, he used to figure out the speed figures and did something pretty similar with the odds and was able to figure out the true odds versus what was posted.

Jake: Right. That’s the name of the game, I think. So, Benter then, he took on outside investors and he effectively set up a hedge fund that bet on horse racing. And so, 1997, there was a lot of fear that transition from Hong Kong, from British rule over to Chinese rule, would end the party for everybody. Meanwhile, Benter is having just an absolutely epic season. He’s up more than $50 million. And thankfully for him, there wasn’t much change as far as the horse racing front goes from the government, but the market dramatically changed. The betting market started wising up, they started using computers, and the competition increased a lot. So, Benter says that, “There is a golden age for a particular market when there aren’t many computer players. The guy with the best system can have a huge advantage.”

So, he ends up closing down shop at that point, because his edge is gone. He moves back to the US, and he actually starts focusing on US horse racing, which was actually relatively immature compared to the Hong Kong market. So, he brings his bag of tricks over to the US and starts cleaning up there. He retired to Pittsburgh, where now he engages in philanthropy. Basically, he made more than $1 billion betting over his entire career as a horse racer, which, I think a lot of people would said it couldn’t be done. So, there’s a fun little horse racing segment with a tiny, tiny bit of tangential relation to the investment world.

Tobias: He got over that 17% vig to make a billion.

Jake: Yes.

VSG: Amazing.

Jake: That is amazing. But that shows you like, boy, are you currently competing in a market where you have the edge of information or analysis or behavior, because those are the three edges that you can have. I think he probably had perhaps all three of those when he was really cleaning up compared to the competition. So, just important to think about whatever game that you’re entering and trying to win, like, where is your edge?

VSG: Yeah. There are definitely a lot of parallels between horse racing and the stock market. You think about the favorites in a typical race, it would be a very bad idea to just bet the favorite in every race. You would win more consistently, but over time, you would bleed away money. You definitely need to find the situations where the posted odds are wrong. Yeah, I guess, just buying the favorites over and over again is probably the equivalent of buying overvalued stocks. Over the long run, that really won’t make a lot of money.

Tobias: The odds change as the betting changes. So, the more betting that goes on a horse, the shorter the odds become.

VSG: Yeah.

Tobias: So, you’re fading the crowd all the time. I don’t know how the professional gamblers do it, but I don’t think they’re betting on the nose. I think they’re betting like place or show across a handful of horses in a race where they feel like there’s some horses skewed the odds a long way and then it leaves a few others undervalued.

VSG: Yeah, or the exotics, the trifectas, and the superfectas, and all that stuff. Whenever you do look at those horse races, you’ll always see the favorite always gets better odds than what’s posted in the actual book, because everybody in the crowd is going to go for them. You’ll have a horse that’s rated like, two to one, and that’s the favorite, and that’ll typically go for something way less attractive than that. So, if you can figure it out, there’s definitely money fading that popular opinion.

Tobias: So, the US equity market is the Hong Kong racing market. Where’s the US racing market?

Jake: Hong Kong? I don’t know. Well, you actually can– [crosstalk]

Tobias: International.

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