EXPECTED RETURNS ANTTI ILMANEN PDF

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 fo 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.

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Low expected returns are going to anchor bad news for all of us for the rest of our working lifetimes, he said. And maybe beyond. And he was scathing about other asset classes, such as private equity and real estate. All long-only investments are expensive, and a rearview mirror approach extrapolating gains for the next 20 to 30 years is not going to work well.

During his presentation, Ilmanen outlined three distinct potential scenarios for the future: Slow Pain: In this scenario, low yields persist for years, and there are no more windfalls from declining rates.

Life insurance companies may suffer badly in this instance. A double whammy for underfunded pension plans with a duration mismatch. Diversify style strategies, but do not try to time them! Ilmanen was not inspired with the prevailing choice between cash or expensive assets.

Taking on more equity risk, going down the credit curve, illiquid alternatives, or hedge funds — all of these have risks correlated with equities. And timing the market risks missing out on rising equities.

Cheap market risk premia is found at the base of his pyramid standard equities and bond market beta. Above that sits the alpha. Taking an asset class, strategy style, and underlying risk perspective, institutional portfolios are commonly skewed toward stocks and growth whilst underweighting exposures to Trend, Volatility, Carry and Value styles. Ilmanen explained that instead, his focus was on harvesting from four to five styles that have historically generated positive long-run risk-adjusted returns across a variety of asset groups and arguably deserve meaningful strategic allocations in investor portfolios.

The styles were Value relative cheapness , Momentum recent winners versus losers , Carry outperformance of high versus low yield assets and Defensive outperformance of lower-risk and higher-quality assets. These four are market neutral styles, but Ilmanen also favored one directional style: Trends recent asset performance consistency relative to itself. Ilmanen evaluated the empirical evidence on long-run returns of these styles. They have all given positive long-run returns, just like the better-known Equity Risk Premium, for various fundamental risk-based and behavioral reasons.

Before the dotcom bubble, the Value style did poorly while less correlated strategies, such as Momentum and Quality, did better. Smart beta portfolios, in contrast, often apply one style tilt in one asset class in long-only form.

He also thought that it could help reduce transaction costs and fees via netting, as well as enabling more patient style investing. Ilmanen pointed to evidence that — at least in the past market-neutral styles — taking away equity and duration exposures have done very well in combination, irrespective of growth or inflation environments. However, he cautioned against a multiple manager, multi-silo approach in order to avoid managers trading against each other.

But this is before transaction costs, and considering lower future returns. A more conservative forecast might be a Sharpe ratio of 0. Market-neutral approaches also perform well in terms of tail risks and rising yield episodes. Low trading costs are another key element to success.

And could the field get crowded? Ilmanen interpreted the data to suggest that factors are not crowded, allocations are as yet small, they represent switches from expensive active managers doing similar things implicitly, and also not all quants are doing the same thing at least currently.

All posts are the opinion of the author. Photo courtesy of Martine Berendsen Photography.

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Antti Ilmanen

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. 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.

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Low expected returns are going to anchor bad news for all of us for the rest of our working lifetimes, he said. And maybe beyond. And he was scathing about other asset classes, such as private equity and real estate. All long-only investments are expensive, and a rearview mirror approach extrapolating gains for the next 20 to 30 years is not going to work well. During his presentation, Ilmanen outlined three distinct potential scenarios for the future: Slow Pain: In this scenario, low yields persist for years, and there are no more windfalls from declining rates. Life insurance companies may suffer badly in this instance. A double whammy for underfunded pension plans with a duration mismatch.

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