My favorite chapter in Antti Ilmanen’s insightful book, Investing Amid Low Expected Returns, is Chapter 13: “Risk Management.” Antti Ilmanen includes a classic story about a novice investor asking an experienced investor for advice during the 1962 Cuban Missile Crisis where the USSR and the USA were within days of a potential nuclear war.
The novice investor asks, “Should I buy or sell stocks right now?”
The experienced investor answers, “Buy, of course. If the nuclear war doesn’t come it’s the Right Call because the Stock Market will go up. If the nuclear war does come, well, who cares about our stocks. We’re toast.” (p. 208)
Risk is ultimately more about survival than volatility. You might remember my post from 2013, “Why I’m Buying Oil Stocks” and my follow-up post from 2014, “Hope You Bought Some Oil Stocks When I Did.” And you might recall my 2018 post, “Buy It, Buy It Now!” where I warned of signs of Inflation. That prediction got delayed by the Pandemic, but it hit us hard in 2022.
Investing Amid Low Expected Returns presents several strategies to make money (and keep it!) despite the dire economic circumstances. One strategy is to buy commodities…like oil. Another is to hunker down and reduce spending until Inflation cools (probably a year or two from now). Another strategy is to sell some assets–sell your house and move into an apartment or condo–and go from two cars down to one car. Or zero cars.
Times are going to be tough, especially for those on fixed incomes, but Investing Amid Low Expected Returns gives you some ideas so you can survive this economic upheaval. How are you doing with Inflation raging? GRADE: A
Table of Contents
Foreword Cliff Asness xiii
Part I Setting the Stage 1
Chapter 1 Introduction 3
1.1 Serenity Prayer and Low Expected Returns 3
1.2 Outline of This Book 6
1.3 On Investment Beliefs 11
Chapter 2 The Secular Low Expected Return Challenge 15
2.1 Broad Context 15
2.2 Rearview-Mirror Expectations, Discount Rate Effect, and Low Expected Returns 17
2.3 How Low Are “Riskless” Long-term Yields from a Historical Perspective? 21
2.4 Decadal Perspective on Investment Returns 24
Chapter 3 Major Investor Types and Their Responses to This Challenge 27
3.1 Three Broad Investor Types 28
3.2 History of Institutional Asset Allocation 33
3.3 How Has the Low Expected Return Challenge Hurt Various Investor Types? 42
3.4 How Are Investors Responding to the Low Expected Return Challenge? 45
Part II Building Blocks of Long-Run Returns 49
Chapter 4 Liquid Asset Class Premia 51
4.1 Riskless Cash Return 52
4.2 Equity Premium 55
4.3 Bond Risk Premium 69
4.4 Credit Premium 74
4.5 Commodity Premium 81
Chapter 5 Illiquidity Premia 87
5.1 Illiquid Alternative/Private Assets 88
5.2 Less Liquid Public Assets 101
5.3 Liquidity Provision Strategies 102
Chapter 6 Style Premia 105
6.1 Value and Other Contrarian Strategies 109
6.2 Momentum and Other Extrapolative Strategies 117
6.3 Carry and Other Income Strategies 124
6.4 Defensive and Other Low-Risk/Quality Strategies 131
Chapter 7 Alpha and Its Cousins 139
7.1 Alpha and Active Returns 139
7.2 Reviewing the Classification of Portfolio Return Sources 146
7.3 Demystifying Hedge Funds, Superstars, and Other Active Managers 147
Chapter 8 Theories Explaining Long-run Return Sources 151
8.1 Rational Reward for Risk or Irrational Mispricing? 152
8.2 “Bad Returns in Bad Times” at the Heart of Risk Premia 153
8.3 Other Core Ideas for Rational Risk Premia and Behavioral Premia 155
8.4 Who Is on the Other Side? – and Related Crowding Concerns 158
Chapter 9 Sustaining Conviction and Patience on Long-run Return Sources 163
9.1 Patience: Sustaining Conviction When Faced with Adversity 164
9.2 Economic Rationale – and Has the World Changed? 169
9.3 Empirical Evidence – and Data Mining Concern 170
Chapter 10 Four Equations and Predictive Techniques 173
10.1 Four Key Equations and Some Extensions 173
10.2 Overview of Predictive Techniques 180
Part III Putting It all Together 185
Chapter 11 Diversification – Its Power and Its Dark Sides 187
11.1 Outline of the Remainder of This Book 187
11.2 Ode to Diversification 188
11.3 Critics’ Laments 193
Chapter 12 Portfolio Construction 195
12.1 Top-down Decisions on the Portfolio 195
12.2 Mean-variance Optimization Basics and Beyond 200
12.3 Pitfalls with MVO and How to Deal with Them 204
Chapter 13 Risk Management 207
13.1 Broad Lens and Big Risks 208
13.2 Techniques for Managing Investment Risk 209
13.3 Managing Tail Risks: Contrasting Put and Trend Strategies 210
13.4 Managing Market Risks: Portfolio Volatility and Beyond 214
Chapter 14 ESG Investing 219
14.1 Booming ESG 220
14.2 How Does ESG Affect Returns? 221
14.3 ESG Impact of ESG Investing – a Case Study on Climate Change 224
Chapter 15 Costs and Fees 225
15.1 Trading Costs 226
15.2 Asset Management Fees 230
Chapter 16 Tactical Timing on Medium-term Expected Returns 235
16.1 Contrarian Timing of the US Equity Market 235
16.2 Beyond Contrarian Timing of Equities: Other Assets and Factors, Other Predictors 240
Chapter 17 Bad Habits and Good Practices 243
17.1 Multiyear Return Chasing 244
17.2 Other Bad Habits and Good Practices 246
Chapter 18 Concluding Remarks 249
Acknowledgments 253
Author Bio 255
Acronyms 257
References 259
Index 277
Boxes
3.1 Global Market Portfolio 39
4.1 A Brief History of Inflation 54
4.2 Weak Empirical Relationship Between GDP Growth and Equity Returns 67
5.1 Share of Illiquid Assets in Global Wealth 89
5.2 Calendar Strategies 103
6.1 The Size Premium 107
7.1 Systematic Versus Discretionary Investing 142
8.1 How to Make Sense of Flow Data When Every Buyer Has a Seller 161
10.1 Machine Learning 183
11.1 Rebalancing 192
12.1 Modern Portfolio Theory and Two-Fund Separation 202
13.1 Can Risk Management Enhance Returns? Volatility Targeting 216
15.1 Taxes 233
