Book Review: Rule Based Investing

Book Review: Rule Based Investing

Everyone would like a “money machine.”  Follow simple rules, and “Wow, this makes money.”  This is that kind of book but it has better foundations than most in its class.

The book examines three types of investing, most of which are foreign to average investors.  Most investors don’t invest in equity by shorting it, and most investors are not currency traders.

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But that is what the book encourages.  I’m going to digress here, because I have to explain some salient matters, and say what I think, so that my later critique makes sense.

Volatility and credit are cousins.  After all when markets go nuts, and everything is in disarray, those that have been trying to borrow at low interest in one currency, and invest at higher interest in another currency get hosed.  Why?  Because in volatile times, the riskier currencies face capital flight versus safer currencies that have the confidence of the markets.

All of the methods mentioned in this book as a result are making bets on volatility/credit, and try to control the bet by monitoring implied volatility, credit spreads, and momentum.  They limit when they are in the market and when they are out.

I don’t have a problem with the theory here, but with the ability of average people to carry it out.  This book would be good for quantitative hedge fund managers; I am less certain about individuals here.

As an aside, what the book describes is how PIMCO has done so well at bond investing over its history — shorting volatility to pick up yield.

But the main criticism is this: the author optimized the book to fit her full data set.  When you read the last chapter, and see that you could have earned 30%+/year for 13 years, if you were as clever as the author, you should think, “Yes, if I had 20/20 foresight.”  The methods will not do as well in prospect as in retrospect.


There is little that I disagree with in the book on a theoretical basis.  Where I differ comes in two areas: individual investors will not have the fortitude to carry out what is a complex method of investment.  Secondly, when enough hedge fund money adopts these strategies, the pricing in the market will shift, and the hedge funds will no longer have easy money.

Who would benefit from this book: If you are willing to do the work of a volatility-selling hedge fund manager, this is the book for you.  If you want to, you can buy it here: Rule Based Investing.

Full disclosure: The publisher sent me the book after he offered me a review copy.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

By David Merkel, CFA of alephblog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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