Antti Ilmanen on Expected Returns

Episode Summary

Executive Summary: Barry Ritholtz interviews AQR’s Antti Ilmanen about his book on investing amid low expected returns. Ilmanen argues that rich valuations, driven largely by decades of falling real yields and a savings glut, imply lower long-run returns and make strategic diversification, discipline, and patience more valuable than market timing. He also covers value investing, commodities, ESG, illiquidity, and the limits of private-market premiums.

Main Topics: Low expected returns and valuations (Priority: 5/5): Ilmanen argues that expensive starting valuations and low yields have pulled future returns forward, leaving investors in a low-return regime for years to come. Savings glut and interest rates (Priority: 5/5): He attributes persistently low real yields mainly to structural savings forces—demographics, wealth concentration, and excess savings—rather than just central-bank action. Alpha, humility, and market timing (Priority: 4/5): The conversation stresses that genuine alpha is scarce, many apparent skill claims are disguised beta or factor exposure, and tactical timing is unreliable compared with strategic investing. Diversification and rebalancing (Priority: 4/5): Ilmanen presents diversification as one of the closest things to a free lunch in investing, and rebalancing as a practical way to preserve risk targets and capture mean reversion. Value investing and style premia (Priority: 4/5): He says value remains historically cheap relative to growth, especially within sectors, and sees continued opportunity in style premia despite recent regime shifts. Alternatives, private markets, and commodities (Priority: 3/5): He is skeptical that illiquidity automatically earns a premium, notes wide dispersion in private assets, and is more constructive on diversified commodities as both inflation hedges and return sources. ESG and expected returns (Priority: 3/5): ESG investing may be beneficial socially, but he argues that constraints and virtue preferences can create financial trade-offs over time, even if transition periods may feel win-win.

Key Arguments: Low starting yields and high valuations are strong anchors for lower future returns, especially over 5-10 year horizons. The long bull market in many assets was aided by falling real rates, which made stocks, bonds, real estate, and credit all look better simultaneously. Most investors overestimate their ability to generate alpha; what looks like skill often reflects hidden beta, style exposure, or leverage. Diversification across uncorrelated strategies can materially improve risk-adjusted returns, but the best diversifiers often require leverage or shorting. Rebalancing helps preserve portfolio structure and can exploit momentum/mean-reversion dynamics if done patiently and not too frequently. GDP growth is a weak predictor of equity returns; China’s rapid growth did not translate into strong equity outcomes. Private-market illiquidity alone does not guarantee an illiquidity premium because the lack of mark-to-market may offset it. Commodities deserve a place in portfolios because they hedge inflation and, when diversified across contracts, can produce positive long-run returns. ESG preferences may lower expected returns over the long run because investors are willing to accept lower returns for non-financial goals. Patience and integrity are essential for investors, especially those pursuing long-horizon or contrarian strategies.

Data Points: Book publication timing: Finished in 2021, published in 2022 - Ilmanen says the book’s low-return thesis landed as markets were weakening, making the timing feel unusually apt. Fed tightening mentioned: 75 basis points + 50 basis points - Ritholtz references recent U.S. rate hikes in mid-2022 while asking about the Fed’s path. Real growth assumption: ~2% real growth - Ilmanen says 2% real growth is “pretty much as good as it gets” in mature economies. Historical bond move: Two-year yields fell from 9.5% to 7.5% overnight - He recalls the October 1987 crash as an early lesson in macro market volatility. CAPE / Shiller P/E: Rose from mildly above average ~20 to wildly above average ~40 in 10 years - Used to explain how rising valuations can deliver strong realized returns even when starting yields are low. Long-run commodity return: ~3% to 4% - He argues diversified commodity futures have earned positive long-run returns, contrary to common belief. Private equity outperformance history: ~3% per year over the S&P 500 - He notes historical PE outperformance but warns future returns are likely lower. Sauna temperature: 80-100°C - A light personal aside about Finnish sauna and cold plunge habits. Portfolio duration of expected returns: 3-5 years; 5-10 years - He frames valuations and starting yields as most relevant for medium-to-long horizons. ESG market size: Over $20 trillion - Ritholtz mentions the scale of ESG investing before asking about return implications.

Pivotal Quotes: "Discipline, humility, and patience as a key to investing success." — Antti Ilmanen: Ilmanen describes the behavioral side of good investing, beyond pure factor models. "We borrowed returns from the future when we were capitalizing everything at those expensive levels." — Antti Ilmanen: He explains how falling yields and rising valuations likely pulled forward future returns. "Diversification is pretty close to a free lunch." — Antti Ilmanen: He makes the case that portfolio construction can improve outcomes more reliably than forecasting.

Implications: Investors should expect lower long-run returns than the recent past, prioritize diversification and rebalancing, and be skeptical of easy alpha, illiquidity claims, and GDP-based return stories. Strategic patience matters more than market calls.