One of the great things about working at Commonwealth is the depth of knowledge of our team. Today, we have another post from Peter Essele, one of our portfolio managers and analysts.

Following on yesterday’s post, we’ll continue looking at various types of alternative strategies that you might consider using in your portfolio. Since “alternative” covers a multitude of sins, I thought it would be useful to offer a brief overview of some of the strategies that fall under that umbrella.

Yesterday, we talked about long-only strategies, which we define here at Commonwealth as “core financial strategies,” and compared them with what we consider “alternative financial strategies.” Both use liquid underlying investments—that is, investments that can be freely bought and sold. The liquidity of the underlying investments is one of the principal determinants of whether a strategy is suitable for use in a mutual fund, which is where many of the strategies I discussed are being deployed.

I’m headed down to New York this morning to speak at a conference about alternative investing strategies, and it occurred to me that many investors have heard a great deal about alternatives—and perhaps know some of the fundamentals—but haven’t really looked at the types of strategies involved, why they might work, and how they are supposed to add value. Today, I want to focus on strategies that use liquid underlying investments (that is, investments that can be easily bought and sold), as these are the strategies that most investors will run into.

Long-only strategies
This type of strategy isn’t an alternative, but rather the baseline against which alternatives are judged. The idea here is to buy things—stocks or bonds—that will go up in price. Success depends to some extent on the manager’s ability to identify undervalued things to buy, but also to a great extent on how the market as a whole does. Returns don’t come only from price appreciation—coupon payments or dividends also contribute—but the price has to appreciate as well.

In my last two posts, about data points that really matter, an implicit assumption is that the data in question (house sales and auto sales) actually drives decisions. Surprisingly, this hasn’t always been the case in many fields. Until fairly recently, many decisions have been largely based on expectations, plausibility, and bias.

Medicine is a great example. I don’t mean to pick on health care—after all, it’s the source of the current gold standard for effectiveness studies, the double-blind clinical trial—but think about the current debate on medical costs. One of the principal arguments for the availability of cost reductions is that no one really knows which treatments are most effective for many problems. Surgery rates for back pain, for example, vary widely among regions—which wouldn’t be the case, I hope, if there were one clearly superior solution. An entire industry, pharmaceuticals, is built around rolling out new treatments that, in many cases, offer little measurable benefit over existing treatments, at a much higher cost. Doctors hold onto their right to practice as they please, without regard for studies of industry best practices. The fact is, in many areas of medicine, we really don’t know what works best and why.

I’m meeting with the investment committee of one of our advisor groups this morning, and, in preparation, they sent me a list of very good questions they want to discuss. We’re also planning to start an “Ask Brad” section of the blog to address common questions. With both of these pending, and a couple of questions on everyone’s mind right now, I thought I’d start out with the big one, which is, of course, What are interest rates going to do?

Interest rates have moved higher again over the past week. What is driving the current spike in rates, as I’ve written before, is price discovery. As the Fed moves closer and closer to tapering away its bond buying, the market will increasingly be driven by supply and demand factors. In recent weeks, foreigners have been selling bonds, as have domestic banks. When and if the Fed starts to taper, demand will decrease even as supply is likely to continue to increase from the increased selling. When demand goes down and supply goes up, prices drop. In the case of bonds, this means yields go up.

Looking for new news today is hard. There are a lot of good economic stories—Europe’s economy has started to grow again, initial unemployment claims have come in at a six-year low, consumer borrowing has picked up again, among other stuff—but I’ve written about that several times over the past couple of weeks.

I could talk about the drop in the stock markets this morning or the uptick in interest rates, but I’ve also covered those topics multiple times lately, most recently yesterday. No doubt I’ll return to them again in the next couple of weeks—maybe even tomorrow, depending on how the market closes today.

Over the past couple of years, I’ve made a concerted effort to be healthier, exercise more, and weigh less. This was prompted by a lot of huffing and puffing from carrying Jackson around, as well as the realization that, the way I was, I would be the “fat dad,” which I was very unwilling to accept.

I had a lot of success, losing about 50 pounds peak to trough. Unfortunately, I then put about 25 of it back on and am now working on getting rid of that again. Being a research geek, I found myself looking at a great number of websites and books, which, in many cases, prescribed opposite courses of action. The diet industry has literally tens of thousands of books and, it seems, even more websites. Many of the diets, if you look into them, are actually repackaged and sold under new names every decade or two.

What seems conspicuously absent in many of these plans, though, is clinical data on what works. What’s almost entirely absent is an analysis of which plans work for different types of people. Even for plans with supporting clinical data, there is a presumption that one size fits all. I doubt that’s the case, since it never has been in any other situation. I suspect that many or all of these plans work for some people, if they stick to it, but not for others.

The other real problem in evaluating the success of any weight loss plan is the selection bias in most of the available data. People who fail on a diet rarely write about it and are certainly never included in the advertising.

For anyone who cares, I seem to have found a mix that works for me, which consists of the following:

• An iPhone app, Lose It!, that allows me to track what I eat. It’s amazing just how difficult it is to pick up that doughnut when you have to record it in your phone, and when you know exactly how much damage it’s doing to your goals.
• Walking while I read. Quite a bit of my job is reading, and now I head to the company gym downstairs—thanks Commonwealth!—to walk while I read. This is worth hundreds of calories a day. An interesting thing about exercise, it seems, is that low-heart-rate activity like walking burns calories without stoking the appetite. Another benefit is that, apparently, if you sit you die, so I’m trying to minimize my sitting.
• Not eating carbs in the morning. Instead, I have an omelette with a meat and vegetable—no bread—which extends the fat burning that started overnight.

I don’t suggest this will work for anyone else, but for me the results are substantial—and, more important, sustainable. This is what killed me before when I put a lot of the weight back on: what I was doing then wasn’t sustainable.

For many people, investing falls under the same category—should do, don’t want to do—as weight loss. It’s something that will pay future benefits but cause present pain. For those people, I think weight loss lessons have some value.

First, set up a regular habit that’s easy to keep. I like omelettes, for example, and the cafeteria in the building next door does a great one—very easy. For my retirement investing, I set a deferral percentage that comes directly out of my pay. If I can save more, I set up a similar direct deposit to an investment account. Another example might be a credit card that automatically deposits some percentage of purchases to an investment account.

Second, use a preset method to determine allocations and rebalance. For many people, a financial advisor is an ideal solution, but other web-based programs are also becoming available. I regularly review and rebalance my portfolios using a predetermined decision rule, so I don’t have to think about it, just execute. This makes it much easier to actually do. Walking while reading is a good example of this—I just grab my reading material and head to the treadmill. No thinking, just do it.

Third, review the analysis behind your decision rules on a regular basis. As with dieting, there are tons of investing options, many of which really work—but you have to be able to stick to them. If your process isn’t working for you, you need to recognize and change that. I have reviewed much of the research and concluded that what I’m doing will work for me, and I’m monitoring the results to make sure it is.

So far, so good.

I am pleased to say that I’ve been asked to write another post for the CFA Institute’s Inside Investing blog. The idea for this one was to consider what we believe but can’t prove in investing. I like these posts because they move away from the day-to-day concerns about what to buy or sell and into the underlying assumptions that help determine the decisions we make.

Hope you enjoy reading it nearly as much as I did writing it.

I’ve been doing a lot of thinking about alternative investments over the past couple of weeks, from a number of different perspectives. But before I proceed any further, I want to make clear that the content of this article does not constitute a recommendation to buy or sell any investment of any type.

Last week, I spoke with an institutional private equity manager, a hedge fund manager, and a major Wall Street financial institution about how they can better access retail investors to sell alternative products. This kind of interest isn’t particularly new; what is new is the recognition that retail investors can be the preferred capital source instead of an afterthought. As more and more companies start to realize this, we can expect to see the current group of offerings double and triple in size, with new players moving into the market and providing strategies and products that simply aren’t available right now.

Today is Nora’s and my 10th anniversary. We got married on July 26, 2003. It was a great wedding. To celebrate, last night we went out to No. 9 Park—a very nice restaurant in Boston—and tried the tasting menu, which I highly recommend. We also went to Tiffany’s, despite my protests that I had already bought her a ring. You can imagine how effective the protests were, and, well, she’s earned it. I can honestly say that I love her even more now than when I married her. Thanks for 10 great years, sweetheart, and I look forward to many more.

Part of our conversation last night was about where we were 10 years ago, and how much has changed. It occurred to me as we spoke that this was a conversation we rarely have—one that explicitly looks at longer periods of time, rather than having an incessant focus on the now. Looking over a decade, events that seemed so important at one time become less so, while events that may have seemed insignificant turn out to be major.