 Welcome everyone to the 49th edition of Bogle Heads On Investing. Today our special guest is Antti Ilmenin. He is the principal and global head of the portfolio solutions group at AQR Capital Management and the author of a new book, Investing Amid Low Expected Returns Making the Boast When Markets Offer the Least. Hi everyone, my name is Rick Ferri and I'm the host of Bogle Heads On Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501C3 non-profit organization dedicated to helping people make better financial decisions. Visit our newly designed website at bogelcenter.net to find valuable information and to make a tax deductible contribution. And don't forget about our Bogle Heads conference coming up this October 12th through the 14th, featuring many speakers that I've heard on this podcast and more. Today our special guest is Antti Ilmenin. Antti is the principal and global head of the portfolio solutions group at AQR and develops AQR's high level investment ideas. Antti received his PhD from the University of Chicago and is the recipient of many awards, including the Graham and Dodd Award, the Harry M. Markowitz Special Distinction Award, and multiple Bernstein-Fabozzi Jacobs Levy Awards. He is the author of two books, Expected Returns, and most recently, Investing Amid Low Expected Returns, Making the Most When Markets Offer the Least. This podcast is a review of his latest book. It's a little less than one hour long, but not nearly enough time. I could have spent 10 hours talking with Antti about all the concepts in this book. It is quite fascinating, but very easy to read. We discussed nominal expected returns of asset classes and investment strategies. Real returns, which are before the inflation rate. How an asset class or strategy may have a negative expected real return, but still be useful to the portfolio because it smooths the return of the portfolio. You may find yourself going back and listening to this podcast two or three times. And every time you do, you're going to catch something new. One more comment before we begin. I bring many guests on this podcast who have many different ideas. It doesn't necessarily mean you should use everything that you hear, but it does add to your body of knowledge, and that's important. So with no further ado, I am very pleased to have with us Antti Ilmenin. Welcome to Bogleheads on Investing. Thanks, Rick. Looking forward to this. You've got quite a prestigious career, but maybe a lot of our listeners, I'm not as familiar with you because you spent a lot of time in the institutional space. So could you tell us a little bit about yourself and go as far back as you like? Sure. I'll try to make it pretty brief. So I'm originally finished and started my working career as a young portfolio manager in Finnish Central Bank, investing the country's reserves. And then I caught a lucky break, and I met Ken French who was teaching us in 1989, and that basically gave me a, I would say, fast track window to come to University of Chicago to do my PhD. And that was just wonderful time for a few years. Learning a lot, and I got both Pharma and French as my dissertation advisors, got to know my future colleagues at AQR, my wife as well. So just wonderful. Wherever you meet your wife, your life has changed. Yeah, absolutely. And well, she happens to be German, and that's why I am talking from Germany now. And so I've always had an international role, but German home base then for her. Anyway, so then after the PhD, I went to work for Salomon Brothers as a bond strategist and bond researcher for a decade, turned into prop trading. And so I was always fixing, I'm oriented, converted into macro strategies and was in macro heads fund Brevan Howard then seven years, 2004 to 11, which was very interesting time, but it's a discretionary place. And I have got a pretty systematic heart. So, so it was sort of matter of time when I would join AQR. Could you explain the difference between systematic and discretionary? Sure. So a discretionary investor makes judgmental decisions where a systematic is basically rules based. You try to, I mean, you use discretion to come up with the rules, but then you really try to stick with them, whereas a discretionary manager basically looks whether it's stockpicking or macro environment, tries to just look at the specifics in that situation without caring about particular rules. So discretionary, I mean war and buffet. That would be a good example. Yes. Yes. And then AQR since 2011, and I've been there now 10 years in my natural home, I would say. You did your PhD at the University of Chicago and your dissertation advisors for both Gene Pharma and Ken French, correct? Yes. Yeah. No, source of pride. Yes. And also I was reading in your book that when Gene Pharma won the Nobel Prize, you were in Stockholm and you were there when he accepted it. I had been advising some Swedish investors in my role and I asked if they could help get a ticket to attend the ceremony. And I could and then could attend some events also with the other professors who were joining Pharma and it was just wonderful. What's it like to be in a room where somebody gets a Nobel Prize? So yeah, you are high up in the Balkan. Yes, it's very serious, serious, but warm atmosphere there. I think like there are only happy people in that in the hall, but there's also a reception then separately where you meet people a little bit more comfortably than in that big event. Well, that was a very unique experience to be there. Absolutely. Yeah. Okay. In addition to your work, your day job at AQR, you have also written a couple of books. And the first book you wrote was Expected Returns. And that was back in 2010, came out 2011. So, you know, 10 years ago. And what was the reasoning for doing that book? Yeah, I think I had already seen earlier when I was a bond researcher, I had seen that maybe the best thing I can do is to be some kind of bridge between academia and practitioner world. Sort of describing some relatively complex ideas like yield curve analysis was my first area where I wrote about and I got, I don't know, I guess I made a name in that niche audience with some writings I did then. And I thought that, okay, I have broadened my perceptions on markets. I had been advising Norway's this oil fund for several years. And I had really thought about all kinds of asset classes and all kinds of good investing. I felt I have read a lot. I have got, I think, a good story to tell of the key components of investing and how to think about this important issue of Expected Returns on pretty much any asset class or strategy that investors consider. So it became sort of my passion project for many years and turned out to be basically a 600 page book. And the premise of this book was to look at various asset classes and try to draw from that where expected returns come from. I mean, you were looking at the cash markets, equity markets, bond markets, credit markets, which is corporate bonds. And also you got into risk premia like value, momentum, so forth. So talk a little bit about that. And then right after that we'll get into, well, so what has changed? Yeah. So I think when you think of expected returns of any asset or strategy, you want to think about theoretical arguments why there should be a premium. And it could be risk based or behavioral. You want to think about historical average returns. Often long run average return is an anchor you think about. But then you want to think about forward looking measures. So current market conditions. It could be starting yields, which is often the case or valuations that guide you on current expected return. So I tried to give basically multiple perspectives to that expected return question. And then draw on both the literature and lots of empirical analysis that I did myself on all of these return sources, highlighting the most important ones. Then you call it an update of your book, cut them an add on to that book, which is the one that just came out earlier this year called Investing Amid Low Expected Return. So obviously your analysis between 2011 or 2010, 2020, 2021, when you wrote this book was that it going forward returns from asset classes, risk premium, style premium, perhaps we don't know, we'll get into it in a second, but particularly asset classes are going to be lower going forward. Was that the premise of what you were trying to put out with the second book? Yeah, yeah. Like you said, first partly an update. I did feel like the world had changed somewhat and there was new research, but especially I had this feeling that this question on low expected returns on major investments is almost like a generational challenge that has been underappreciated, partly because realized returns have been quite benign. So in some sense of key thesis I have there is that lower and lower bond yields in recent decades, including the last one, have been helping all other assets get to lower starting yields and low, those low starting yields, which you can also think of high valuations. They basically promise us low future returns. We don't know quite when whether it's going to be fast or slow, but that challenge is there. But because while the required years were falling, that at the same time basically gave richened those assets, we got pretty nice realized returns on bonds and on stocks and on anything really, all major asset classes during this time. And that made me worried that investors don't see the challenge because they look at the rear view mirror of realized returns. Back in 1980, the 10 year treasury bond had a yield of about 16 percent and 20 years later, 2020, it was less than 1 percent. So this fall of interest rates from 16 to less than one on a 10 year treasury and also a rapid decline, fairly similar fact, probably larger on T bills, which is considered the risk-free rate. This caused a very large excess return among asset classes, stocks, bonds, real estate, over a 40 year period of time. And as a baby boomer, I mean, this was been great, right? We have really benefited, but that has ended. And now we're back to reality. Yeah, that's a key theme. And while I say this is not only bonds, it's all asset classes, but it emanates from bonds. And just to show the parallel there to other asset classes, if we take the discount rate for equities, like simple way of thinking of the equity markets discount rate would be to look at the chiller earnings yield. So this is the inverse of the Cape ratio. One can think of that as the discount rate for S&P 500. And that was basically 10% 40 years ago, and then it came down to 3%. And that gave very nice returns as the re-pricing happened. But prospectively, that sort of guarantees as problems for the future. And I think a good way of thinking of this situation is that all asset classes, whether we talk of bond stocks or housing, you can think of them as basically priced through estimating expected future cash flows and discounting them by your common discount rate, which would be this, let's say, real treasury yield, and then some asset specific premium. And when that common discount rate is so low as it became negative real yield, that made everything expensive at the same time. We've had this sort of everything bubble innocence. And one way of thinking of this is that while 40 years ago we were having high expected return, but cheap valuations, now we have got low expected returns and high valuations. Effectively, we have sort of borrowed returns from the future by pricing all these assets so expensively. Yeah, let's get into that just for a second. About 2021, when the stock market went way up unexpectedly, but interest rates did come down to, as I said, below 1% for the 10-year treasury. That, in effect, with real estate and with equity and with bonds, we were borrowing returns from the future. Yeah, yeah. So when people think of the cushy returns that they have been getting in recent years, it's not something that in some way you should certainly expect to be repeated, but in some sense you should expect that in the future you will get something less because those higher prices you get for your assets brought the starting yields lower and the starting yields on any investment, they are a heavy anchor. They do matter for those expected returns. That's most obvious for bonds, but this is, again, it's very true also for those other asset classes, equities, housing, etc. And so I do not know whether the low expected returns will materialize through what I call the slow pain of staying in this world of high valuations and low starting yields, where we just clip ever smaller coupons and dividends, friends, or whether we get a re-pricing, which now has happened in 2022, that I call the fast-pain. So I said sort of pretty pretty unhappily told that we can sort of expect that it's going to be either a slow-pain or fast-pain or some combination of those two. It turns out that we got quite a bit of fast-pain this year, but not enough it turns out that it would have solved the problem. We have seen assets cheap and somewhat, but not nearly enough to get them back to sort of long-run average levels. We had this sell-off in the equity market and in the fixed income market this year, 2022, but now we've had a rebound of equity prices and interest rates have fallen, not nearly as low as what they were in 2021, but they have come back, but that's not enough, you don't think. You think that it's going to go more, even though we've had this fast correction, get some asset prices closer to perhaps where they should be, that probably we still have more to go and the question is, is it going to be ripping the band-aid off and getting it all done all at once, or is it just going to be sort of a slow bleeding? Yeah, basically the starting yields, if you think of government bonds, real yields, they were sort of minus one percent when they were very low last year and they got to near zero now, and so there's been about one percent move on that front. For equities I would say that the change has been less than that, maybe half a percent and both of them are a couple of percentage points away from long-run historical leverages, what you could get. So if we'd get to those averages, there would be much more to happen, but maybe we don't get there. So my short-term view, and this is getting to the speculative foundation, is that the inflation problem is serious enough, and that's going to basically force more monetary policy tightening than markets discount now, and that I think maybe the young generation of investors don't really understand what it means when Fed is tightening seriously, because that has not happened often and not really in their investment lifetime, but I think some pain will be needed for asset owners before this inflation genie is taken care of. I want to talk about the risk-free rate, which is called the Treasury Bill, which all of these valuation models and equations stem from, you know, what is the risk free rate, T-bills, and historically, globally, not just the U.S., but globally, the T-bill rate has basically been the inflation rate. It hasn't been true in the United States over the last several years. The T-bill rate was actually a little higher as we came off, as inflation dropped, and then it took a while for interest rates to come back down, but now going forward over the next 40 years, let's say, it seems reasonable to assume that the risk-free rate and the inflation rate will be close. Do you agree with that? Yeah, yeah, and so it is. So one, one maybe detail is that one can debate whether the risk-free rate that's relevant for long-run investors is the T-bill rate or the long-term bond rate, and there's some term premium between those, but all of these came to very low levels, and I would say that, roughly speaking, short-term, right now, short-term cash, long-term bonds, expected 10-year inflation, they are sort of similar level, near a little under 3% or so. So let's then move to equities. So equities have an expected real risk-premia over the risk-free rate. Historically, in the U.S., it's been higher than it has globally. Globally, it's been about 5%, but in the U.S., it's been higher over 6%. This is a compounded. Can we reasonably expect globally that it should continue to be 5%? Yeah, that's probably optimistic. I think it is likely that equity risk premium will be thinner, so I think total expected real returns on equities, ballpark of 4%, probably a little less than that in the U.S., a little above that outside the U.S., and then you can add the expected inflation on top of that to get a total return estimate. Fair enough. I want to get into the components of the real return 4%. That can be broken down to a real growth rate of our earnings per share and then dividends. Cole, you break that down and then for coming up with your number. Sure, so I think a good way of thinking of if we focus on equities is this idea of just dividend discount model where you are earning some real yield and real growth and then maybe inflation if you think of that, but let's just focus on real yield, real growth, and it could be both, by the way, ballpark 2% each. And then there's a question whether there's a change in valuations. So when you look at the realized returns, like Class Decade had much higher returns because the valuations basically doubled. Schiller PE went from 20 to 40, so realized returns were much more, but sort of roughly 4% expected return, half from real compound growth and half from starting yield. And you can think of dividend yield and a little bit from net buybacks, those other components. How does that all work into a global GDP growth? Equity market returns, so they are higher than what you get on GDP growth, which has been typically 2% to 2.5% or something like that, partly because equity is sort of a levered exposure to economic growth. There's that nice intuition there, but that doesn't mean that there's a tight correlation between economic GDP growth and equity returns. It turns out that there's almost zero correlation. So this is one of these things I highlight in the in the book that when you look at these numbers in the U.S. over time, or you compare across countries, you find very modest relations between GDP growth and equity returns, even though we intuitively think that equities are sort of participation in the real economy. And I read that and I understand on a country-by-country basis, you can't say GDP growth is this, therefore earnings per share growth is that, therefore you take some multiple, and therefore this is what the price of the stock market should be. On a country-by-country basis, I understand that, but globally, you know, looking at global GDP growth, isn't it more highly correlated that the global equity market to global GDP growth? Contemporaneously, there's almost nothing, but equity markets tend to predict next year's growth, so that way you do get something. And I think it is true, and certainly when equity markets are predicting next year recession, then you have got low returns. So yeah, I think that correlation becomes when you take, not looking at monthly returns, but you look at, let's say, annual returns and in a forward-looking sense, you do find some decent relation. And so the intuition, I think, is right that equity returns are both somehow participation in global growth and they are vulnerable to any hiccups or something more serious to that global growth. And that's a big risk then in equity markets. So the real expected return of equity using the simple model of a two percent dividend yield or earning dividend yield, real and two percent, real growth comes out to four percent, and then you add on to that your inflation number and now you come up with, well, if you're going to use the Fed's inflation number of two percent, then you're at about a six percent nominal, long-term expected return for equity. This is a reasonable number to plan for? Good numbers, yeah. I think so. I think it's a good point estimate, but then we have to sort of recognize that we can debate each of those two percent numbers however much. And so fair sort of humility or sense of uncertainty around them, but as point estimates, that's what I would use. So that's one side of the equation, right? We're talking about a 60-40 portfolio, a 60 percent equity, 40 percent fixed income as an example. Now we've got to go to the fixed income side. So we have an expected long-term return on equities of six percent nominally, four percent real. Now we go to the fixed income side and we've got choices there between treasury bonds and corporate bonds. So let's start out with treasury bonds, intermediate term treasury bonds. There has been a premium paid for going out on the yield curve to the 10-year mark where you've picked up more than just the inflation rate. And we have agreed that T-bills in the U.S. yielded a little bit more than inflation, but let's say going forward that T-bills are going to give us inflation. So now inflation plus something for treasury bonds, for a longer term, say 10-year treasuries. I mean, what, historically, what's it been and what do you think it might be going forward? Yeah. So it's, well, it's, the realized return has been quite benign because again we got these windfall gains when bond yields were falling and that is probably not fair to think. In a forward-looking sense what we should expect to get over cash has been becoming, in some sense, stingier. And the intuition is that government bonds used to have an extra term premium partly because of the high inflation uncertainty, sort of inflation risk premium, and that probably was beat down to near zero in the stable inflation decades after 2000. And then government bonds further turned into a safe haven asset when stock bond correlation turned negative. So simple capital asset pricing model intuition says that that if you have got a negative beta investment which basically really smooths equity returns, then that could even justify your negative premium. And I think that has helped government bonds become more expensive and in a forward-looking sense then we really may have even justified negative premium. And again, realized returns turned out to be very good because of the surprisingly benign picture on both inflation expectations and falling real yields. Looking ahead, I think there will be some mildly positive term premium but less than the over one percent that people were earning. So I would expect something half to one percent maybe extra over cash. So roughly that amount of real return on intermediate and 10-year bonds. That's very interesting that it's come down. What about, you know, the Fed's balance sheet and the Fed letting these bonds roll off and so there's going to be more supply out there? I mean wouldn't that have an effect of pushing up the yield, the real yield? Yeah. So besides inflation risk premium, safe haven premium, we said supply demand factors are the next thing. And that clearly was helpful during the time of quantitative easing and now it's going to give some headwinds during quantitative tightening. That's why I chose to talk about 10 years where I sort of hope these things don't play out anymore. The quantitative tightening story is hopefully there for the next couple of years and then that issue is over. So we're looking at somewhere between a half a percent to one percent perhaps over the risk-free rate or over T-bills. Realistically. I mean you're going to get paid something for taking terms. Exactly. Not as much as it was. Yes. And very short-term there is this question what happens with inflation and if Fed has to be more aggressive because of that and that may tell a more bearish story for the next couple of years. So let's move on then to another premium in the fixed income market and this is credit risk. Instead of being in treasuries we're going to be in intermediate term corporate bonds or mortgages or high yield versus investment grade corporate bonds. We're going to take credit risk and in here I found interesting in your book because you changed your mind on this. You were kind of negative on investment grade corporate bonds but you seem to have changed your mind here in this book. So talk about credit risk and then talk about what caused you to change your mind. Sure. Sure. Well first so I would say empirical evidence that says that you do earn some of the credit spread but you don't you don't tend to earn all of it. It's roughly speaking historically you've earned about half of the half of the spread and we may we may return to that that a little later. But then there's a question like are credits worth including they have an odd blend between government bonds and equities and it might be that they are sort of a superfluous asset there and I was leaning towards this idea in my first book that maybe you really don't need them and in the second book I was leaning the other way. I'm sort of notoriously two-handed economist that I don't have very black and white views but so certainly I did lean more positive and the arguments why I lean more positive on credits were partly just from having strong decade like after 2010 we had just you know relatively bad decade for credits and now we say our strong decade so that more importantly I looked at some historical research of many decades back which was telling a more positive story on credit performance and it's sort of extra benefit you get beyond government bonds and equities however I actually I've been called on this topic many times and people are saying you really shouldn't trust too much the data from 1930s to 1960s in credit markets the data just sucks so badly that evidence is relatively weak and then arguably the last decade evidence again should be discounted because Fed obviously had a big role in pushing also credit asset prices higher during that period so I would still lean mildly more positively but you hear very very weak views but you do you are or you were positive in your view of double B rated bonds so-called fallen angels and I'd like to hear this if you're still positive on that and the reason I say that is because individual investors sometimes take a position in a vanguard high yield corporate bond fund now I don't own this fund so I'm not touting it I do talk about it in some of my books for the exact reason that you you've talked about it in your books but this double B rated area where the fallen angels are does tend to seem to have an extra kick to it so you talk about that and you think if that does have any benefit potentially to a portfolio yes I think so I mean it is it's a micro story but it is in credit markets it is the best pocket and the intuition so fallen angels now refers to bonds that are downgraded from investment grade to speculative grade so typically triple B to double B and many institutions have got rules that they have to sell bonds during the next month to stick with their mandates and there is effectively a fire sales and I already wrote about it in my first book and I basically checked the evidence for the second book is the is the is the effect still there and it is still there in through 2010s and so on it has been very costly for investors to sell those fallen angels in this fire sales indeed like if you look at the long run performance how how much of the overall credit spread investment grade investors earned in excess return over treasury its its ballpark is about half and there's not much default loss that happens there so there are some technical effects and this is the most important technical effect even broadly speaking we are eating up a meaningful part of this extra credit spread investors lose a meaningful part of the average credit spread by participating in that fire sales so by selling those fallen angels within the first month you're talking about investment grade credit spread by selling the fallen angels they lose a lot of total credit spread yes those bonds that are downgraded they lose a lot of value in that next month if you even would wait six months that would help meaningfully but but ideally ideally just try to stick with those because they have got as good performance historically as as any other credit investments under liquid asset class premiere you do list commodities and there you talk not only about individual commodities but about commodity strategies so could you go into commodities sure many investors think that there is no reward for commodity investing and it turns out that that's that's true in the long run if you think of a single especially single spot commodity but if you think of a diversified portfolio of commodity futures you actually have earned something like three percent and a little bit of that comes from the futures part the role effect in the in the long run historically but the bigger part is is so called diversification return this is something that pharma and booth already discussed with equities in early nineties and it's a very small effect in equities but basically with commodities it's it's it's important and worth three percent the intuition is that a single commodity is very volatile often thirty percent or more volatility and that gives a drag volatility drag to the compound return it takes down the compound return geometric mean but those individual commodities are also very lowly correlated with each other so you can diversify across them in very simple ways and you can reduce portfolio volatility and reduce that volatility drag and that gets the average return from typical single commodity zero over cash to about three percent over cash just thanks to this effect that you are reducing portfolio volatility I'm going to push back a little bit here please that is a trading strategy that's that's not a premium on a asset class correct I mean as you said if you just bought the asset class and held it buy and hold basically you get maybe the inflation rate but what you're talking about is a no no okay go ahead you really get the three percent by naive diversification it's true that you have to you have to buy I mean in theory you might do it with spot commodities by the way no but nobody could do that because you don't want to buy your Pocbellies no I understand you're doing you're doing one month futures or something yeah so but it is it is really the only thing you are doing here you are rolling every month or quarter something so it is none of the things that you it is it is not momentum strategy role strategy this part that will be extra this is saying that just by reducing portfolios volatility and the volatility drag you are generating positive return it's a complicated thing I understand but it's not a a market weighted or capitalization weighted strategy at all it is a basically an equal weighted strategy so you have to come up with your equal weighted index that you're going to target and then every month you have to trade the portfolio to get it back to the equal weight so I mean it's an active strategy it is but it is it can be a very simple strategy that means you got to pay somebody to do this I mean somebody some active managers I think that's fair that's so the yeah it's it's it is not it's a it's a future trading strategy somebody will have to do that it can be at a very low cost or you can try to add some of those some extras carry and momentum type of strategies on top of that but but if you want to keep it simple it is very modest turn over modest modest cost but there's it's it's true that it is it's not total buy and hold when you use futures let's talk about gold for a second you did talk about gold and your view on that was zero real return in the long run it is low compared to many other assets but it makes sense mechanically because you are not earning any any coupons or dividends and logically it sort of makes sense because gold has been a sort of safe haven nor hedge and admittedly imperfect one but against a variety of ills it has tended to do relatively well both in rising inflation scenarios or in equity market drawdowns not very reliably for example this year we had both of those and gold hasn't shown interesting okay so those are the asset classes cash equities treasury bonds corporate bonds including a fallen angel high yield bonds and commodities so those are the asset classes in the risk premium now let's get into the second part of your book style premium things like value investing momentum investing quality investing and then you have carry yeah yeah so there are some styles where I think the consensus of researchers has converged to saying that there is an long-run premium which looks pretty much empirically as good as equity premium this is a this is long short or just long only and this can be this can be both any of these strategies can be applied as long only portfolios where you tilt a little more and you already favor favor last year's winners in momentum favor more boring good quality or low beta stocks in defensive or high dividend yield stocks in carry or you can do a long short strategy in all of these cases and you could also apply them outside stocks election do this use this in country allocation and if you do this so both of these are useful the latter approach long short is more aggressive it will give wonderful diversification benefits because then you have got many different return sources but it has got problems because they are unconventional and they will challenge investor patients much more than equities if you have a bad window for these strategies I think that most individual investors if they are going to do style premia factor investing it's going to be long only and it's going to be in one fund so it's a multi-factor fund how do you feel about multi-factor oh thank you I clearly like it because again I like diversification and many of these styles relative to each other are very lowly correlated even value and momentum as active fields are negatively correlated and sometimes some others but you get really nice benefits of when you combine these strategies so I think anybody who chooses to use only single one style has to have a really strong conviction that this is the one thing I believe in as opposed to the other ones because again there are these three, four, five things which all seem like quite good complements to each other as well you find that there's a higher value premium in small cap rather than large cap I think for many of these premia we find that on paper small small segment is a better fishing pond which is a so so higher premium there and again that's on paper and it could be that after trading costs much of that goes away so in general I think we tend to find as good opportunities after costs in large cap and small cap segments so I don't have a strong view on this as I know many other people do the last item that you put in style premium is called carry where carry is a long short strategy and the simplest way of describing it is what looks expensive you sell and what looks cheap you buy so you're selling very low yielding country bonds and you're buying very high yielding country bonds is that a fair assessment of carry well I think when you say the cheap and expensive I would call that the value strategy whereas for carry I would just call it high yielding and low yielding and in some cases carry and value sort of go hand in hand and I like dividend yield strategies and book to price strategies are highly correlated but but they can be so so I would say inequities the carry strategy would be using dividend yield or a broader payout yield metric to to favor certain stocks or or others but then if you think of some other asset contexts the most famous carry strategy perhaps is currency carry and then basically currency carry strategy or favoring high yielding currencies is very different than currency value strategy where you look for the currencies that look cheap based on purchasing power parity that's strictly a yield concept buy the high yield sell the low yield and it could be across any asset class so this is what carry means okay but it is long short I mean it's not just long only yes can be both again you can do long only favoring high dividend yielders it's not a great strategy but it's a mildly positive sharp ratio strategy the next area is what's called illiquidity premia and here can be divided up into the three major categories which is real estate private equity and then private loans or private credit let's start out with real estate a lot of people just own a home or they have rental property or they buy or read funds sure well first people may extrapolate too much when you when you look at real estate prices in recent decades I think with with these illiquid assets it's also helpful to take this dividend discount model idea that you you ask what's the expected return through expected yield expected real growth and maybe expected change in valuation empirical evidence suggests that with real estate you pretty much get the yield so you shouldn't expect change in valuations and the real growth you can debate whether it's been positive or negative in the long run and I think zero is a very reasonable number so I would say basically think that you are you are going to earn your yield and and the relevant yield for really real estate is basically something free cash flow yield so if you are thinking of a bigger number like rent to price ratio rental yield that's that's sort of too high because you have to subtract expenses which is often one third of that so my reading is if there's four percent rental yield nowadays then then you get something like two and a half percent expected real return more than bonds but less than equities and the intuition is that you don't get any real growth and give me your views on REITs sure lots of thinking about illiquidity premia because like I sometimes say illiquidity premia are overrated and one intuition just is that people really like the smoothing feature that it's it's sort of painful to lock your money for a long time but it's really nice to get the lack of mark to mark it and those two features could offset each other and so one place where you can measure illiquidity premia arguably pretty well is in the real estate where you compare listed REITs to direct real estate which is much less liquid and it turns out that when you look at this pretty long history we've got 45 years of data in the US we find that actually there's been inverse illiquidity premium REITs have outperformed and then the counter argument will be that they are not really comparable that REITs have got lots of beta and leverage and it's true that when researchers have adjusted for those beta and leverage differences you get some of that negative illiquidity premium away but you never get a positive illiquidity premium in any analysis that I've seen so again the evidence is very modest on the idea that there are great illiquidity premia in private assets that's very interesting and the other two which I don't really want to spend that much time on is private equity and private credit most individual investors that really don't have access to good private equity they are recently they are sort of institutional favorites but I think that institutions tend to be overoptimistic on them and partly they really like the smoothing feature but also I think they have got higher expectations I think because of this growing investor interest in that space I think even if there was an extra return I think much of that has been beat down and again another logic is that the smoothing has taken it down so I think it's a pretty reasonable thing to think that you get pretty similar returns from private equity as public equity after all fees which are much higher in private equity and likewise private credit versus public credit net returns could be very similar on both sides so I don't think investors are missing much by not having access to this but there are lots of dream sellers out there who tell a different story well let's talk about the active managers and alpha which is the fourth category that you have and there we've got managers that are trying to pick stocks not systematic but trying to pick stocks and talk about alpha alpha decay you know should investors be seeking alpha yeah I mean that is that's the holy grail which is so lovely but so elusive and I think it's good to be realistic about it and expect very little on that obviously there's a lot of marketing for it and there is to be to be clear there is some evidence you know mutual fund evidence is not good on managers generally providing net positive alpha but institutional managers hedge funds private equity may have collectively outperformed but that's again it has come down you mentioned this concept of alpha decay that evidence from more recent data is questioning even that whether there is there has been net outperformance obviously some managers will outperform and then you can question whether it's been like core skill and so on and this is one of these eternal debates and yet it is interesting that so many investors still like to do either own active investing or traditional active managers and pay decent fees and that is somehow telling of the both marketing success and overconfidence that we have so that's the technical side of your book but then you have a whole different side of the book it had to do with behavior and being patient and sustaining a conviction and so could you talk about why you wrote this side of the book and the main points on what you were trying to get across yeah I think if I if I have to pick one sort of bad habit from investors it tends to be related to impatience and you can also think a flip side of that can be chasing last three for two five year returns and capitulating after three to five bad years but basically statistical evidence after a few years is very weak it could be that if somebody has got very good or very bad performance it is more likely to be random luck than than really sign on some wonderful skill and and so investors chasing those returns and being impatient after bad returns is a very costly tendency and I try to then highlight be more specific what could be the costs and they include things like you may miss out on long run returns could be equity premium could be any of these other premiums where you get a disappointing draw and you leave that strategy you will miss out on the long run premium Opportunity cost yeah yeah yeah so that's opportunity cost indeed and then there's the actual cost basically trading out of those positions and and all kinds of friction from from related to trading and then to the extent that there is something like three to five year mean reversion and to the extent that investors tend to chase returns just like at those frequencies then that is particularly costly so cliff asness my voice has sometimes said that there is this unfortunate tendency of investors to act like momentum investors at the reversal horizons so chasing three year returns when you look at historical market data there's a greater tendency to see mean reversion over three year horizons so all of those possible costs are there and so my goal then needs to highlight the costs and then discuss ways if investors buy the idea that patience is good it's a virtue it will make give better long run results what kind of strategies you can use to make yourself more patient cultivate personal or organizational patients so discipline tools is what you talked about education our review broadly and infrequently make a bigger organizational commitment and I put in parentheses the Bogleheads in other words just keep going to the Boglehead site to remind yourself yeah move slowly into new ideas yeah avoid complexity yeah and a few others as well yeah yeah and I think anything that enhances patience tends to be good so equities are forgiven a bad decade or at least a bad few years nothing else will stay in investor portfolios with such a long disappointing period so the conviction that investors have because of the evidence and theories on equity premium are helpful and I think just the mere conventionality people are so used to it so that is great I would you know I'm cautious about illiquids but I would say smoothing makes people more patient with styles diversification can help but in general I confess that with the things that I love some of the style premium the unconventionality it makes them challenging from patient's perspective you talked about just doing simple rebalancing versus doing tactical market timing could you just touch on that yeah well so rebalancing really tries to stick with some long run targets so market timing especially contrarian timing I sometimes say is a proactively contrarian strategy if markets fall and become cheap you want to buy more than normally whereas with rebalancing you are sort of defensively contrarian you just want to get back to your target weights so I think the key idea with rebalancing is that you've got some idea what's a good long run portfolio for you asset class weights or risk targets and you want to basically stick relatively near to those and you rebalance back towards those targets and that's good for keeping the risk level that you like and maintaining diversification and then there might be some extra return enhancement that comes either either from the kind of thing I mentioned earlier there with commodities is reducing portfolio volatility that can help to some extent but especially if there are some mean reversion patterns that you could catch that would be that would be icing on the cake and your last chapter or one of the last chapters 17 you talked about good and bad habits of investors and the bad habits are selling losers and buying the winners over extrapolation meaning just too much complexity I call it mood trading where hey I think this is good let's buy this or I think this is bad let's buy that overconfidence in your ability and these are the bad habits that people have a good habits of the discipline and be very thoughtful about your asset allocation decision and don't take too much of too little risk in various asset classes and invest strategically and keep your costs down if you have any more you'd like to add to that to the good and bad habits that is the key list that again the first one I said is related to impatience so sort of multi-year return chasing I sometimes call the premiere bad habit and maybe overconfidence I think the important implication of that is over trading and that of course has been historically quite costly and maybe I do mention something beyond this tell a few times in the book okay I'm envious towards various I don't know discretionary investors and other well active managers who have got great stories whether it's a stock picker or macro and I think when I'm a systematic investor and I bet this factor investing diversification they don't they don't lend themselves well to great stories but so then I say that at some point I say that actually it could be that stories are really bad that they cater to some biases that we have like they cater certainly to our hindsight bias they make future seem more predictable than it is and another concept is so called base rate neglect so we think too much of the salient cases rather than apply probabilistic thinking so really I think stories while they are humanly so important they also can be reasons for some bad investment practices and so I'm trying to you know defend this kind of quanti quanti statistically oriented mindset and claim that there are some advantages let's hold on and you also have your stories right I mean every DFA advisor out there is saying we have noble prize winning economists you know giving us our information I mean so they have their stories too yeah but the stories tend to be let's say that they well by the way I of course I believe in more of these stories like but they are they are maybe more boring and abstract we rarely have a colorful story to tell well Cliff Asnes wrote the forward on the book and he reiterated something that you wrote in the book which is investors really have three options for dealing with this low expected return he came up with these three things and number one he said you could take more risk basically you take more equity risk which means you have to deal with more volatility that is one way in which you can increase your expected return so instead of doing 60 40 you do 70 30 or 80 20 but knowing that you're going to be having more risk more volatility so that's one thing secondly he said you could incorporate other sources of return such as style premia multi-factor model multi-factor fund of some sort which is what you had suggested and then he said the third thing is you could do the john bogel argument which is stay the course write it out accept the lower return no matter what but I'll also add to that something that you put in the book it also means you need to save more money because according to your data since the expected returns have fallen people actually need to save more and in fact the data that you had in your book was that instead of saving 10% per year you really need to try to save 20% per year so comment on all that please yeah you know that's it is it's a good summary and and I would I would say that most investors have seen apparently taking that take more risk approach and it can be more equity so then they go private equity with the smoothing advantage and so so so so that that I think is and that somehow I found from historical data that it is so common when expected returns for investors are used to earning what they they want to keep earning what they are used to and then they they adjust their portfolios and and that could end into in tears I like more the diversification story but I also I do like the last store this this Jack Bogle idea just just humbly accepted markets and I'm offering less and and let's just do the best we can in that situation Auntie thank you so much for coming on Bogleheads on Investing we greatly appreciate your insight really love the work that you're doing and keep on writing it's very interesting stuff thanks Rick very enjoyable conversation this concludes this edition of Bogleheads on Investing join us each month as we interview a new guest in the meantime visit bogelcenter.net bogelheads.org the bogelheads wiki bogelheads twitter listen live each week to bogelheads live on twitter spaces the bogelheads youtube channel bogelheads facebook bogelheads reddit join one of your local bogelheads chapters and get others to join thanks for listening