So You Wanna Buy a Baseball Team

In a postseason full of headline-grabbing stories (the ball is de-juiced! Gerrit Cole is a cyborg! The Nationals win in the playoffs now!), a quiet bulletin came out on Wednesday. Bloomberg’s Scott Soshnick reported that Major League Baseball will now allow investment funds to take minority stakes in teams.

The news cycle moved on. The Yankees-Astros game was postponed! What will A.J. Hinch and Aaron Boone do with their rotation flexibility? Did you know Juan Soto isn’t yet 21? There are big baseball things happening right now! Investment mumbo-jumbo has a way of fading to the background.

I’m here to tell you that it matters. Not in an urgent, baseball-ends-today way, but in a way that could change the nature of the sport long-term. This story might not be on everyone’s radar right now, but it’s important to consider the ramifications and conflicts of interest that can arise from a small change.

To understand what this decision means, we’ll need a little background. First, let’s talk about what an investment fund is. It’s a broad term by design, one that encompasses many different ways of pooling together money. Without further comment from MLB, we can’t know the exact specifications of what they’ll allow, but we can make some educated guessed. A college endowment? Definitely. A special purpose fund raising money from 100 rich people to invest in teams? Certainly — one has already been started, and it plans to raise $500 million to purchase minority stakes.

What about a pension fund? Pension funds’ preferred tax status mirrors that of college endowments, and the two invest in very similar ways. A hedge fund? Baseball will have to spell out the rules, but that doesn’t seem so different from letting endowments or pensions own minority shares, and it’s certainly not much different than a special purpose vehicle. Heck, hedge funds are largely specialized investment pools already, and endowments and pensions make up a sizable portion of hedge fund assets under management.

There are some details that we’ll simply need to see. What about a mutual fund? Could a fund provider create a closed-end fund that invests in a team, or even a pool of teams? That hasn’t been spelled out. Could an ETF do the same? That would require some deft financial engineering, as ETF shares need a creation/redemption mechanism that would be at odds with the way major league ownership works, but closed-end funds behave roughly the same way.

Regardless, the general idea of this new policy is to allow a wider population of groups of people to purchase minority stakes in teams, bringing to the ownership table broad pools of money rather than single individuals. Why does baseball want to do that? Per Bloomberg: “It’s MLB’s answer to a problem affecting all the major U.S. sports leagues: Teams’ multibillion-dollar valuations have made it difficult for part-owners — known as limited partners, or LPs — to find buyers for their stakes when it’s time to sell.”

Your mileage may vary as to whether that is a problem worth solving, but let’s explain the issue. Think of it this way: let’s say a team is worth $2 billion. In theory, 49% of that team should cost $980 million, and, as so few teams change hands, that should be a valuable commodity. In practice, however, it’s hard to find a billionaire who wants to plunk down $980 million to not run the ship, to have the garish red button that says “Press for High-Dollar Free Agent” just out of reach.

Ownership structures vary, and the majority owner won’t always have complete final say over team decisions, but for our purposes here, the majority owner is the decider. The difference between 51% control and 49% control is meaningful, and it follows that not every stake is equally desirable.

To be sure, there are still plenty of good reasons to be a minority owner in a sports team. If you’d been a minority owner of the Marlins since Jeffrey Loria bought them in 2003, you would have realized a 14.4% annualized return on your investment, roughly double the return you would have gotten by investing in the S&P 500. You could sit in the owner’s box whenever you wanted, and you’d have a sweet championship ring to show your friends at the yacht club.

But even with those benefits, it’s not quite the same. Minority stakes should trade at a discount when decision-making power is a key reason to own something, and sports teams definitely fit that bill. So minority stakes aren’t as appealing as majority stakes, and that’s fine. There’s some market-clearing price for that.

The problem comes when you try to sell a billion dollars worth of minority stakes, and only a small pool of people are eligible to buy. When teams cost $125 million, you might be able to cobble together 12 well-to-do businesspeople and get them to each pony up $5 million, getting you a $60 million minority share. It’s trickier to get $50 million from each of them, let alone $100 million. Minority stakes in teams simply don’t have enough demand, it seems, to meet the supply of people wanting to cash in on their gains, and it’s creating an illiquid market.

Opening up ownership to investment funds is a good way to bolster demand. Find an investment with an expected return of 14% a year and you’ll have no trouble attracting institutional investors to buy a share. It’s not at all a question of whether there’s enough money bouncing around — CalPERS, the pension fund for California’s public employees, had a total market value of $381.49 billion as of October 14, and they’re one of many pension funds struggling to find returns. Funds like that would surely love to invest $500 million, or even $5 billion, into something with such a high return.

But in solving the plight of the minority-stake-holding millionaires, baseball would create a new problem. Think about this CalPERS money as if it were your pension, or part of your retirement savings. You, Alex Smallbanks, might have a 0.000262% interest in CalPERS (if you had a million dollars coming to you), or you might have far less. You won’t be part-owner of the Dodgers in a meaningful way, even if the fund were to invest in a 25% stake in the team.

It’s rational, and even prudent, for an investment fund to prioritize profit to the exclusion of everything else. Depending on the type of investment fund, its decision-makers might even have what’s called fiduciary duty, the responsibility to act in a way that best serves the client’s financial interests regardless of their own views. For most businesses, that isn’t a problem. If a fund buys a stake in, say, a publicly traded pizza company, the system works. The pizza company tries to make as much money as possible, consumers try to get the best deal on their pizza, and everyone, for the most part, is fine with this kind of bargain — the pizza company’s success, measured in dollars, equates to the pensionholder’s success, and the company succeeds by making the best pizza for the lowest price.

That’s how capitalism works, and while I’m not going to get into a debate about the merits of that economic system as a whole, you don’t have to be a skeptic to realize that the system might not work that well for sports teams. Sports teams, at least nominally, aren’t run as profit-maximizing enterprises with no other goals. They’re civic enterprises, competing for titles, and they care about winning for its own sake.

To some extent, that’s a naive view. Teams care a ton about payroll, and every time that the Red Sox say they’re working to get below the tax threshold or the Blue Jays brag about years of control, the cracks in that worldview grow slightly wider.

But those cracks come about because we want owners to care exclusively about making the team the best it can be, while they only care partially. That’s not the same as being purely profit-driven, not even a little bit. Ask an owner if they’d accept a deal that would cost them $20 million upfront, net them $15 million in increased revenue, and guarantee them a World Series title, and I’m pretty sure they’d take it even if they knew it was a small money loser. You probably don’t buy a sports team and not want the prestige at all.

But it wouldn’t work that way if ownership were an investment fund. The fund has a duty to its stakeholders to maximize profit. Those stakeholders don’t vote on every single decision that every company the fund has any interest in makes; the fund makes decisions on their behalf by trying to maximize profit.

Let’s go back to our Alex Smallbanks example from above. You, Alex, have a small share of every single investment your pension fund makes, but you almost certainly don’t know the names of all the companies, bonds, and derivatives the fund invests in. You probably wouldn’t even know you were a part owner of a baseball team. As far as you’re concerned, your pension is just a number that grows, and it’s in your interest to have that number grow as quickly as possible.

Now imagine the process a pension-owned team would have to go through to construct its roster. Want a fourth outfielder? You better be able to show that the fourth outfielder will increase revenue by more than his salary, through increased attendance or a better TV deal or a greater likelihood of playoff berths and the accompanying windfall.

It gets even murkier when you consider how this works with baseball’s current revenue environment. Between revenue sharing and TV deals that lock in for decades at a time, there’s an argument to be made that trying to win isn’t economical anymore, that you should collect RSN fees and revenue sharing and cool it on player expenditures. That’s bad for baseball, and it feels like it’s already happening to some extent, but what we’ve seen so far might pale in comparison to what would happen if every decision had to maximize profit.

Of course, that’s not what baseball is proposing right now. As reported, they’re only offering minority stakes. In theory, the majority owners who are in control today will still be in control even if an investment fund buys up their minority stakes. But in practice, it’s a dangerous road. We aren’t privy to the internal articles of incorporation for ownership groups, but what’s to stop a hedge fund from teaming up with a billionaire to jointly buy a team, with the hedge fund acquiring a 49% stake but also dictating profit-maximizing rules the majority owner must follow? What’s to stop two investment funds from each acquiring 30% stakes, then teaming up to vote together and acquire effective control?

Without more details, we’re left to make educated guesses about the consequences of this decision. Maybe MLB has all the loopholes covered, and it will just be business as usual, the changing minority stakeholders invisible to our eyes. Maybe they had this figured out all along, and streamlining the market for buying and selling teams will be beneficial. Heck, maybe widening the ownership pool will help curtail some of the sport’s worst player-acquisition practices — owners get access to a team’s books and records, and pension funds and endowments have little tolerance for the types of behavior some teams have exhibited in the past.

But I’m skeptical. It seems pretty clear to me that maximizing profit and maximizing winning won’t always have the same solution. It’s also clear that investment funds will come down on the profit-maximization side of the equation every time. They should! They have a fiduciary responsibility to the people whose money they’re managing.

A college professor once told me something that has stuck with me ever since. Corporations are incredible vehicles for maximizing profit. Put them in any scenario, and they’ll tend towards profit optimization. The goal of regulation, then, should be to design incentives for these companies such that profit-maximizing behavior also maximizes the greater good.

Baseball, right now, doesn’t have regulations that maximize the greater good of the sport. There’s no salary floor, and little that stops teams from manipulating players’ service time to delay the free agency of young stars and keep payrolls down. Put a team in the hands of an exclusively profit-maximizing actor, rather than a sometimes profit-maximizing actor, and I don’t think we’d like the results.

It’s still early days in this discussion. Someday, presumably, an owner will want to cash out a majority share and won’t be able to find a suitable bidder, and they’ll pressure the league to allow investment funds to take majority stakes. When that happens, I hope there’s an earnest and realistic discourse about it. Investment funds are a practical way of letting many people invest intelligently without having to become subject matter experts in every single industry. I’m just not sure that baseball, as it’s currently set up, is ready for the pure dollar efficiency they bring.