Cliff Asness: Be Realistic About 2.5% Real Returns

/Cliff Asness: Be Realistic About 2.5% Real Returns

Cliff Asness: Be Realistic About 2.5% Real Returns

By | 2017-08-18T17:08:05+00:00 July 19th, 2014|Uncategorized|15 Comments

Cliff Asness had a great interview with Steve Forbes back in April (a copy is here) that highlights the dilemma facing investors today: stocks and bonds are overpriced, so what do you do?


…Looking at stocks and bonds, are they both overpriced?

Asness on market valuations:

Yeah, they are…if you’re going to say, “what are the next 10 years going to look like?”…value has some power to forecast the next decade…right now my favorite measure of value…is Bob Shiller’s PE. It’s gotten very popular. I’ve been looking at it since the late 90s. And that’s about the 85th percentile expensive back to 1926, so only 15 percent of the time has it been more expensive. It’s occasionally been way more expensive, so percentiles…people can use them to be tricky. Statisticians have all kinds of tricks…We’re at 25 on the Shiller PE. The 100th percentile, hit in early 2000, was 45…I would not call this a bubble, I would just call this an expensive market.

Asness on real yields:

The real bond yield…that’s just the 10-year bond minus our best guess of what economists are forecasting for inflation. I say “our best guess,” because we have their actual guess for 20, 30 years, [but] databases don’t exist and we have to guess at what they were guessing before that, but that’s also about the 85th percentile. The difference between them is relatively normal. People focus on bonds because it feels much more measurable. And yields are [low]…[this is] not a commercial for bonds…85th isn’t so good.

Both [stocks and bonds] are very similar [at the 85th percentile]…For truly long term investors, I would not use this to time the market…I still think returns will be positive. So if you’re out of the market for the next 10 years, that’s not going to help, and I don’t think you’re going to get the exact timing right. But I would lower my expectations. Whether you’re a pension plan, or an individual with a sheet of paper trying to figure out, “how much do I need to retire?” if we are right that these higher than normal prices, [and] lower than normal yields, are going to lead to positive, but lower than normal returns, well, you have to use those.

We think a 60/40 portfolio of U.S. stocks and bonds has averaged about 5% over inflation historically. We think, even if valuations stay high — and it could be worse if valuations fall, right? Regression to the mean. If those PEs come down, it could be worse — but even if they stay high we think they…offer 2 to 3 percent over inflation.


…You’ve said two and half percent real return. That sucks!


…You are obviously well-versed in the technical quantitative terms, but yeah, versus history, that sucks…It’s actually about the worst ever, and if you heard me, I said bonds are 85th and stocks are 85th, neither were the worst ever, but what’s particularly rare is both are in the 85th percentile at the same time. Even in the peak of the tech bubble, where stocks made a new 100th percentile bad in terms of valuation…(they made a new 100th percentile every day), bonds were offering you a fat 4% real yield on government bonds just for showing up. So very often these things are at least to some degree offsetting.

Right now we have a time where I don’t think (and some disagree) that there is a tremendous trade in or out of stocks versus bonds. And I don’t think you want to sell them both if you are long term because timing that is not an easy exercise. You’re very likely to hurt yourself…I think more likely than to help yourself.  I think the best to do is, yes, it might suck, but it’s still positive, and it’s still the deal that we’re being given.

Asness reiterating opportunity costs:

…If something “sucks,” but it’s the best deal out there, the one thing you don’t want to do is ignore the bad news. Have a sheet of paper that says, “I can retire,” (and by the way, pension funds do it in a more sophisticated way with actuaries and other things, but it’s not that different than individuals with a spreadsheet or a sheet of paper), “[so] what do I have to earn on these assets to meet my needs?” If you don’t acknowledge the 2.5% real, and you don’t have to agree with my precise numbers, but if you don’t acknowledge that these are expensive, and going to return less, and go, “well, I think inflation is going to be more like 3%, and they’re going to make their normal 7% real, so I think [a 60/40 portfolio is]  going to make 10% going forward”…If you use that and it doesn’t happen, that’s where the trouble lies.

So I think this stuff, while it might be depressing, and not useful to jump in and out, is actually quite useful for making your plans, because you know what you gotta do…and the world, sadly, is up against a harder challenge than it normally is.

What’s the bottomline?

Unicorns, fairy godmothers, and trolls all exist in fantasyland.

Similarly, 10% annual returns–without exceptional risk–likely exist only in fantasyland.

Maybe we should all be planning for reality, but hoping for a fantasy…?

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About the Author:

David Foulke
Mr. Foulke is currently an owner/manager at Tradingfront, Inc., a white-label robo advisor platform. Previously he was a Managing Member of Alpha Architect, a quantitative asset manager. Prior to joining Alpha Architect, he was a Senior Vice President at Pardee Resources Company, a manager of natural resource assets, including investments in mineral rights, timber and renewables. He has also worked in investment banking and capital markets roles within the financial services industry, including at Houlihan Lokey, GE Capital, and Burnham Financial. He also founded two technology companies:, an internet-based provider of automated translation services, and, an online wholesaler of stone and tile. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.


  1. The_early_trader July 21, 2014 at 12:27 pm

    I started an pension plan last October with an year target of 2 % by the the end of 2014 (very defensive). Today I have over 10 % on almost no high beta assets, what shuld I do? Get out of stocks, enjoy my 8 % surplus and wait on a yield rise or stay invested and see it maybe melted?? Remember, its pension money which is needed
    Problem: There are no undervalued assets to switch my higher risks in.

    2.5 % real is not bad in a zero-interest area.

  2. Michael Milburn July 22, 2014 at 11:36 pm

    David, have you done any work w/ the low beta/low risk approach Asness mentions in the Forbes interview? I did a quick run through on 2000-2012 data on SP500 companies and don’t see low volatility outperforming in a noticeable way. Actually it seemed like selecting based on high volatility at the extremes (stocks that average about 4X+ market volatility levels based on daily % range) seemed to outperform instead. Alot of the current higher volatility names also seem to be the high momentum names, so there seems to be some overlap.

    Anyhow, just curious if I should dig more. I like some of the companies w/ low volatility from a quality standpoint (firms like CB, MCD, WMT, BRK.A), but the anomalous high returns seemed to be around high volatility.

    • Jack Vogel
      Jack Vogel, PhD July 22, 2014 at 11:46 pm

      Michael, here is one post on low volatility investing we recently wrote. The post references a paper written about this topic:

      • Michael Milburn July 22, 2014 at 11:58 pm

        Jack, Thank you for the reply. I had not seen that post (I just recently found this site). It’s interesting that a short interest binary so effectively interacts w/ volatility.

        • Jack Vogel
          Jack Vogel, PhD July 23, 2014 at 12:06 am

          Your welcome, hope you like the site! We agree and are a little disconcerted that one variable (short interest) can effectively ruin a strategy (low volatility).

          • Michael Milburn July 23, 2014 at 12:38 am

            I do. I love this site! There aren’t many places where these topics are discussed.

            Re short interest: There’s good info here, imho. Many of the high momentum stocks also seem to have high volatility so might apply there also? I’m actually a bit inclined to look at high volatility as an approach based on initial results of what I’m seeing, so the short interest finding is intriguing in that context. High volatility might just turn out to be a stealth momentum strategy, but I’m not sure.

          • Michael Milburn July 23, 2014 at 12:47 am

            I meant to type “so short interest might apply there also.”

          • Jack Vogel
            Jack Vogel, PhD July 23, 2014 at 2:27 pm

            I am not sure about the correlation between high momentum and high volatility; it would be interesting to see their relationship.

          • Michael Milburn July 23, 2014 at 5:16 pm

            Jack, there might not be as much to the volatility/momentum as I was thinking there might be. I ran some numbers on companies today that are 20% or more stronger than the market over the past 6mo, and then looked at price volatility over past 6 mo, Here’s the list from SP database.

            The volatility column is a multiple of volatility vs. the index, and avg company seems to be around 2X. Most of these companies w/ momentum are more volatile, but not outrageously so. Avg for the hi momentum group is 2.6X, median 2.5x.

            ticker, price 7-22, volatility
            AA 17.09 2.9
            AGN 170.43 2.81
            AIV 33.86 1.72
            AMAT 22.52 2.63
            APC 108.32 2.45
            ATVI 22.94 2.44
            BHI 74.69 2.12
            BRCM 38.75 2.31
            DVN 78.15 1.99
            EA 38.42 2.88
            EOG 116.55 2.47
            ETR 76 1.76
            GMCR 121.88 4.55
            HAL 73.29 2.29
            HAR 114.31 3.27
            HP 116.04 2.53
            HUM 133.56 2.59
            ILMN 176.31 5.03
            INTC 34.79 1.78
            KR 50.17 1.84
            LNG 74.5 3.76
            LRCX 71.58 2.61
            LUV 28.05 2.62
            MAR 66.11 1.81
            MMP 86.1 2.2
            MU 33.63 3.66
            NBR 28.96 3.28
            NFLX 431.09 3.92
            NFX 44.82 3.2
            POM 27.5 1.52
            PXD 229.17 3.11
            SLB 113.41 1.82
            SNDK 94.64 2.75
            TAP 72.44 1.72
            TEG 69.07 1.72
            WMB 58.45 2.16

            Avg 2.6
            median 2.5

            What’s the goal of looking at this?

            I guess my initial thought is that maybe some stocks (lower volatility) might need to have less momentum to be predictive than others (higher volatility).

            For example: INTC recently acquired momentum status but has lower than average volatility at 1.78x index volatility. So I wonder does a big company like INTC have to move less than others for it’s movement to be predictive? Do different momentum thresholds apply based on characteristics of the company (ex: INTC vs. something like GMCR or ILMN which have much higher volatilities 4-5X.)

            Anyhow, that’s the loose idea. I’m not really sure what type of volatility makes sense in the context when paired w/ longer term momentum. For example: Is daily price volatility really meaningful when looking at price strength measured over months? I’m really not sure, but maybe a longer term volatility might be more telling?

            I guess underlying it all is the idea that smaller levels of momentum in some companies might be more meaningful than larger moves in other companies, and am thinking of maybe tuning the signals to this if possible.

            Anyhow… 🙂

          • Jack Vogel
            Jack Vogel, PhD July 23, 2014 at 8:17 pm

            Michael, here is a paper which finds that high momentum firms with less volatility have more persistent returns (relative to high momentum firms with higher volatility). This speaks to your intuition you posted: “I guess underlying it all is the idea that smaller levels of momentum in some companies might be more meaningful than larger moves in other companies, and am thinking of maybe tuning the signals to this if possible.”


            Hope you enjoy the paper!

          • Michael Milburn July 23, 2014 at 9:20 pm

            That’s an interesting framework to think about volatility and trends. Sounds like we might want distinguish between “smooth” momentum and “spiky” momentum.

            Maybe distinguish between something like Alcoa AA which has a relatively high daily price range variance of 2.9x index, but otherwise has a smooth trend similar to what we might expect from continuous information drip.
            Despite above average daily price range volatility, it’s longer term trend path seems smoother.

            Something like GMCR seems to have more discreet information bumps w/ 4.5X index volatility:
            Based on the paper, we might think GMCR has higher likelihood of flaming out because it’s information trend looks less continuous and more discrete.

            Intel, INTC, in this context actually looks a little bit spiky in recent months despite it’s lower avg daily price volatility over the past 6mo:

            Good stuff to think about. Thanks for the link.

          • Jack Vogel
            Jack Vogel, PhD July 23, 2014 at 10:30 pm

            Your welcome, thanks for the comments.

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