"Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least"
Consider this a bit of a “reality check” to return to logic and caution after more than a decade of boundless investor optimism. Lots of Risk Parity-esque insights. Recommended, but maybe better suited for pros though, as the DIY investor can get the message through Ilmanen’s podcast appearances.
Important Points for the RP Investor:
One of the most anticipated and talked about investing books of 2022, Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least, is a follow-up to another investing classic by Ilmanen, Expected Returns, which came out in 2011. Written during the pandemic, IALER is above all a great reminder of sensible investing for times when the stock market won’t be bullish and the bond market won’t be characterized by low and dropping interest rates. If there were one overarching message I got from the book, it is this: the previous decade was unexpected and unusual; investors would be wise to recalibrate their behavior for more modest years ahead.
The first part is called “Setting the Stage,” where Ilmanen reviews the returns of the previous decade and finds that future gains have been brought forward, resulting in prices for investments that are high compared to historical norms. As he writes on page 3, “The payback time for the recent decades' windfall gains is approaching.” The strong returns of the past decade have also impacted investors’ behavior, as they have become over-accustomed to growth, more aggressive in their use of leverage, and less willing to be patient through periods of sub-par returns. Such approaches will be thoroughly tested when/if the investing returns to more modest patterns.
Part two covers the “Building Blocks of Long-Run Returns”: the various elements of portfolios that drive long-run returns. This section is very much a review of recent evidence and expert opinion onto what truly does, and does not, contribute to performance. Ilmanen discusses various market risk premia, the illiquidity premium, plus style premia, and alpha. This section is perhaps best suited for professional investors, as I got a bit lost in the weeds with all the citations and references to research. This part might also be better if you take it in small chunks.
Part three is more helpful to amateur investors. Titled “Putting it All Together,” Ilmanen discusses how to use that knowledge gained from Part two and apply it to more “normal” investing regimes. A couple of the chapters in this part are strongly recommended:
- Chapter 11: Diversification
- Chapter 12: Portfolio Construction
- Chapter 13: Risk Management
- Chapter 17: Bad Habits and Good Practices
In these chapters, Ilmanen advocates for investing choices that are music to the ears of Risk Parity investors: prepare for various regimes instead of trying to predict which, diversify your portfolio, construct resilient portfolios by paying attention to correlation between assets. He stops short of advocating for a Risk Parity approach in so many words, but it is clear that he is favorably disposed to the general Risk Parity framework.
In fact, in a podcast interview on ReSolve Riffs, host Adam Butler remarks on the similarity between Ilmanen’s advice and Risk Parity, even though he doesn’t use the term to describe his views. Ilmanen responds in the affirmative, saying that he and Risk Parity are “singing from the same songbook.” The exchange starts at 1hr 17min, though as I’ll mention below, the whole interview is well worth a listen:
Ilmanen also notes some of the barriers for Risk Parity adoption, namely the ability to stick with it when it underperforms compared to a more equity-heavy portfolio, such as in the 2010s, when a Risk Parity portfolio with higher allocation to lower-returning alternatives would have been hard to stick with. Ilmanen notes elsewhere that those lower returns can be mitigated through the use of leverage, yet many individual investors have an aversion to leverage even as they double-down on exposure to equity risk.
Returning to podcasts, Ilmanen went on a lengthy podcast tour to promote his book in the spring and summer of 2022. I must have listened to at least three, but maybe five, and felt like I had a great sense of his argument even before I read the book this November.
All in all, I recommend this book for DIY investors interested in Risk Parity, though I would say parts one and two won’t be quite as helpful as part three, and you might want to give a few of the podcasts a listen to gauge whether you’d like the added depth provided by the book. With the book, you do get the references to the academic papers and industry white papers, plus a reference source to return to.
Other Resources Related to this Paper:
Seemed like over the summer, you couldn’t swing a dead cat without finding Ilmanen on a podcast; whatever your favorite investing one is, I’m sure he has been on it! Here are three of my favorites:
Gestalt U/ReSolve Riffs in YouTube form:
Also available in podcast form linked above.
Rational Reminder Podcast, episode 202:
Masters in Business with Barry Ritholtz:
Antti Ilmanen is Principal and Global Co-head of the Portfolio Solutions Group at AQR Capital Management.