Expected Returns

2 ideas

1. Decompose returns into asset, style, and macro drivers

   Any portfolio's return can be viewed through three complementary lenses: traditional asset class premia (equity, bond, credit), style factor premia (value, carry, momentum, defensive), and exposures to underlying macro drivers (growth, inflation, liquidity, tail risk). Looking at style and macro exposures often reveals that apparently diversified asset-class holdings are concentrated bets on one or two common risk factors, especially equity-growth risk.

2. Historical average returns mislead as expected return forecasts

   Realized past returns are poor estimates of forward-looking expected returns because they embed windfall gains from repricing, such as falling yields and rising valuation multiples, that cannot repeat. Better forecasts come from ex-ante indicators like dividend yield plus growth for equities or current yield and term spread for bonds, combined with survey expectations and theoretical priors.

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