INVESTMENT PERSPECTIVES Silver lining to a snoozer

Nearly halfway through the fourth quarter of the 2019 , the New England By Analytic Investors Patriots and were tied 3-3 in a game dominated by defense. Then, Patriots connected one last time with tight end Rob Gronkowsi on a 29-yard pass to the 2-yard line. ran it in for a on the next play, and approximately 98 million Americans watching on television at home abruptly woke up. The Patriots went on to win 13-3 in the lowest-scoring Super Bowl in history. On the bright side, the Analytic Investors team correctly predicted the outcome—improving our overall record to a respectable 11-5 (69%) against the spread.

Thanks to a controversial non-call of an obvious pass interference in last year’s NFC championship game, the 2019 season began with yet another rule change. The NFL Competition Committee approved the use of instant replay to review pass interference calls/non-calls for one year only. However, it was not without controversy as a mere 24% (24 out of 101) of such challenges were reversed by the NFL’s instant replay center in New York. In spite of this, and wide receiver Antonio Brown being released by both the Oakland Raiders and Patriots in a matter of weeks back in September, the NFL didn’t miss a beat.

The game remained as popular as ever. Its already-high television ratings increased, thanks to star both young ( and ) and old (Drew Brees and Aaron Rodgers). The attempted to build on last year’s resurgence by trading for star wide receiver Odell Beckham Jr. but managed to underachieve in their typical fashion. The Oakland Raiders made one final run at the playoffs for their faithful in the Bay Area, but they ultimately fell short and packed their bags for their shiny new digs in Las Vegas. CBS commentator Tony Romo continued to show an uncanny ability to predict upcoming plays, earning him and/or his crystal ball a reportedly record-setting contract offer from ESPN. Finally, the surprising Tennessee Titans upset the defending champion Patriots in the wild card round of the playoffs, and football fans outside of New England rejoiced.

January 2020 The NFL’s centennial season concludes in Miami on Table 1. Alphas for all 32 NFL teams Sunday, February 2, 2020, when the Alpha 2019 season face the in Super Bowl LIV. 2019 2018 Alpha Favorite/ This matchup features two historically successful Team season season change Record underdog franchises that haven’t hoisted the Lombardi Trophy in 70.3% 7.6% 62.7% 5-11 0-16 25 and 50 years, respectively. While football fans in New Orleans Saints 43.7% 32.9% 10.8% 13-3 11-5 general are happy to see an AFC team other than the 39.4% -27.0% 66.4% 7-9 5-11 Patriots appearing in this game, it may actually also be a 39.3% 8.5% 30.8% 14-2 12-4 good sign for our prediction. More on that later. 38.7% -40.8% 79.5% 13-3 12-4 San Francisco 49ers 37.8% -44.7% 82.5% 13-3 11-5 Alpha explained 29.4% 12.8% 16.6% 11-5 11-5 24.5% 15.2% 9.3% 10-6 7-9 At the core of this annual paper is a computation we Kansas City Chiefs 24.1% 18.0% 6.1% 12-4 13-3 developed way back when Tom Brady and 19.1% 48.8% -29.7% 10-6 7-9 only had one Super Bowl to their names. We think Tennessee Titans 17.5% 36.9% -19.4% 9-7 10-6 of it as the merging of football and our quantitative Oakland Raiders 11.3% -26.4% 37.7% 7-9 4-12 approach to investment management, called “NFL alpha.” 6.0% -21.4% 27.4% 7-9 5-11 New York Jets 4.2% -35.9% 40.1% 7-9 5-11 This version of alpha is the cumulative return on 3.6% -16.4% 20.0% 7-9 7-9 investment (ROI) for all 32 NFL teams’ performances -0.1% 14.6% -14.7% 7-9 8-8 relative to wagering market expectations for all regular -0.3% 8.0% -8.3% 8-8 9-7 season games. Minnesota Vikings -1.9% -13.0% 11.1% 10-6 11-5 -3.7% -5.5% 1.8% 12-4 16-0 To illustrate, let’s assume a $100 “money line” wager -4.5% 27.9% -32.5% 9-7 9-7 on the Green Bay Packers to win before each of their -6.6% -25.9% 19.2% 5-10-1 1-15 16 games. If the Packers win in a given week, one would Los Angeles Rams -9.5% 9.7% -19.2% 9-7 13-3 collect the $100 wager plus an additional amount that’s Jacksonville Jaguars -11.7% -34.8% 23.1% 6-10 4-12 a function of their win probability, as implied by the -15.7% 30.1% -45.8% 8-8 11-5 wagering that week. Should they lose, one would -26.9% 46.8% -73.7% 8-8 14-2 lose the $100. Once the season concludes, we then add up Cleveland Browns -31.5% 0.5% -32.0% 6-10 11-5 the winnings and compare that number with the $1,600 -35.0% -4.6% -30.4% 5-11 6-10 total amount wagered during the season ($100 per game Los Angeles Chargers -40.5% 24.6% -65.1% 5-11 10-6 for 16 games). Any amount above $1,600 would imply Washington Redskins -41.8% 6.5% -48.3% 3-13 2-14 a positive NFL alpha, and anything less would indicate a -49.3% -27.3% -22.0% 4-12 5-11 negative one. In this case, one would have tallied just over -54.7% -6.0% -48.7% 3-12-1 3-13 $2,218 due to the Packers alpha of 38.7%—fifth-best in -69.6% -29.0% -40.6% 2-14 3-13 the NFL and a whopping 79.4% improvement over 2018 Source: Analytic Investors (see Table 1 on right). Could this be attributed to the Packers’ new , Matt LaFleur? We’ll leave that to the analytics community to debate. The Dolphins traded away a number of star players at the Can one game affect alpha? beginning of the season in hopes of ending up with the #1 pick in next year’s draft. Some experts coined this strategy The process of writing this paper begins with an annual “Tank for Tua”—a perceived effort to lose every game in rite of passage: a number of Analytic team members order to take star Alabama quarterback . submit their guesses on which teams will be at the top But as typical with the NFL, nothing ever seems to go and bottom of our NFL alpha results. While the lowest- as predicted. Tagovailoa suffered a season-ending ranked team wasn’t much of a surprise, the top-ranked hip injury, and the rag-tag Dolphins decided to rally one was. The Miami Dolphins finished with a whopping behind rookie coach . After starting 0-7, the 70.3% alpha, the highest for a team since 2009. As the team upset the New York Jets, Indianapolis Colts, and underdog in all 16 of their games, the Dolphins were given Philadelphia Eagles to end up in slightly positive alpha plenty of opportunity to outperform expectations. territory. But the best was yet to come.

2 In week 17, Miami went into Gillette Stadium to face the Let’s examine two more cases in which one game had a 17-point-favorite Patriots, who needed a win to secure meaningful impact on teams’ alphas. The Atlanta Falcons a in the first round of the playoffs. Should be a no- started the season 1-7, and rumors were flying that brainer, right? Not for the resilient Dolphins. Journeyman head coach Dan Quinn was on the verge of being fired. quarterback threw a touchdown pass After their bye week, the team had a tall task: going into to Mike Gesicki with 24 seconds left in the game to give New Orleans to face the heavily favored 7-1 Saints. Miami a 27-24 victory, resulting in a massive surge in In typical any-given-Sunday fashion, the Falcons upset alpha (see Chart 1, below) and very likely contributing to the Saints 28-9, and their alpha jumped from -73.3% to New England’s early playoff exit the following week. 6.6% (see Chart 2, below). Then they upset the 49ers 29- 22 in week 14 on the way to recording the third-highest On the flip side, there are always the perennial alpha alpha of the season—39.4%—and managed to save flatliners. This year, it was the Cincinnati Bengals. Quinn’s job in the process. They lost star wide receiver A.J. Green to a fluke ankle injury in a July training camp practice, and it was all The Los Angeles (NOT San Diego) Chargers had a similar downhill from there. The team started the season 0-11 turning point in their season. After defeating the before upsetting the Jets (notice a trend?) and Browns, Indianapolis Colts in week 1, the Chargers appeared to locking in a -69.6% alpha (see Chart 1, below) and the be the same playoff-caliber team they were last year. top pick in the 2020 draft. We’d like to add more color But it didn’t last. They went into Detroit and lost 13-10 to here, but this was simply a bad football team. Take heart, the hapless Lions, causing their +45.2% alpha to plummet Bengals fans. Having the worst alpha means that your to -27.4% (see Chart 2, below). The team stayed in team will have the chance to draft your next franchise negative alpha territory the rest of the season, thanks quarterback: Heisman Trophy and national championship partly to the declining play of quarterback Philip Rivers. winner Joe Burrow of LSU. As the team prepared to move into the new Sofi Stadium with their cross-town rival Rams in 2020, rumors surfaced Chart 1. Cumulative alphas: Miami Dolphins and that the NFL may be realizing the error of its ways in Cincinnati Bengals relocating the Chargers from San Diego and would 80 even consider moving the team to London in the future. No word yet on whether we’ll eventually be calculating 60 alphas in pound sterling, but stay tuned. 40

20 Chart 2. Cumulative alphas: Atlanta Falcons and Los Angeles Chargers 0 60 -20 40

Alpha (%) -40

-60 20 -80 0 -100 -20 -120

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Alpha (%) -40 Miami Dolphins Cincinnati Bengals -60 Source: Analytic Investors -80

-100 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Atlanta Falcons Los Angeles Chargers

Source: Analytic Investors

3 The “lottery ticket” Postseason struggles

Since 2004, the Analytic team has been managing low- The bulk of this paper has focused on the regular season. volatility equity assets based on our published research, Now it’s time to focus on the playoffs and our predictions. which demonstrates that low-risk equities tend to When we first published this paper back in 2004, it was outperform higher-risk ones over time. As we’ve also based on our finding that teams who outperformed outlined previously, there’s a similar trend in the world of expectations in one NFL season tended to underperform football wagers. Specifically, bets placed on large favorites in the following season, and vice versa. We found this with lower payouts (in other words, less risky) typically same relationship also exists between the regular season outperform bets placed on heavy underdogs that pay out and the postseason. As a result of this football form significantly more—often referred to as lottery tickets. of mean reversion, the team with the lower alpha is In 2018, these higher-risk wagers outperformed lower- typically undervalued when compared with its higher- risk ones for the first time since the 2015 season. alpha opponent.

This trend, albeit not as pronounced, continued in 2019. In the current postseason, this approach has resulted in a Low-risk wagers returned -0.7% while higher-risk, 4-6 record, breaking our streak of 15 consecutive years longshot bets returned 4.8% (see Chart 3, below)—an with at least a 50% postseason success rate. Two of the outperformance of 5.4% and consistent with the stories of losses were by a mere half point: The Buffalo Bills blew a the Dolphins and Falcons outlined above. A similar pattern 16-point lead to the Houston Texans and lost on a field occurred in the markets in 2019 as high-beta equities goal in overtime, and the Seattle Seahawks failed to generally outperformed their low-beta counterparts. convert on a late 2-point conversion attempt in a loss to the Packers (see Table 2, below). Oh, that dreaded “hook!” Chart 3. Low-volatility analysis 2019 season 10 Despite the above, our historical average now stands at a respectable 59%. 5 6. 3.0 4. 0 -0. -5

-10

Average return to return Average -2.

money line wager (%) money -15 -11 and -4.5 to -4 to 4/ 4.5 to 10.5/ 11 and above/low -10.5/fair average moderate above/high Line/volatility

Source: Analytic Investors

Table 2. Postseason analysis (4-6 record)

Lower-alpha team Higher-alpha team Alpha (Analytic’s pick) Alpha Favorite Result Win Houston Texans 24.5% Buffalo Bills 19.1% Texans by 2.5 Texans 22-19 Tennessee Titans 17.5% New England Patriots -3.7% Patriots by 4.5 Titans 20-13 New Orleans Saints 43.7% Minnesota Vikings -1.9% Saints by 7.5 Vikings 26-20 Seattle Seahawks 29.4% Philadelphia Eagles -4.5% Eagles by 1 Seahawks 17-9 San Francisco 49ers 37.8% Minnesota Vikings -1.9% 49ers by 7 49ers 27-10 Baltimore Ravens 39.3% Tennessee Titans 17.5% Ravens by 10 Titans 28-12 Houston Texans 24.5% Kansas City Chiefs 24.1% Chiefs by 10 Chiefs 51-31 Green Bay Packers 38.7% Seattle Seahawks 29.4% Packers by 4.5 Packers 28-23 Kansas City Chiefs 24.1% Tennessee Titans 17.5% Chiefs by 7 Chiefs 35-24 Green Bay Packers 38.7% San Francisco 49ers 37.8% 49ers by 8 49ers 37-20

Source: Analytic Investors 4 A second predictive approach: Computer-reading Super Bowl LIV between the lines Unlike last year’s game, which had two single-digit alpha As if one predictive approach weren’t enough, in 2019 teams, Super Bowl LIV pits two teams in the top 10: the we debuted a second one that’s based on machine sixth-ranked San Francisco 49ers (37.8%) against the ninth- learning (ML). Even though last year’s ML prediction ranked Kansas City Chiefs (24.1%) (Table 3 on page 6). incorrectly picked the Rams to win, we wanted to The 49ers also had the highest change in alpha from 2018, give this approach another chance. So, we’re again at 82.6%. This is primarily because the 49ers had a league- supplementing our traditional alpha model pick with worst -44.7% alpha last year, thanks largely to quarterback a Super Bowl prediction courtesy of the machines. ’s season-ending knee injury during a Readers may recall that our previous ML pick week 3 loss to—you guessed it—the Chiefs. relied upon feature mining and gradient descent. Particularly astute readers may recall that the pick This year’s game features two evenly matched teams: the proved to be incorrect, in spite of encouraging Chiefs’ high-flying offense led by superstar quarterback historical performance (55% accuracy). Mahomes going up against a stout 49ers defense anchored by rookie pass rusher . It also features two This year we took a turn from straight statistical ML offensive-guru head coaches with something to prove: and explored the value of natural language processing. young , who was of What could we glean from the words of sportsbook the Falcons during their epic collapse to the Patriots in the “sharps” themselves? To accomplish this, we collected 2017 Super Bowl, and veteran , who’s seeking text from a group of professional handicappers that his first title in 21 seasons. The game is also reminiscent explains the rationale behind their picks. For each of a previous Super Bowl, when the 49ers faced a young team in each matchup, we took all sentences star quarterback in his second season as a starter. That was justifying that particular pick and fed them into Super Bowl XIX in 1985, and they defeated ’s a deep, bidirectional linguistic neural network. Dolphins 38-16. Could history repeat itself 35 years later? These are a family of language models that have a powerful understanding of syntax and semantics. Our pick is the lower-alpha Chiefs to win the game by more They exhibit superhuman performance on tasks than one point. Considering that our model has correctly ranging from document summarization to predicted seven of the eight Super Bowls (88%) that have prepositional logic—and they’re widely assumed to not involved the Patriots (dating back to 2004), we remain automatically generate the words spoken by the cautiously optimistic about this selection. And speaking of robot in the Fox booth. In our case, these the Pats: This model does not have a prediction on what cutting-edge tools simply allowed us to quantitatively team Brady will be quarterbacking in 2020. measure the pairwise similarities of all arguments in favor of a particular pick.

Having created this distance matrix, we extracted the maximum eigenvalue—roughly, the magnitude of importance of the dominant argument being made in this collection of sentences—and compared it with the theoretical limit for this value. We interpreted this distance as the overall conviction held by the set of handicappers regarding the critical feature of the matchup that leads to the pick. Then, we picked the team having the more relatively dominant argument, conversely going against the team whose advantages weren’t widely apparent to our set of professional handicappers.

This approach yielded strong performance in these playoffs, with a 75% hit rate. For the Super Bowl, it favors the 49ers by 1 point. We’re assuming this machine pick is free of bias in spite of the fact that our hardware is from the Silicon Valley.

5 Table 3. Super Bowl results

Lower alpha team Super Bowl Date Higher alpha team (Analytic’s pick) Favorite Result Prediction correct XXXVIII 2/1/2004 New England Patriots (67.0%) Carolina Panthers (39.0%) Patriots by 7 Patriots 32-29* XXXIX 2/6/2005 New England Patriots (33.5%) Philadelphia Eagles (12.6%) Patriots by 7 Patriots 24-21* XL 2/5/2006 Seattle Seahawks (25.0%) Pittsburgh Steelers (11.4%) Steelers by 4 Steelers 21-10 XLI 2/4/2007 Chicago Bears (17.8%) Indianapolis Colts (14.5%) Colts by 6.5 Colts 29-17 XLII 2/3/2008 New England Patriots (22.9%) New York Giants (14.6%) Patriots by 12.5 Giants 17-14 XLIII 2/1/2009 Pittsburgh Steelers (33.6%) Arizona Cardinals (-6.4%) Steelers by 6.5 Steelers 27-23* XLIV 2/7/2010 Indianapolis Colts (37.6%) New Orleans Saints (12.8%) Colts by 4.5 Saints 31-17 XLV 2/6/2011 Pittsburgh Steelers (28.6%) Green Bay Packers (1.3%) Packers by 3 Packers 31-25 XLVI 2/5/2012 New York Giants (32.8%) New England Patriots (15.8%) Patriots by 3 Giants 21-17 XLVII 2/3/2013 San Francisco 49ers (23.1%) Baltimore Ravens (2.2%) 49ers by 4.5 Ravens 34-31 XLVIII 2/2/2014 Seattle Seahawks (13.7%) Denver Broncos (4.6%) Broncos by 2 Seahawks 43-8 XLIX 2/1/2015 New England Patriots (28.2%) Seattle Seahawks (9.9%) Patriots by 1.5 Patriots 28-24 50 2/7/2016 Carolina Panthers (61.5%) Denver Broncos (31.9%) Panthers by 4 Broncos 24-10 LI 2/5/2017 New England Patriots (40.5%) Atlanta Falcons (29.2%) Patriots by 3 Patriots 34-28 LII 2/4/2018 Philadelphia Eagles (31.8%) New England Patriots (12.4%) Patriots by 4 Eagles 41-33 LIII 2/3/2019 Los Angeles Rams (9.7%) New England Patriots (-5.5%) Patriots by 2 Patriots 13-3 LIV 2/2/2020 San Francisco 49ers (37.8%) Kansas City Chiefs (24.1%) Chiefs by 1 ? ?

*While in these games lower-alpha teams did lose to higher-alpha teams, the predictions are correct because the lower-alpha teams covered their respective point spreads. Source: Analytic Investors

6 We want to help our clients build for successful outcomes, defend portfolios against uncertainty, and create long-term financial well-being. To discuss your investment needs, please contact us:

• To reach our U.S.-based investment professionals, contact your existing client relations director, or contact us at [email protected].

• To reach our U.S.-based intermediary sales professionals, contact your dedicated regional director, or call us at 1-888-877-9275.

• To reach our U.S.-based retirement professionals, contact Nathaniel Miles, head of Defined Contribution at Wells Fargo Asset Management, at [email protected].

• To discuss environmental, social, and governance (ESG) investing solutions, contact Hannah Skeates, global head of ESG at Wells Fargo Asset Management, at [email protected].

All investing involves risks, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. Wells Fargo Asset Management (WFAM) is the trade name for certain investment advisory/management firms owned by Wells Fargo & Company. These firms include but are not limited to Wells Capital Management Incorporated and Wells Fargo Funds Management, LLC. Certain products managed by WFAM entities are distributed by Wells Fargo Funds Distributor, LLC (a broker-dealer and Member FINRA). This material is for general informational and educational purposes only and is NOT intended to provide investment advice or a recommendation of any kind—including a recommendation for any specific investment, strategy, or plan.

INVESTMENT PRODUCTS: NOT FDIC INSURED n NO BANK GUARANTEE n MAY LOSE VALUE © 2020 Wells Fargo & Company. All rights reserved. PAR-2020-02962