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


Expected Returns is a one-stop reference that gives investors a comprehensive toolkit for harvesting market rewards from a wide range of investments. Written by an experienced portfolio manager, scholar, strategist, investment advisor and hedge fund trader, this book challenges investors to broaden their minds from a too-narrow asset class perspective and excessive focus on historical performance. Coverage includes major asset classes (stocks, bonds, alternatives), investment strategies (value, carry, momentum, volatility) and the effects of underlying risk factors (growth, inflation, illiquidity, tail risks). Judging expected returns requires balancing historical returns with both theoretical considerations and current market conditions. Expected Returns summarizes the state of knowledge on all of these topics, providing extensive empirical evidence, surveys of risk-based and behavioral theories, and practical insights.

"This is the best book on active management ever written - and it achieves that status without mentioning a single stock or bond by name. Anyone who performs the rigorous analysis Ilmanen describes - admittedly a neat trick, since the world's most sophisticated investors struggle to do it successfully - will beat the market."
Laurence B. Siegel, Former Director of Research, The Ford Foundation

"Antti Ilmanen shows the way forward for the investment management profession in this remarkable book. In a comprehensive and impressive way, he combines financial theory, historical performance data and forward-looking indicators, into a consistent framework for assessing expected returns and risk. His approach is both scientific and practical, based on decades of studies and his own trading experience. With a touch of personal wisdom and humility, Ilmanen's book is a fascinating and educational journey into the future of investment management."
Knut N. Kjaer, Founding CEO of the Norwegian Government Pension Fund/NBIM and former president of RiskMetrics Group

"Ilmanen's wonderful book manages to be exquisitely readable while covering just about every aspect of the investment process. Filled with many, many fresh and useful insights. This volume deserves to be read and then kept close at hand - because it is sure to be needed again and again."
Martin L. Leibowitz, Managing Director, Morgan Stanley, and former CIO, TIAA-CREF

Antti Ilmanen is a senior portfolio manager at Brevan Howard, one of the world's foremost macro hedge funds. 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.
Foreword by Clifford Asness.


Abbreviations and acronyms.


1 Introduction.

1.1 Historical performance.

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

1.3 Forward-looking indicators.

1.4 View-based expected returns.

1.5 General comments about the book.

1.6 Notes.

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

2.1 Historical performance since 1990.

2.2 Sample-specific results: Dealing with the pitfalls.

2.3 Forward-looking return indicators.

2.4 Notes.

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

3.1 Stocks.

3.2 Bonds.

3.3 Real asset investing and active investing.

3.4 FX and money markets.

3.5 Real return histories.

3.6 Notes.

4 Road map to terminology.

4.1 Constant or time-varying expected returns?

4.2 Rational or irrational expectations formation?

4.3 Return measurement issues.

4.4 Returns in what currency?

4.5 Risk-adjusted returns.

4.6 Biased returns.

4.7 Notes.

5 Rational theories on expected return determination.

5.1 The old world.

5.2 The new world.

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

5.4 Notes.

6 Behavioral finance.

6.1 Limits to arbitrage.

6.2 Psychology.

6.3 Applications.

6.4 Conclusion.

6.5 Notes.

7 Alternative interpretations for return predictability.

7.1 Risk premia or market inefficiency.

7.2 Data mining and other ‘‘mirage’’ explanations.

7.3 Notes.


8 Equity risk premium.

8.1 Introduction and terminology.

8.2 Theories and the equity premium puzzle.

8.3 Historical equity premium.

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

8.5 Survey-based subjective expectations.

8.6 Tactical forecasting for market timing.

8.7 Notes.

9 Bond risk premium.

9.1 Introduction, terminology, and theories.

9.2 Historical average returns.

9.3 Alternative ex ante measures of the BRP.

9.4 Yield curve steepness: important predictive relations.

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

9.6 Tactical forecasting—duration timing.

9.7 Notes.

10 Credit risk premium.

10.1 Introduction, terminology, and theory.

10.2 Historical average excess returns.

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

10.4 Understanding credit spreads and their drivers.

10.5 Tactical forecasting of corporate bond outperformance.

10.6 Assessing other non-government debt.

10.7 Concluding remarks.

10.8 Notes.

11 Alternative asset premia.

11.1 Introduction to alternatives.

11.2 Real estate.

11.3 Commodities.

11.4 Hedge funds.

11.5 Private equity funds.

11.6 Notes.

12 Value-oriented equity selection.

12.1 Introduction to dynamic strategies.

12.2 Equity value: introduction and historical performance.

12.3 Tweaks including style timing.

12.4 The reasons value works.

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

12.6 Relations between value and other indicators for equity selection.

12.7 Notes.

13 Currency carry.

13.1 Introduction.

13.2 Historical average returns.

13.3 Improvements/refinements to the baseline carry strategy.

13.4 Why do carry strategies work?

13.5 Carry here, carry there, carry everywhere.

13.6 Notes.

14 Commodity momentum and trend following.

14.1 Introduction.

14.2 Performance of simple commodity momentum strategies.

14.3 Tweaks.

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

14.5 Momentum in other asset classes.

14.6 Notes.

15 Volatility selling (on equity indices).

15.1 Introduction.

15.2 Historical performance of volatility-trading strategies.

15.3 Tweaks/Refinements.

15.4 The reasons volatility selling is profitable.

15.5 Other assets.

15.6 Notes.

16 Growth factor and growth premium.

16.1 Introduction to underlying factors in Chapters 16–19.

16.2 Introduction to the growth factor.

16.3 Theory and evidence on growth.

16.4 Asset market relations.

16.5 Time-varying growth premium.

16.6 Notes.

17 Inflation factor and inflation premium.

17.1 Introduction.

17.2 Inflation process—history, determinants, expectations.

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

17.4 Time-varying inflation premium.

17.5 Notes.

18 Liquidity factor and illiquidity premium.

18.1 Introduction.

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

18.3 Historical evidence on average liquidity-related premia.

18.4 Time-varying illiquidity premia.

18.5 Note.

19 Tail risks (volatility, correlation, skewness).

19.1 Introduction.

19.2 Factor history.

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

19.4 Theory and evidence on the skewness premium.

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

19.6 Time-varying premia for tail risk exposures.

19.7 Notes.


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

20.1 Feedback loops on the direction of risky assets.

20.2 Feedback loops on less directional positions.

20.3 Agenda for market timers and researchers.

20.4 Notes.

21 Forward-looking measures of asset returns.

21.1 Popular value and carry indicators and their pitfalls.

21.2 Building blocks of expected returns.

21.3 Notes.

22 Interpreting carry or non-zero yield spreads.

22.1 Introduction.

22.2 Future excess returns or market expectations?

22.3 Empirical horse races for various assets.

22.4 Conclusions.

22.5 Notes.

23 Survey-based subjective expected returns.

23.1 Notes.

24 Tactical return forecasting models.

24.1 Introduction.

24.2 What type of model?

24.3 Which assets/trades?

24.4 Which indicator types?

24.5 Enhancements and pitfalls.

24.6 Notes.

25 Seasonal regularities.

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

25.2 Monthly seasonals and the January effect.

25.3 Other seasonals.

26 Cyclical variation in asset returns.

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

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

26.3 Notes.

27 Secular trends and the next 20 years.

27.1 Contrasting 1988–2007 with 1968–1987.

27.2 Reversible and sustainable secular trends.

27.3 The next 20 years.

27.4 Notes.

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

28.1 Introduction: how can investors enhance returns?

28.2 Risk.

28.3 Investment horizon.

28.4 Skill.

28.5 Costs.

28.6 Notes.

29 Takeaways for long-horizon investors.

29.1 Key takeaways from theory.

29.2 Empirical return sources.

29.3 My take on key debates.

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

29.5 Institutional practices.

29.6 Notes.


A World wealth.

A.1 Global total.

A.2 Asset class detail.

A.3 Notes.

B Data sources and data series construction.

B.1 Asset class and sector returns.

B.2 Strategy style returns.

B.3 Factor proxies.

B.4 Forward-looking yields and spreads.

B.5 Survey data and expected inflation.

B.6 Miscellaneous other.