This book is written by Antti Ilmanen. He is a Principal at AQR Capital Management. He has received quite a number of awards in the investment field. Expected Returns is meant to provide enough materials and references to help a thoughtful reader make his or her own judgement.
Layout of Expected Returns
Expected returns has 29 chapters with a foreword and two appendices. The chapters are divided into three parts.
Part I is Overview, historical returns, and academic theories. There are seven chapters in this part. It introduces historical average returns, key concepts, and theory of expected return determinants.
Part II is A dozen case studies and consists of 12 chapters. The author discusses expected returns of 12 cases, namely four asset classes, four active strategies, and four underlying risk factors.
Part III is Back to broader themes. It contains 10 chapters and looks at expected returns from different angles. This part also contains the recommendations of the author.
Highlights
This book discusses the expected returns of a few asset classes, active investing strategies, and some risk factors. I will only talk about some lessons that I find related to value investing in the equity market.
Expected returns are the average money earned over time on an investment or strategy. However, expected returns are unobservable before hand, and can only be estimated with noise.
The author says that any highly profitable financial regularity will lose its advantage in the end as it attracts competition once it is widely known. So, hot strategy might not be a winner as time goes by. However, there might be some strategies that are able to consistently do well such as equity value.
There is one thing in this book that might be true but I do not think I will ever do it. The author opines that prudent leverage will improve long-run returns. Nonetheless, I am not confident with using margin in investing. Thus, I am not going to employ margin trading yet.
For investors who are unwilling to use leverage, the author recommends to focus on volatile asset classes such as equity which I am doing. Equities can be traded directionally (market timing) or on a relative value basis (stock selection). Value investing is one of the stock selection strategy.
For long-horizon investors, we should be contrarian. We can hold illiquid and risky assets but also be buyers when market’s risk aversion and liquidity needs are especially high. Market timing is hard, thus we do not have to be a perfect market-timer.
How can we improve our portfolio performance? By managing risks, horizon, skill, and costs. Last but not least, simple approaches are often as good as theoretically superior approaches in the real world.
Conclusion
Overall, I find this book to be too academic and a bit hard to read. Perhaps it is understandable because its target audience is experienced professional investors and advanced finance students. It took me a very long time to finish this book.
Having said so, I cannot deny that there are a lot of lessons to be learned from it. What I discuss above are just about equity, but the author also talks about commodity, bonds, and alternative assets in the book. If you would like to know more about these asset classes, perhaps it would be a good book.
Let’s end this with some quotes from the book.
“A central insight from academic finance theories is that required asset returns have little to do with an asset’s standalone volatility and more to do with when losses can expected to occur.”
“No investment is attractive at any price, however fast growing it has been.”
“Unfortunately the skills of truly superior investors are hardly replicable.”
“Whenever we observe exceptionally attractive historical returns, it is healthy to adopt a skeptical approach.”
“More knowledge may even be harmful as it often raises our confidence more than our forecasting ability.”
“The stock does not know that you own it, let alone at what price.”
“Market inefficiencies disappear when many investors learn about them and more smart capital is allocated to exploiting them – a standard “competitive pressures” story.”
“Minimizing costs is not always smart; being cost-effective and avoiding wasteful expense is.”
“To really benefit from compounding, an investor needs time, return, and reinvesting.”
Recommended book
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