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The 2020 plague grounded Antti Ilmanen from his regular job at AQR advising institutions on asset allocations. While he was not as productive as Isaac Newton was when he escaped the plague in 1665, it allowed him to update his classic Expected Returns (2011), which surveys the basic statistics of the major investment classes. Any investment professional should be familiar with the data and arguments presented in this book. At only 250 pages (including many footnotes), it is a concise source to start or refresh your knowledge in this space.

The first thing to note is that interest rates were relatively stable until 1950, revealing a seemingly steady bond return of around 4%. However, when interest rates started rising after World War 2, they rose continuously to record levels over the next three decades. One can empathize with the many economists in the 1960s who kept predicting yields would fall because they were at historical highs in a data set that went back 100 years, unaware they would have to wait 10 years to see mean-reversion kick in.

The second half of this chart involved the slow process of leaving the gold standard, which started in 1934 and was finalized by 1971. Given the enormous rise in inflation at the beginning of the fiat era and the latter decline, we have two observations in this dataset regardless of how many minutes, months, or years. Financial data can give the illusion of many degrees of freedom, but for many assets, the critical issue is how they behave over a full market cycle. Alas, the US has had only 11 bear markets since 1945.

This is why it is good to look not merely at countries like the US but also at other countries. For example, in the early 1920s, hyperinflation destroyed bonds in Austria, Germany, Greece, Hungary, and Poland. It’s common to omit these as outliers, the result of mistakes our stupid ancestors made, as exemplified by the eponymous hero of the do-gooder economist tribe:

“A preference for a gold currency is … a relic of a time when governments were less trustworthy in these matters than they now are.”

~ John Maynard Keynes, Indian Currency and Finance (1913)

We should remember the theme of the Old Testament’s book of Judges, written three thousand years ago: a generation that grows up in good times will forget the virtues that got them there.

The average annual bond returns for countries lucky enough to win the big wars and avoid socialism may be 2% above cash, but this is a selective sample, and a 1% probability of a disaster event would reduce the US sample return by 50% (see Barro’s Rare Disasters and Asset Markets in the Twentieth Century). The real possibility of a regime change makes base rate data interesting, but not compelling.

A final point on the chart above is that the past 40 years have seen a continuous decline in interest rates. Antti estimates this added a whopping 2% annually to bond and equity returns over the past generation. This trend gives Antti the title of his book, in that we should get ready for an era where interest rates are, at best, no longer going to help us.

Below are observations on various asset classes mentioned.

Low Volatility Premium

Antti mentions two models that explain the low volatility effect: Black (1972) and Asness, Frazzini, and Pedersen (2020). The latter paper is empirical but references a model by Frazzini and Pedersen (2014). Black’s model was inspired by the idea that only the government can borrow at the risk-free rate, anchoring the Security Market Line (SML) above the risk-free rate and making it flatter. The approach of Frazzini and Pedersen (F&P) involves investors reaching for greater market exposure, as rules of thumb constrain them (e.g., the 60-40 equity-bond mix), and so try to get more of the equity premium by taking on higher beta. This also flattens the SML.


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