Expected Return: Asset Classes, Strategy Styles, and Risk Factors

Recently, the Institutional Department of the China Securities Regulatory Commission (CSRC) issued the 'Notice on Carrying Out Pilot Programs for Publicly Offered Securities Investment Fund Advisory Services' (hereinafter referred to as the 'Notice'), officially launching the long-awaited pilot program for publicly offered fund advisory services. The investment advisory business functions similarly to an intermediary—FOFs operated by securities firms or private fund managers often play a comparable role. To serve effectively in an advisory capacity, one must possess not only expertise on the funding side but also deep familiarity with and command of the asset side. Coincidentally, I had just finished reading Antti Ilmanen’s 2011 book Expected Return, whose insights struck me as highly illuminating. Expected Return was published in 2011 by Antti Ilmanen, a partner at AQR Capital Management. Though over a decade old, its analyses and perspectives remain remarkably current. The book comprehensively examines numerous sources of investment returns: major asset classes (equities, bonds, alternative investments, etc.), strategy styles (value, carry, momentum, etc.), and risk factors (growth, liquidity, tail risk, etc.). It also outlines several key elements for assessing investment returns: historical performance, investment theories (e.g., market efficiency theory, asset pricing theory, portfolio optimization theory), and forward-looking indicators. (Those unwilling to read further can simply refer to the diagram below.) 1. Key Content of the Book This book is an encyclopedic survey. Readers seeking thorough understanding are encouraged to consult the original text (those interested in an electronic version may follow and leave their email address). This article merely highlights some essential points. The first seven chapters critically review historical returns across asset classes and explore theoretical foundations—including rational theories grounded in market efficiency, as well as behavioral finance perspectives addressing arbitrage constraints and psychological biases. The core of the book can be visualized using the following cubic diagram, whose three faces represent asset classes, strategy styles, and risk factors. Expected return sources can thus be holistically analyzed from these three interrelated dimensions. The first face—asset classes—discusses risk premiums (Risk Premium) across equities, bonds, credit bonds, and alternative assets (REITs, commodities, hedge funds, private equity), offering extensive theoretical and empirical summaries for each category. The second face focuses on equity-based value strategies, currency carry strategies, commodity trend-following strategies, and options (short-volatility) strategies—detailing their historical origins and explaining why such strategies have succeeded. The third face addresses risk factors (or 'factors'), including growth, inflation, liquidity, and tail-risk factors (e.g., volatility, correlation, skewness), along with their empirical performance and patterns of return decay over time. The third part covers broader themes, including feedback effects of expected returns, forward-looking indicators of asset returns, seasonal patterns, cyclical return variations, long-term return outlooks, and methods to enhance returns through risk control, horizon management, skill enhancement, and cost optimization. This section is closely tied to practice, emphasizing issues such as strategy overcrowding, portfolio construction across assets, strategies, and factors, and improving portfolio returns via leverage and cost optimization.

How to Better Understand Key Financial Statement Indicators—In-Depth Explanation of EBIT (Earnings Before Interest and Taxes) and Its Year-on-Year Growth Rate, and Their Analytical Applications

EBIT (Earnings Before Interest and Taxes) analysis is essential primarily because enterprises operate under varying business environments, which significantly affect net profit. Relying solely on net profit for comparative analysis therefore introduces bias. As noted earlier, analyzing EBIT and its year-on-year growth rate serves to eliminate environmental differences—such as disparities across peer firms within the same industry or across different periods for the same firm—thereby enabling a more accurate assessment of a company’s underlying operational capability. These environmental differences mainly manifest in two ways: 1. Differences in shareholders’ capital contributions: Firms with insufficient equity investment rely more heavily on bank loans to fund operations, resulting in higher interest expenses than peers with ample shareholder capital. This artificially depresses their net profit, rendering comparisons unfair. 2. Differences in policy environments: Within the same industry, some firms benefit from corporate income tax incentives while others do not. Even if operational capabilities are identical, firms enjoying tax preferences will inevitably report higher after-tax net profits—or net profit margins—than those without such benefits, again distorting fair comparison. EBIT and its year-on-year growth rate effectively neutralize these environmental influences, placing firms on a level playing field for comparative analysis. Only then can investors identify truly valuable investment candidates—those demonstrating superior profitability and growth potential. Both EBIT and its year-on-year growth rate are positive indicators: larger values are favorable for the enterprise; smaller values are unfavorable. Analysts typically adopt segmented accounting-period approaches—examining EBIT and its growth rate based on current period, quarterly, or annualized figures. i. Quarterly EBIT or its year-on-year growth rate refers to the EBIT and corresponding growth rate realized by the enterprise during a specific quarter. ii. Current-period EBIT denotes cumulative EBIT from the start of the fiscal year through the financial statement’s reporting date. For example, the semi-annual report’s EBIT covers January–June (two quarters), whereas the third-quarter report’s current-period EBIT covers January–September (three quarters). iii. Annualized EBIT is calculated by summing EBIT over the most recent four consecutive quarters. This approach smooths out seasonal fluctuations, enabling meaningful year-on-year or quarter-on-quarter comparisons across different periods. For instance, the annualized EBIT for Q3 2018 becomes directly comparable to that for Q2 2018. In contrast, raw quarterly or current-period EBIT and its growth rate are only meaningfully comparable year-on-year—not quarter-on-quarter—where such comparisons lack validity and analytical significance. By jointly analyzing annualized EBIT and its year-on-year growth rate, analysts obtain dynamic, near-calendar-year EBIT and growth metrics that most closely reflect a company’s true annual operating performance.

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