Roger Ibbotson22 March 2019

Roger Ibbotson Discusses the History of Finance (Podcast)

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Insights & moments

The myth-busts, hot takes, explainers, and tools worth keeping.

Myth Buster· 1

Myth Buster38:45

Why the Best Backtest May Fail in a Real Portfolio

An academically strong strategy can become unusable when it requires expensive trading. Even if costs are manageable initially, publication and investor adoption can direct enough capital toward the anomaly to change prices and erase its historical payoff.

High turnover can consume a theoretical return advantage.
Many investors cannot implement the lowest-cost version of a strategy.
Backtests describe past conditions rather than guaranteed future payoffs.
Discovery attracts capital to previously neglected trades.
Crowding can price an anomaly out of existence.

“A lot of the very best ideas have high trading costs”
Roger Ibbotson · 39:04

“once they're discovered and known, tend to be heavily invested in get popular actually, and once they get popular, they get priced out out of…”
Roger Ibbotson · 39:24

#backtesting#trading costs#strategy crowding#portfolio management

Hot Take· 1

Hot Take40:00

Why More Index Products Can Make Markets More Efficient

Ibbotson rejects the claim that indexing necessarily harms markets. Specialized ETFs and index funds let investors express precise views on industries, styles, and capitalization groups, reducing the unrelated exposures that previously obscured those trades.

Index products extend beyond broad market benchmarks.
Sector and style funds allow targeted investment views.
Targeted products reduce unrelated stock-specific noise.
Easier trade expression can improve rather than weaken market efficiency.

“I don't actually think it's hurting markets.”
Roger Ibbotson · 40:19

“that makes it markets more efficient because if we can target our opinions into a trade directly”
Roger Ibbotson · 41:10

#index funds#etfs#price discovery#market efficiency

Explainer· 4

Explainer04:04

How CRSP Turned Finance Into an Empirical Discipline

Before standardized market databases, researchers lacked a consistent picture of historical stock returns. CRSP supplied structured return data that universities could analyze, allowing financial theories to be tested against evidence rather than discussed only in the abstract.

Early researchers had little reliable knowledge of realized stock-market returns.
CRSP assembled consistent historical return data.
Universities beyond Chicago adopted the database.
The data enabled empirical testing of modern finance theories.

“Chris really put the data on the map.”
Roger Ibbotson · 05:19

“suddenly finance became an empirical subject that people people could study.”
Roger Ibbotson · 05:48

#crsp#financial history#market data#academic finance

Explainer16:45

What Historical Data Revealed About Risk Premiums

Ibbotson and colleagues organized stocks, bonds, Treasury bills, inflation, and defaultable debt to quantify the payoffs associated with different risks. The work translated emerging theories of equity, term, default, and real-interest-rate premiums into measurable historical evidence.

Equities earned a premium over safer assets.
Long bonds incorporated an interest-rate or term premium.
Lower-grade bonds offered a default premium.
Treasury bills could be compared with inflation to estimate real returns.
Historical measurements gave investors numbers for previously theoretical relationships.

“The purpose originally was to measure these risk premiums and see how they had done historically because we had the theory”
Roger Ibbotson · 17:46

“everybody could now see the numbers of the kinds of things that we kind of knew were there, but we hadn't seen the numbers.”
Roger Ibbotson · 18:01

#risk premium#asset allocation#bonds#equities#inflation

Explainer41:48

The Mathematical Reason Active Investors Lag After Costs

Active management is a relative zero-sum game before expenses because all investors collectively hold the market. For every investor who outperforms, another must underperform relative to the same benchmark; once costs are deducted, the average active result falls below the market.

Investors collectively earn the market return before costs.
Relative outperformance requires offsetting underperformance.
Fees and trading expenses lower the average result.
The argument is a mathematical identity, not merely an efficiency claim.
Overconfidence keeps investors participating despite the arithmetic.

“the market is a zero sum game before costs”
Roger Ibbotson · 41:48

“after costs, Uh, we're gonna on average do a little bit worse than the market.”
Roger Ibbotson · 42:01

#active management#zero sum#fees#benchmarks

Explainer48:56

How an Indexed Annuity Can Substitute for Bonds

With low starting yields and potential capital losses if rates rise, Ibbotson argues that conventional bonds may deliver weak or negative returns. He describes an insured, risk-controlled equity index offering partial upside participation with a protected downside, producing a return distribution intended to resemble bonds rather than stocks.

Bond returns combine yield with capital gains or losses.
Rising yields can cause substantial losses on long-duration bonds.
The described index targets five percent volatility.
Insurance and option structures protect the downside.
Reduced equity participation finances the protection.
The product is presented as a bond substitute, not a stock substitute.

“if he yields rise one percent and the duration is ten on a bond, you're you lose ten on that bond.”
Roger Ibbotson · 49:49

“It's not a substitute for stocks. It's a substitute for bonds that doesn't ever lose money.”
Roger Ibbotson · 53:09

#annuities#bonds#risk control#retirement income#interest rates

Story· 2

Story12:04

Reconstructing New York Stock Prices From 1815 Newspapers

Researchers extended New York Stock Exchange history back to 1815 by manually reading microfiche and old newspapers in Yale's Beinecke Library. Early listings contained relatively few companies, low trading activity, and stocks whose price behavior sometimes resembled bonds.

The historical series had to be collected manually.
Shipping newspapers also printed New York stock prices.
Early markets contained fewer than one hundred stocks for much of the period.
Sparse trading and par-like prices made early equities appear bond-like.

“we had to collect hand collect all that data”
Roger Ibbotson · 12:04

“They weren't that volatile.”
Roger Ibbotson · 13:44

#nyse#market history#historical data#equities

Story22:28

When a Basic Duration Formula Created Bond Opportunities

Duration had existed academically for decades before many practitioners learned to use it to estimate bond-price sensitivity. Ibbotson applied it while managing bonds in the 1970s, when delayed adoption left pricing distortions that would be unlikely to persist in today's faster information environment.

Duration links a yield change to an approximate bond-price change.
Academic knowledge once took decades to reach practitioners.
The delay created exploitable bond-price distortions.
Modern financial discoveries move into practice much faster.
Rapid adoption makes markets more efficient and arbitrage opportunities shorter-lived.

“with duration, you could figure out easily in your head how much if yield changed, how's the price of a bond would change?”
Roger Ibbotson · 22:46

“We're talking about thirty forty years of delay before something kind of caught on.”
Barry Ritholtz · 23:23

#duration#bond trading#arbitrage#market efficiency

Q&A· 1

Q&A19:01

Why Stocks Are Harder to Forecast Than Real Interest Rates

Ibbotson identifies equities as the most difficult major asset class to forecast because volatility creates substantial noise. Near-term real interest rates are more tractable because current inflation helps inform expected inflation, which in turn influences bill and bond yields.

Stock-market volatility makes equity forecasts highly uncertain.
Risk and forecast difficulty are related to the equity premium.
Expected inflation drives a large portion of nominal bond yields.
Current inflation can be informative about near-term expected inflation.
Long-horizon inflation forecasts remain less reliable.

“the hardest to forecast is always the stock market because there's so much volatility, there's so much noise.”
Roger Ibbotson · 19:09

“a very large part of a body yield is the expected inflation.”
Roger Ibbotson · 19:59

#forecasting#stocks#interest rates#inflation

Takeaway· 2

Takeaway43:25

The Post-2008 System Fixed the Last Crisis, Not the Next One

Post-crisis reforms reduced leverage and counterparty risk but did not permanently eliminate financial instability. Ibbotson credits the Federal Reserve's balance-sheet expansion with averting a severe breakdown, while warning that slow rate normalization left policymakers with less conventional firepower for a future recession.

Reforms primarily addressed leverage and counterparty risk.
Regulation can improve resilience while adding market burdens.
The Federal Reserve needed balance-sheet tools after rates reached zero.
Emergency intervention helped prevent a financial breakdown.
Persistently low rates reduced room for future rate cuts.

“I don't see these were as any permanent fixes.”
Roger Ibbotson · 44:14

“they don't have the same firepower going into any new activity that happens that we had back in oh eight.”
Roger Ibbotson · 48:47

#financial crisis#federal reserve#leverage#monetary policy

Takeaway1:04:34

Start With the Market Price Before Claiming an Edge

Efficient-market thinking gives portfolio managers a disciplined default: without special information, price is the best available estimate of value. That assumption reduces unnecessary trading and shifts the burden of proof onto any proposed deviation from the market.

Treat price as the default estimate of value when information is limited.
Do not assume every security is obviously mispriced.
Inaction can be a valid portfolio decision.
Trade only when the expected edge is strong enough to add value.
The starting assumption simplifies an otherwise overwhelming selection problem.

“if you know nothing about a company or or a security, it's the prices the kind of the best guess of what its value is.”
Roger Ibbotson · 1:05:08

“you only want to trade when you really do have the edge that you're actually going to add value.”
Roger Ibbotson · 1:05:45

#market efficiency#investing#portfolio management#decision making