Save time by listening to our audio articles as you multitaskThis brings us to the more serious business of investing, and a sequel of a very different kind. Ten years ago Antti Ilmanen, a finance whizz, published “Expected Returns”, a brilliant distillation of investment theory, practice and wisdom. His latest book, “Investing Amid Low Expected Returns”, is an update, taking in a decade’s worth of additional research and data.
Start, though, with a recap of the expected-returns framework. There are two sources of return on an investment: income and capital gain. The income on, for instance, a government bond is the interest paid once or twice a year. Bond prices and yields move inversely. So when interest rates fall, as they did for much of the past four decades, bond investors enjoy a capital gain. In essence a capital gain of this kind brings forward future returns.
What now? As Mr Ilmanen sees it, low expected returns can materialise through either “slow” or “fast” pain. In the slow-pain scenario, assets remain expensive and investors receive desultory bond coupons, equity dividends and rental receipts for years on end. In the fast-pain scenario yields revert to their higher historical averages. This implies a spell of brutal capital losses followed by fairer returns thereafter. The choice is between well-heeled stagnation and a crash.
Mr Ilmanen is too much of an epistemological sceptic to put all his chips on one scenario. He is also too careful an analyst to miss that low inflation made the high-asset-price, low-yield 2010s what they were. Many of the factors that kept a lid on inflation in that decade—globalisation, efficient supply-chain management, tight fiscal policy, an expanding global workforce—are now attenuating or unwinding.
Faced with lower expected returns, investors have three courses of action: they can take more risk to reach for higher returns; they can save more; or they can accept reality and play the hand they have been dealt as well as they can. The first approach may increase returns but also makes them more uncertain. Saving more means sacrificing today for the sake of tomorrow, a highly personal choice. Understandably, Mr Ilmanen’s focus is on the third approach.