Expected Returns: An Investor's Guide to Harvesting Market Rewards
For any investor, understanding the expected rewards that markets offer is central to long-term investment success. The traditional paradigm for assessing expected returns has focussed on historical performance and asset class management. However, Antti Ilmanen contends that this approach to investment decision-making is too narrow in its asset class focus and in the inputs used for assessing expected returns. He challenges investors to broaden their perspectives in two ways:
  • Excess returns should be harvested from diverse sources. Strategy styles and risk factors, as well as asset classes, are sources of return, thus warranting three-dimensional analysis of investments.
  • Any investment's return prospects should be judged in a way that incorporates all knowledge, including historical experience, financial and behavioral theories, and current market conditions, without being overly dependent on any one of these.

Beginning with comprehensive introduction and overview, Expected Returns goes on to analyze the historical record, give a roadmap of terminology, explore rational and behavioral theories, and look at alternative interpretations for return predictability. A series of case studies provide detailed analysis of assets (equity, bond and credit risk premia, as well as alternative asset classes), dynamic strategy styles (value, carry, momentum, volatility) and underlying risk factors (growth, inflation, liquidity and tail risks), before moving back to broader themes, including time-varying expected returns, and seasonal, cyclical and secular return patterns.

Concluding with a series of investment lessons, Expected Returns is the complete guide for the long-term investor, providing wide-ranging empirical evidence, and a platform for forecasting the expected returns of an investment portfolio for asset allocation and portfolio balancing purposes

 "Job one for any investor is to estimate asset class returns. For the first time, Antti Ilmanen has assembled into one volume all of the tools necessary for this task: for the working money manager, a unique treasure trove of analytical techniques and empirical evidence; for the academic, a comprehensive guide to the relevant academic literature; and for the consultant, a blinding light with which to illuminate performance. Expected Returns is destined to occupy the front shelves of investment professionals around the world."
William J. Bernstein, author of The Intelligent Asset Allocator, The Birth of Plenty, and A Splendid Exchange, and co-principal of Efficient Frontier Advisors

"Antti's synthesis of experience and theory has given us a book which fills a major gap in the literature on investing. Amazing, but true, this is the first book dedicated to the critical and challenging task of estimating how much we should expect to earn on our investments. This illuminating book, teaming with valuable insights that have never before been gathered under one roof, cannot fail to make the reader a more successful and discerning investor."
Victor Haghani, Associate Lecturer, London School of Economics, and former founding partner of LTCM

"Ilmanen has written a thorough and detailed analysis of one of the central issues in investing."
Ken French, Heidt Professor of Finance, Dartmouth College

"Investors' decisions should be evidence based. Antti Ilmanen assembles a global body of evidence, and interprets it with insight. Read this book and you will improve your understanding of the future."
Elroy Dimson, Emeritus Professor of Finance, London Business School

"If I could choose only one book on active management, I would choose Expected Returns. This book is extremely thorough and well researched, yet direct and to the point."
Roger G. Ibbotson, Professor in the Practice of Finance, Yale School of Management, and Chairman and CIO of Zebra Capital Management  

1124372503
Expected Returns: An Investor's Guide to Harvesting Market Rewards
For any investor, understanding the expected rewards that markets offer is central to long-term investment success. The traditional paradigm for assessing expected returns has focussed on historical performance and asset class management. However, Antti Ilmanen contends that this approach to investment decision-making is too narrow in its asset class focus and in the inputs used for assessing expected returns. He challenges investors to broaden their perspectives in two ways:
  • Excess returns should be harvested from diverse sources. Strategy styles and risk factors, as well as asset classes, are sources of return, thus warranting three-dimensional analysis of investments.
  • Any investment's return prospects should be judged in a way that incorporates all knowledge, including historical experience, financial and behavioral theories, and current market conditions, without being overly dependent on any one of these.

Beginning with comprehensive introduction and overview, Expected Returns goes on to analyze the historical record, give a roadmap of terminology, explore rational and behavioral theories, and look at alternative interpretations for return predictability. A series of case studies provide detailed analysis of assets (equity, bond and credit risk premia, as well as alternative asset classes), dynamic strategy styles (value, carry, momentum, volatility) and underlying risk factors (growth, inflation, liquidity and tail risks), before moving back to broader themes, including time-varying expected returns, and seasonal, cyclical and secular return patterns.

Concluding with a series of investment lessons, Expected Returns is the complete guide for the long-term investor, providing wide-ranging empirical evidence, and a platform for forecasting the expected returns of an investment portfolio for asset allocation and portfolio balancing purposes

 "Job one for any investor is to estimate asset class returns. For the first time, Antti Ilmanen has assembled into one volume all of the tools necessary for this task: for the working money manager, a unique treasure trove of analytical techniques and empirical evidence; for the academic, a comprehensive guide to the relevant academic literature; and for the consultant, a blinding light with which to illuminate performance. Expected Returns is destined to occupy the front shelves of investment professionals around the world."
William J. Bernstein, author of The Intelligent Asset Allocator, The Birth of Plenty, and A Splendid Exchange, and co-principal of Efficient Frontier Advisors

"Antti's synthesis of experience and theory has given us a book which fills a major gap in the literature on investing. Amazing, but true, this is the first book dedicated to the critical and challenging task of estimating how much we should expect to earn on our investments. This illuminating book, teaming with valuable insights that have never before been gathered under one roof, cannot fail to make the reader a more successful and discerning investor."
Victor Haghani, Associate Lecturer, London School of Economics, and former founding partner of LTCM

"Ilmanen has written a thorough and detailed analysis of one of the central issues in investing."
Ken French, Heidt Professor of Finance, Dartmouth College

"Investors' decisions should be evidence based. Antti Ilmanen assembles a global body of evidence, and interprets it with insight. Read this book and you will improve your understanding of the future."
Elroy Dimson, Emeritus Professor of Finance, London Business School

"If I could choose only one book on active management, I would choose Expected Returns. This book is extremely thorough and well researched, yet direct and to the point."
Roger G. Ibbotson, Professor in the Practice of Finance, Yale School of Management, and Chairman and CIO of Zebra Capital Management  

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Expected Returns: An Investor's Guide to Harvesting Market Rewards

Expected Returns: An Investor's Guide to Harvesting Market Rewards

Expected Returns: An Investor's Guide to Harvesting Market Rewards

Expected Returns: An Investor's Guide to Harvesting Market Rewards

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Overview

For any investor, understanding the expected rewards that markets offer is central to long-term investment success. The traditional paradigm for assessing expected returns has focussed on historical performance and asset class management. However, Antti Ilmanen contends that this approach to investment decision-making is too narrow in its asset class focus and in the inputs used for assessing expected returns. He challenges investors to broaden their perspectives in two ways:
  • Excess returns should be harvested from diverse sources. Strategy styles and risk factors, as well as asset classes, are sources of return, thus warranting three-dimensional analysis of investments.
  • Any investment's return prospects should be judged in a way that incorporates all knowledge, including historical experience, financial and behavioral theories, and current market conditions, without being overly dependent on any one of these.

Beginning with comprehensive introduction and overview, Expected Returns goes on to analyze the historical record, give a roadmap of terminology, explore rational and behavioral theories, and look at alternative interpretations for return predictability. A series of case studies provide detailed analysis of assets (equity, bond and credit risk premia, as well as alternative asset classes), dynamic strategy styles (value, carry, momentum, volatility) and underlying risk factors (growth, inflation, liquidity and tail risks), before moving back to broader themes, including time-varying expected returns, and seasonal, cyclical and secular return patterns.

Concluding with a series of investment lessons, Expected Returns is the complete guide for the long-term investor, providing wide-ranging empirical evidence, and a platform for forecasting the expected returns of an investment portfolio for asset allocation and portfolio balancing purposes

 "Job one for any investor is to estimate asset class returns. For the first time, Antti Ilmanen has assembled into one volume all of the tools necessary for this task: for the working money manager, a unique treasure trove of analytical techniques and empirical evidence; for the academic, a comprehensive guide to the relevant academic literature; and for the consultant, a blinding light with which to illuminate performance. Expected Returns is destined to occupy the front shelves of investment professionals around the world."
William J. Bernstein, author of The Intelligent Asset Allocator, The Birth of Plenty, and A Splendid Exchange, and co-principal of Efficient Frontier Advisors

"Antti's synthesis of experience and theory has given us a book which fills a major gap in the literature on investing. Amazing, but true, this is the first book dedicated to the critical and challenging task of estimating how much we should expect to earn on our investments. This illuminating book, teaming with valuable insights that have never before been gathered under one roof, cannot fail to make the reader a more successful and discerning investor."
Victor Haghani, Associate Lecturer, London School of Economics, and former founding partner of LTCM

"Ilmanen has written a thorough and detailed analysis of one of the central issues in investing."
Ken French, Heidt Professor of Finance, Dartmouth College

"Investors' decisions should be evidence based. Antti Ilmanen assembles a global body of evidence, and interprets it with insight. Read this book and you will improve your understanding of the future."
Elroy Dimson, Emeritus Professor of Finance, London Business School

"If I could choose only one book on active management, I would choose Expected Returns. This book is extremely thorough and well researched, yet direct and to the point."
Roger G. Ibbotson, Professor in the Practice of Finance, Yale School of Management, and Chairman and CIO of Zebra Capital Management  


Product Details

ISBN-13: 9781119990772
Publisher: Wiley
Publication date: 04/20/2011
Sold by: JOHN WILEY & SONS
Format: eBook
Pages: 608
File size: 8 MB

About the Author

Antti Ilmanen is a Principal at AQR Capital Management, a leading global investment-management firm. Since starting as a central bank portfolio manager in Finland in 1986, Antti has worn many hats to bridge academic finance and practitioner investing. Having earned a finance PhD in 1994 from the University of Chicago Graduate School of Business, he spent a decade at Salomon Brothers/Citigroup as a bond researcher, strategist, managing director and a trader. Before joining Brevan Howard in 2004, Antti had published extensively in finance and investment journals and had received a Graham & Dodd scroll and the Bernstein Fabozzi/Jacobs Levy award for his articles. Over the years, Antti has advised many institutional investors, most regularly Norway's Government Pension Fund Global on its long-run investment strategy.

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Table of Contents

Foreword by Clifford Asness xi

Acknowledgments xvii

Abbreviations and acronyms xix

Part I Overview, Historical Returns, and Academic Theories 1

1 Introduction 3

1.1 Historical performance 7

1.2 Financial and behavioral theories: A brief history of ideas 9

1.3 Forward-looking indicators 13

1.4 View-based expected returns 15

1.5 General comments about the book 16

1.6 Notes 20

2 Whetting the appetite: Historical averages and forward-looking returns 23

2.1 Historical performance since 1990 24

2.2 Sample-specific results: Dealing with the pitfalls 27

2.3 Forward-looking return indicators 32

2.4 Notes 35

3 The historical record: The past 20 years in a longer perspective 37

3.1 Stocks 39

3.2 Bonds 43

3.3 Real asset investing and active investing 47

3.4 FX and money markets 50

3.5 Real return histories 52

3.6 Notes 52

4 Road map to terminology 57

4.1 Constant or time-varying expected returns? 57

4.2 Rational or irrational expectations formation? 58

4.3 Return measurement issues 59

4.4 Returns in what currency? 60

4.5 Risk-adjusted returns 61

4.6 Biased returns 63

4.7 Notes 63

5 Rational theories on expected return determination 65

5.1 The old world 66

5.2 The new world 68

5.3 Detour: a brief survey of the efficient markets hypothesis 81

5.4 Notes 83

6 Behavioral finance 87

6.1 Limits to arbitrage 87

6.2 Psychology 89

6.3 Applications 98

6.4 Conclusion 106

6.5 Notes 107

7 Alternative interpretations for return predictability 111

7.1 Risk premia or market inefficiency 111

7.2 Data mining and other “mirage'' explanations 112

7.3 Notes 115

Part II A Dozen Case Studies 117

8 Equity risk premium 119

8.1 Introduction and terminology 119

8.2 Theories and the equity premium puzzle 120

8.3 Historical equity premium 122

8.4 Forward-looking (ex ante objective) long-term expected return measures 128

8.5 Survey-based subjective expectations 141

8.6 Tactical forecasting for market timing 144

8.7 Notes 149

9 Bond risk premium 153

9.1 Introduction, terminology, and theories 153

9.2 Historical average returns 157

9.3 Alternative ex ante measures of the BRP 160

9.4 Yield curve steepness: important predictive relations 161

9.5 Explaining BRP behavior: first targets, then four drivers 164

9.6 Tactical forecasting—duration timing 174

9.7 Notes 177

10 Credit risk premium 179

10.1 Introduction, terminology, and theory 179

10.2 Historical average excess returns 183

10.3 Focus on front-end trading—a pocket of attractive reward to risk 188

10.4 Understanding credit spreads and their drivers 191

10.5 Tactical forecasting of corporate bond outperformance 198

10.6 Assessing other non-government debt 199

10.7 Concluding remarks 204

10.8 Notes 205

11 Alternative asset premia 207

11.1 Introduction to alternatives 207

11.2 Real estate 210

11.3 Commodities 219

11.4 Hedge funds 226

11.5 Private equity funds 241

11.6 Notes 245

12 Value-oriented equity selection 249

12.1 Introduction to dynamic strategies 249

12.2 Equity value: introduction and historical performance 251

12.3 Tweaks including style timing 258

12.4 The reasons value works 261

12.5 Does the value strategy work in equities beyond individual stock selection or in market or sector selection in other asset classes? 265

12.6 Relations between value and other indicators for equity selection 267

12.7 Notes 268

13 Currency carry 271

13.1 Introduction 271

13.2 Historical average returns 272

13.3 Improvements/refinements to the baseline carry strategy 276

13.4 Why do carry strategies work? 282

13.5 Carry here, carry there, carry everywhere 288

13.6 Notes 290

14 Commodity momentum and trend following 293

14.1 Introduction 293

14.2 Performance of simple commodity momentum strategies 294

14.3 Tweaks 298

14.4 Why does momentum—such a naive strategy—work? 299

14.5 Momentum in other asset classes 301

14.6 Notes 305

15 Volatility selling (on equity indices) 307

15.1 Introduction 307

15.2 Historical performance of volatility-trading strategies 311

15.3 Tweaks/Refinements 314

15.4 The reasons volatility selling is profitable 315

15.5 Other assets 319

15.6 Notes 319

16 Growth factor and growth premium 321

16.1 Introduction to underlying factors in Chapters 16–19 321

16.2 Introduction to the growth factor 327

16.3 Theory and evidence on growth 328

16.4 Asset market relations 331

16.5 Time-varying growth premium 338

16.6 Notes 338

17 Inflation factor and inflation premium 341

17.1 Introduction 341

17.2 Inflation process—history, determinants, expectations 345

17.3 Inflation sensitivity of major asset classes and the inflation premium 350

17.4 Time-varying inflation premium 356

17.5 Notes 356

18 Liquidity factor and illiquidity premium 359

18.1 Introduction 359

18.2 Factor history: how does liquidity itself vary over time? 362

18.3 Historical evidence on average liquidity-related premia 365

18.4 Time-varying illiquidity premia 370

18.5 Note 374

19 Tail risks (volatility, correlation, skewness) 375

19.1 Introduction 375

19.2 Factor history 378

19.3 Historical evidence on average asset returns vs. volatility and correlation 380

19.4 Theory and evidence on the skewness premium 389

19.5 Verdict on why high-volatility assets fare so poorly 392

19.6 Time-varying premia for tail risk exposures 395

19.7 Notes 396

Part III Back to Broader Themes 399

20 Endogenous return and risk: Feedback effects on expected returns 401

20.1 Feedback loops on the direction of risky assets 401

20.2 Feedback loops on less directional positions 403

20.3 Agenda for market timers and researchers 405

20.4 Notes 407

21 Forward-looking measures of asset returns 409

21.1 Popular value and carry indicators and their pitfalls 410

21.2 Building blocks of expected returns 413

21.3 Notes 416

22 Interpreting carry or non-zero yield spreads 419

22.1 Introduction 419

22.2 Future excess returns or market expectations? 420

22.3 Empirical horse races for various assets 424

22.4 Conclusions 428

22.5 Notes 429

23 Survey-based subjective expected returns 431

23.1 Notes 435

24 Tactical return forecasting models 437

24.1 Introduction 437

24.2 What type of model? 438

24.3 Which assets/trades? 441

24.4 Which indicator types? 442

24.5 Enhancements and pitfalls 443

24.6 Notes 444

25 Seasonal regularities 445

25.1 Seasonal, cyclical, and secular patterns in asset returns 445

25.2 Monthly seasonals and the January effect 446

25.3 Other seasonals 453

26 Cyclical variation in asset returns 457

26.1 Typical behavior of realized returns and ex ante indicators through the business cycle 458

26.2 Typical behavior of realized returns and ex ante indicators across different economic regimes 461

26.3 Notes 465

27 Secular trends and the next 20 years 467

27.1 Contrasting 1988–2007 with 1968–1987 467

27.2 Reversible and sustainable secular trends 468

27.3 The next 20 years 474

27.4 Notes 478

28 Enhancing returns through managing risks, horizon, skill, and costs 479

28.1 Introduction: how can investors enhance returns? 479

28.2 Risk 482

28.3 Investment horizon 492

28.4 Skill 496

28.5 Costs 499

28.6 Notes 501

29 Takeaways for long-horizon investors 503

29.1 Key takeaways from theory 504

29.2 Empirical return sources 504

29.3 My take on key debates 506

29.4 Know thyself: large long-horizon investors’ natural edges 512

29.5 Institutional practices 513

29.6 Notes 514

Appendices 515

A World wealth 515

A.1 Global total 516

A.2 Asset class detail 516

A.3 Notes 518

B Data sources and data series construction 519

B.1 Asset class and sector returns 519

B.2 Strategy style returns 521

B.3 Factor proxies 522

B.4 Forward-looking yields and spreads 523

B.5 Survey data and expected inflation 523

B.6 Miscellaneous other 524

Bibliography 527

Index 551

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