MIPS Expected Return Inputs, very rough/incomplete overview:

Supplementing systematic data with discretionary information - but doing so in a process-driven way
Part 1: Components of expected excess return estimates
CATEGORIES:
i

estimating expected
returns

Historical Data:
Quantity, quality,
present-day
relevance
Core forecasting
metric (if any)
Belief discounting:
primarily systematic
Belief discounting:
primarily qualitative
Examples: Academic papers
Long-dated vs.
recency weighted
While IS, adjust if
not full-cycle?
Starting yields
Merger arb spreads
Behavior post-
publication
Overcrowding (as
measured by
changes in asset
inflows)
Robustness of
economic
justification
Limits to arbitrage /
capacity estimates
STRATEGIES/AC's:
World Bonds (IG):
Contribution %:
E[return] estimate or
reduction, if applicable
Long-dated
25%
Yes, but weighted
Yield
65%

Yes, but weighted?
[TK]

5%

5%
Value effect:
Contribution %:
E[return] estimate or
reduction, if applicable
Papers. F-F data.
30%
250bps
Book/Market
10-25%
[TK]
15-25%

20-45%
Equity smart beta: max
deconcentration
Contribution %:
E[return] estimate or
reduction, if applicable
Sci-Beta data (40
yrs after fri)


..

Part 2: Excess return estimates for optimizer
Strategy E[excess return], start of In
Sample
Vary over time: forecast? Vary over time: other?
World Bonds (IG): 2% Yes
Value effect: 1.75% Yes (but implement later) Possibly
Equity smart beta: max
deconcentration
[better number once we
have 40-year data]
Unlikely Post-publication-ish
.




Comment [AL1]: Possible sub-heading on part
of a presentation slide, or still way too strong?

Variant could be smthng like
Process-driven improvements to systematic [risk
factor, etc] collection:
Comment [AL2]: This is a very loosely structured
chart - improvements welcome (fixing the
appearance and categories is lower priority)
Comment [AL3]: We'll obviously have our core
time series (the ones that we're still using to
generate our covariance matrix via REF). These are
often shorter in timeframe, or proxies for indices
that better capture "true" effects - so the average
historical return (resampled or not) calculated from
those time series can stand to be greatly enhanced.

To supplement our go-forward return estimates:
1. Use quality academic papers / white papers that
might have better historical returns (though no time
series) [Ivona: this will draw from the strategy
summaries]
2. Use longer timeframe historical data (since some
of our core time series go back much further than
20 years)
etc.
Comment [AL4]: I'm not typically going to put
some excess return estimate in each column, and
then literally weight by contribution %.

Would welcome other more intuitive ranking
schema, but I also think the precise form matters
less than having some kind of structure

Comment [AL5]:
Our World Bonds (IG) index includes corporate and
gov't bonds, etc. Normally, historical data / papers
tend to break these up by categories.
Comment [AL6]: BONDS only: for gen0
convenience, might incorporate yield variable more
directly into E(returns)
Comment [AL7]: details will be in strategy
summary slides
Comment [AL8]: These numbers are EXTRA
placeholderish
Comment [AL9]: Discount belief after generic
smart beta papers were published.
Probably not much additional discount after EDHEC-
SciBeta papers published
Some comments:
1) Most of the above happens outside Infrastructure's optimizer implementation, and we definitely don't have to fill
out every line of every chart for every effect/AC before proceeding
2) REF implementation still drives covariances/variances; resampling of negatively skewed+fat-tailed distributions also
implicitly increases weight on shock risk (even before we add explicit shock risk implementation)
3) Asset classes vs. effects/strategies: asset class return forecasts are likely to be driven to different degrees by starting
yields - gov't bonds are the prime example (corporate bonds less so)
4) As mentioned above, these categories are loosely defined and clearly overlap, e.g.
a. Historical data on an effect may go back fifty years and also be of high quality. However, if we believe (and
seem to verify) that post-publication decay of effect over time is significant, we put less emphasis on
historical data (and more emphasis on beliefing down the go-forward effect)
5) SPTR-hedging (or duration hedging for bonds) - future implementation
a. Most relevant for AC's like bonds, equities, but also potentially relevant for strategies.
b. In ideal world, would try to do SPTR hedging for almost every return series.
c. Purer, hedged excess returns might make qualitative estimates/adjustments easier to think about
d. In current implementation, will only add beta-hedging on an as-needed/as-easy basis:
i. E.g., for AC's like bonds, it's most relevant _and_ easiest to do (but even there, I'll probably avoid for
gen0)
ii. Would definitely delay implementation for most effects/strategies (a lower-priority task: higher
frequency return data->infrastructure for clean/match->better betas)
e. Note:
i. Large % of higher-quality academic studies (even of mkt-neutral strategies) will have non beta-
hedged returns. [placeholder: foolish consistency pt]
ii. Marginal issue: backtests could be more confusing from a presentation standpoint if we're listing
each return series (some w/hedges, some w/o). Probably fine.
6) Interaction of excess return adjustments with covariance matrix - Deepee input here especially valuable
a. Say excess return expectations were scaled down by for belief. Scaling down covariance entries by
(variances by ()^2) - still seems iffy to me. (I will also try to quickly run some of this stuff by Kahn, hopefully
if he's free this weekend.)
i. Especially wrong when effects are not beta-hedged.
ii. Would rather just leave them w/o rescaling - this is effectively a double penalty [fill in explanation
later, probably during conversation topic tonight]
b. Try to treat tilt forecasts as independent/separate from E[Returns]? (probably not worth effort unless
Deepee disagrees)



i
These categories are loosely defined, can overlap, and may appear aggressive wrt what investors / Magnitude would find credible.
ALSO: many of these #'s are approximate placeholders
Comment [AL10]: NTS: explicitly mention
variances instead of just writing covariances
Comment [AL11]: strategies with legitimate
positive skew basically a non-issue right now