Expected Returns: An Investor's Guide to Harvesting Market Rewards

2

Whetting the appetite: Historical averages and forward-looking returns

• I present some historical performance statistics for major asset classes and investment strategies, but I also highlight the pitfalls in using such data.

• Average returns across asset classes seem positively related to volatility and illiquidity. Bearing duration risk and emerging market risk were exceptionally well rewarded during the past 20 years, equity risk not.

• The results for 1990–2009 may be sample specific, reflecting an abnormally benign environment for certain asset classes. This problem can be mitigated by adjusting average returns for any windfall gains and by studying subperiod results and longer return histories.

• Historical average returns are particularly misleading measures of prospective long-term returns if expected returns vary over time and the past sample period includes a significant repricing. Forward-looking value indicators have their own limitations but are often superior proxies for expected returns.

Before delving into the terminology and theories of expected return determination in the next chapters, I provide some empirical appetizers. Chapters 2 and 3 focus on historical average returns over a 20-year window and over even longer windows. I emphasize the pitfalls in interpreting historical data. If you do study historical returns, as most investors do, this chapter reminds you of several skeptical questions you should ask.

I first summarize the performance of all major ...