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Expected Returns: An Investor’s Guide to Harvesting Market Rewards – Antti Ilmanen

8th August 2020
expected returns book cover


I have chosen Expected Returns to read after I saw it in the recommended list on a financial blog. The target audience of this book is actually experienced professional investors and advanced finance students in CFA or MBA programmes but I am not one of them. I just want to know how the author calculates expected returns.


Antti Ilmanen is a Principal and Global Co-Head of Portfolio Solutions Group at AQR Capital Management. Before that, he had worked at Brevan Howard, Salomon Brothers/Citigroup and Bank of Finland. He has advised many institutional investors, including Norway’s Government Pension Fund Global and the Government of Singapore Investment Corporation. He has received multiple awards such as Graham and Dodd award, Harry M. Markowitz special distinction award, Bernstein Fabozzi/Jacobs Levy awards, and CFA Institute’s 2017 Leadership in Global Investment Award.


Expected Returns has a total of 29 chapters, a foreword, and 2 appendices. The chapters are divided into 3 parts. As there are a lot of chapters, I will not list down the chapter names here.

Part I is Overview, historical returns, and academic theories. This part contains 7 chapters and serves as an introduction on historical average returns, key concepts, and theory of expected return determinants, including both rational and irrational stories.

Part II is A dozen case studies and has 12 chapters. This part presents expected returns of 12 cases, namely 4 asset classes (stocks, credits, government bonds, and alternatives), 4 popular active strategies (equity value, currency carry, commodity momentum or trend, and volatility selling), and 4 underlying risk factors (growth, inflation, liquidity, and tail risks which include volatility, correlation and tail risks).

Part III is Back to broader themes. There are 10 chapters in this part. It serves to shine light on expected returns from different directions.

Each part begins with a list of chapters and every chapter begins with a summary in points form.

The 2 appendices are World wealth and Data sources and data-series construction.


Expected Returns talks about historical average returns, financial and behavioural theories, forward-looking market indicators, and discretionary views. It is primarily about long-term expected returns of certain asset classes and investment strategies, not about risk management or portfolio construction. In this book, the author’s aim is to provide enough material and references to help a thoughtful reader make his or her own judgement.

First, let’s define expected returns. Expected returns are how much you make on average over time on an investment or strategy. Expected return contains both compensation for time and for risk bearing. However, expected returns are unobservable and at best estimated with noise. The other end of the spectrum is realized returns which are dominated by randomness, structural uncertainty, and rare events.

The strategies discussed in the book are equity value, currency carry, commodity momentum and equity index volatility selling. These are long-short strategies which suit leveraged investors more than traditional long-only investors. The author opines that prudent leverage would boost portfolio performance. But I think it is hard for retail investors like me to use leverage in a judicious manner.

As this is a very long book, I will only share what I find thought-provoking or interesting in this review.

Required risk premia reflect the way that asset returns covary with the marginal utility of an extra dollar of investor wealth. It means that when we feel poor, we require higher returns to part with our money.

Required asset returns have little to do with an asset’s standalone volatility and more to do with when losses can be expected to occur. But volatility is not a sufficient risk measure. Assets or strategies that perform badly in bad times warrant a high risk premium such as currency carry.

Equity return has depended on volatility and inflation conditions more than on growth; they excel in disinflationary and stable environments. Bonds have primarily depended on inflation conditions (benefiting from disinflation), while commodities and housing returns have varied most with the growth environment (benefiting from strong growth).

One interesting finding in this book is that people have skewness preferences (willing to pay up for lottery-type payoffs or for downside protection), even though it might reduce the returns.

One of the risk factor discussed is tail risks. I do not know what is tail risk before this. Tail risk is non-normal market moves such as abnormally large price changes or correlations spiking higher during crises.

Financial regularities are fragile because any highly profitable regularity attracts competition. Alpha (should be compensated with extra returns) will change into beta (should not be compensated with extra returns) once the factors are known. Whenever historical returns were exceptionally attractive, it is best to be skeptical. Higher past returns can be indicative of lower future returns.

What cause financial crises? According to the author, fast credit growth and financial deregulation or innovation commonly cause major bubbles that eventually burst.

The author mentions about disposition effect which I can identify with. Disposition effect is the tendency to hang on to losing stocks (more willing to sell small winners than small losers). But doing so would hurt our long-run returns. I will try my best to avoid this action.

Superior macro-investor goes beyond historical regularities and asks what is unique in the current situation, how policymaker and investor responses break past patterns, and what relevant structural changes are molding the world. It is the ability to adapt to changing environments through innovation and flexibility that leads to investment success. Risk consciousness, return seeking and cost consciousness are important attributes of active investors. However, skills of truly superior investors are hardly replicable.

Investors looking for high raw returns who, are unable or unwilling to use leverage, have to focus on inherently volatile asset classes such as equities which may be traded directionally (market timing) or on a relative value basis (stock selection). Long-run returns can be improved by customising benchmarks and execution strategies that do not mechanically trade together with the index crowd. Best results can be achieved by broad diversification with underweighting of expensive and overcrowded asset classes or strategies.

Avoid highly positive correlated trades as they are poor diversifiers. Examples of negatively correlated trades include pro-growth equities and anti-growth Treasuries, the value or contrarian style and momentum style, and carry and trend styles.

The author suggested 4 paths to improve portfolio performance: managing risks, horizon, skill and costs. Simple approaches are often competitive with any theoretically superior approaches in real world.

Author’s recommendation to true long-horizon investors is to be contrarian. Long-horizon investors can hold illiquid and risky assets but also be opportunistic buyers and liquidity providers when the market’s risk aversion and liquidity needs are especially high. Save ammunition in good times and gradually take advantage of episodes when liquidity and other premia widen out, while recognising that nobody can be a perfect market-timer. Market timing is hard as it requires judicious choices to leave risky assets and later re-enter the market at lower levels. It also involves a high tolerance of regret and of being “wrong and alone” for a long time.

One nugget of truth that I concur is that diversity in choices is a good outcome for markets where investment approaches that are too homogeneous can lead to systemic problems.

After I finished reading this book, there was a great sense of relief. I find it quite hard to read this book as the contents are esoteric. I gave a low star rating not because the contents are bad, it is just my personal subjective assessment. Perhaps professional investors would find the contents to be digestible than retail investors. However, it is still a good book to read about the expected returns of different asset classes and investment strategies.

If you are a retail investor like me, Part II is too academic for us. Perhaps you can just skip it or read the chapters that interest you. The author has some predictions for future 20 years since 2008 in Chapter 27. Some have come true such as technological progress and environmental concerns while others not. Chapters 28 and 29 should be read as they contain the author’s advice on improving portfolio performance and takeaways for long-horizon investors.


  1. No investment is attractive at any price, however fast growing it has been.
  2. More knowledge may even be harmful as it often raises our confidence more than our forecasting ability.
  3. The stock does not know that you own it, let alone at what price.
  4. Minimizing costs is not always smart; being cost-effective and avoiding wasteful expense is.
  5. To really benefit from compounding, an investor needs time, return, and re-investing.


1 out of 3 stars

Interested in Expected Returns?

You may get the book from Kinokuniya Malaysia or through the links below*.



*Disclosure: The above links are affiliate links. Thus, I may earn a small commission when you purchase the book through the links.

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