Prepare for Long Period of Low Returns

A recent article in CFA Institute offers insight from AQR’s Antti Ilmanen on how investors can adapt to a low-interest rate environment.

The article reports that at a recent conference in Denmark, Danmarks Nationalbank Board of Governors chair Lars Rohde said it would be wise for “the financial sector and investors to prepare for a long period of very low interest rates.”

“Past this point,” the article notes, “a brave new world awaits, one in which previously reliable central bank policies whose outcomes were largely predictable will cease to be effective.”

Ilmanen offers the following insights on “possible pathways and their drawbacks amid a continuing low-returns scenario.”

  • More equities: Although equities have a good track record, they might be carrying more risk due to the late stage of the current cycle. It’s difficult to gauge market maturity, especially at this stage of a bull market—and Ilmanen believes the strategy of bulking up on equities might be overused, adding, “Hopefully, it’s not the only answer.”
  • More illiquid/private assets: The Yale Endowment, among others, has focused on private and alternative investments to support its long-term strategy, but there is very little data available on premia associated with these asset classes. Ilmanen says, “There is something very useful in illiquid assets, but not as useful as currently thought.”
  • Add factor tilts: AQR research points to evidence of style premia, “and not necessarily just for long-only equity portfolios. In fact, long-short multi-asset portfolios show the most potential for diversification benefits.”
  • Accept, Prepare, Adapt: Ilmanen warns there is no single strategy that will create a high-return environment, but that the aforementioned “three solutions in a wide-harvesting approach that combines diversification across premia is a good start.”

The more difficult question, Ilmanen asserts, is what to avoid. He advises investors against attempting to time the market, adding that “very low rates for a very long time could lead to a returns dystopia, in which previously successful investment strategies, like traditional monetary policies, no longer function.”