Antti Ilmanen: Investing Amid Low Expected Returns

Antti Ilmanen’s Investing Amid Low Expected Returns updates his 2011 Expected Returns, a volume considered by many the definitive work on the subject.

Alas, like many classic reference sources, the 2011 volume was a doorstop, weighing in at over 600 pages; its new successor is less than half its size and thus much more easily digested. Better yet, while a writer’s prose rarely blossom in late-middle age, Ilmanen’s clearly has. One shouldn’t expect a book about the risk-free rate, the burgeoning zoo of risk premiums, and portfolio construction to be a piece of chocolate cake, but this one goes down remarkably easily.

The expected returns of investments, it turns out, have been falling for a long, long time. Four thousand years ago, the wealthy citizen of Nippur or Uruk with a few extra pounds of silver could lend them out at 20% per annum – a rate limited by statute – to merchants who might, for example, want to purchase grain and hire ships to sail down the Persian Gulf to Dilmun (roughly, modern-day Bahrain) to trade for copper, whose ores were absent on the alluvial Mesopotamian plain.

Or better yet (at least from the lender’s perspective), one could loan seed grain to needy farmers at zero interest with the expectation that a certain percentage of them would default, in which case they’d seize them and their families as highly valued slaves.

It’s been downhill from there for investment returns; as documented by economic historians like Sydney Homer, Richard Sylla, and Paul Schmelzing, the return on loan capital has fallen, in fits and starts, to today’s negative real rates on government debt, as measured by those offered on inflation-protected bonds.

The long-term trend of expected stock returns is less certain for the simple reason that their track record is far more sparse than for debt; trading on the Amsterdam exchange began only 400 years ago; before 1800, only two companies traded regularly on it, and only three traded in enough volume to record in London. Data from the twentieth century in a few dozen nations suggests an equity risk premium of around 4% on top of today’s near-zero government bond rate.