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It seems like these excess returns are a special case of the general principle that taking on more risk yields higher average rewards at the cost of more volati

It seems like these excess returns are a special case of the general principle that taking on more risk yields higher average rewards at the cost of more volatility. (Compare stocks vs. bonds, for example [0].) Quoting from the third link above: > So it has high excess returns and has worked basically everywhere it has been tested, what’s not to like? As the authors go on to say, this incredible performance is also accompanied by periodic, soul-crushing declines: > "In 1932, the winners-minus-losers (WML) strategy [momentum] delivered a -91.59% return in just two months. In 2009, momentum experienced a crash of -73.42% in three months. Even the large returns of momentum do not compensate an investor with reasonable risk aversion for these sudden crashes that take decades to recover from." > This is why momentum investing can be so deadly. When things are going right, they can go very right, but when they go wrong, it can get ugly fast. [0] See https://www.investopedia.com/terms/e/equityriskpremium.asp https://www.investopedia.com/terms/e/equityriskpremium.asp or the corresponding Wikipedia article.

throw0101a 6y ago
> It seems like these excess returns are a special case of the general principle that taking on more risk yields higher average rewards at the cost of more volatility. Yes, but there are times when one takes on extra risks that offer no added reward: > [Mladina's] findings[0] were surprising. The factor exposure of real estate roughly resembles that of a portfolio consisting of 60% small-cap value stocks and 40% high-yield bonds. This tells us that REITs are not necessarily going to give us something we could not already get by investing in stocks and bonds. > But there’s more to know. One of the study’s most important findings also suggested that real estate risk is primarily driven by the idiosyncratic risk of the real estate sector. This point is crucial to understanding why REITs might not fit into a portfolio as perfectly as presumed. Put another way, Mladina found that REIT returns were explained by priced risk factors, but real estate risk was primarily driven by the idiosyncratic risk of the real estate sector, which is not a priced risk. That is, it is not a risk that you expect a positive return for taking. * https://rationalreminder.ca/blog/2019/8/23/reconsidering-reits-in-your-investment-portfolio https://rationalreminder.ca/blog/2019/8/23/reconsidering-rei... * [0] https://joi.pm-research.com/content/27/1/109 https://joi.pm-research.com/content/27/1/109 So momentum does have added risk, but one is rewarded for it. Similarly for small-cap: smaller companies are riskier than larger ones, and so a (rational) investor would demand more reward (returns) for investing in such a company.

throw0101a 6y ago

> It seems like these excess returns are a special case of the general principle that taking on more risk yields higher average rewards at the cost of more volatility. Yes, but there are times when one takes on extra risks that offer no added reward: > [Mladina's] findings[0] were surprising. The factor exposure of real estate roughly resembles that of a portfolio consisting of 60% small-cap value stocks and 40% high-yield bonds. This tells us that REITs are not necessarily going to give us something we could not already get by investing in stocks and bonds. > But there’s more to know. One of the study’s most important findings also suggested that real estate risk is primarily driven by the idiosyncratic risk of the real estate sector. This point is crucial to understanding why REITs might not fit into a portfolio as perfectly as presumed. Put another way, Mladina found that REIT returns were explained by priced risk factors, but real estate risk was primarily driven by the idiosyncratic risk of the real estate sector, which is not a priced risk. That is, it is not a risk that you expect a positive return for taking. * https://rationalreminder.ca/blog/2019/8/23/reconsidering-reits-in-your-investment-portfolio https://rationalreminder.ca/blog/2019/8/23/reconsidering-rei... * [0] https://joi.pm-research.com/content/27/1/109 https://joi.pm-research.com/content/27/1/109 So momentum does have added risk, but one is rewarded for it. Similarly for small-cap: smaller companies are riskier than larger ones, and so a (rational) investor would demand more reward (returns) for investing in such a company.