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
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.
'...insightful and wonderfully lucid book'. (Economist, April 2011).
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