Claude B. Erb

Expected Returns and Volatility in 135 Countries

We analyze expected returns and volatility in 135 different markets. We argue that country credit risk is a proxy for the ex-ante risk exposure of, particularly, segmented developing countries. We fit a time-series cross-sectional regression using data on the 47 countries which have equity markets. These regressions predict both expected returns and volatility using credit risk as a single explanatory variable. We then use the credit rating data on the other 88 countries to project hurdle rates and volatility into the future. Finally, we calculate for each country, the expected time in years, given the forecasted country risk premium and volatility, for an investor to break even and double the initial investment - with 90% probability. This is the final working paper version of our 1996 Journal of Portfolio Management paper.

The Strategic and Tactical Value of Commodity Futures

Investors face numerous challenges when seeking to estimate the prospective performance of a long-only investment in commodity futures. For instance, historically, the average annualized excess return of the average individual commodity futures has been approximately zero and commodity futures returns have been largely uncorrelated with one another. The prospective annualized excess return of a rebalanced portfolio of commodity futures, however, can be “equity-like.“ Some security characteristics (such as the term structure of futures prices) and some portfolio strategies have historically been rewarded with above-average returns. It is important to avoid naive extrapolation of historical returns and to strike a balance between dependable sources of return and possible sources of return.

The Tactical and Strategic Value of Commodity Futures

Historically, commodity futures have had excess returns similar to those of equities. But what should we expect in the future? The usual risk factors are unable to explain the time-series variation in excess returns. In addition, our evidence suggests that commodity futures are an inconsistent, if not tenuous, hedge against unexpected inflation. Further, the historically high average returns to a commodity futures portfolio are largely driven by the choice of weighting schemes. Indeed, an equally weighted long-only portfolio of commodity futures returns has approximately a zero excess return over the past 25 years. Our portfolio analysis suggests that the a long-only strategic allocation to commodities as a general asset class is a bet on the future term structure of commodity prices, in general, and on specific portfolio weighting schemes, in particular. In contrast, we provide evidence that there are distinct benefits to an asset allocation overlay that tactically allocates using commodity futures exposures. We examine three trading strategies that use both momentum and the term structure of futures prices. We find that the tactical strategies provide higher average returns and lower risk than a long-only commodity futures exposure.

The Influence of Political, Economic and Financial Risk on Expected Fixed Income Returns

Is there information in the commonly used indicators of country risk for expected global fixed income returns and volatility? We examine the information content in publicly available measures of political, financial and economic risk. We find that these ex-ante measures contain important information about the cross-section of expected fixed income and currency returns. Trading strategies based on the change in, and level of, these risk measures produce positive risk-adjusted returns. We find that the country risk measures are significantly correlated with international bond metrics, such as real yields. This is the final working paper version of our 1996 Journal of Fixed Income publication.

New Perspectives on Emerging Market Bonds

This article examine the role of emerging market bonds in global investment portfolios. The authors explore the history of these bonds and examine expected returns, risk, and higher moments with data extending though the emerging market crash. The authors find that country risk measures are valuable in explaining expected returns and volatilities in these markets. They also argue that the high expected returns are compensation for large negative skewness risk.

The behavior of emerging market returns

The behavior of emerging market returns differs substantially from the behavior of developed equity market returns. We show that these differences have persisted in the period ending March 1996 but, at the same time, document how some salient characteristics of emerging markets vary through time. Finally, we offer some ideas on the forces that drive the cross-section of returns, volatility, skewness, kurtosis and correlation in emerging markets and detail the implications for asset allocation.

National Risk in Global Fixed-Income Allocation

TADAS E. VISKANTA is an asset allocation analyst for First Chicago Corporation. hile national equity market returns have received considerable attention in the tactical global asset allocation decision, relatively little W is known about national fixed-income returns. Our goal is to explore measures of global fixed-income risk that let us explain why expected fixed-income returns differ across national markets. An understanding of the risk and expected return relation is critical for successful allocation decisions. Interestingly, the attractiveness of global fixedincome as an active asset class is somewhat in dispute. Some authors, such as Burik and Ennis [1990], argue that investors derive little benefit from including foreign bonds in their portfolios. Others, such as Levy and Lerman [1988], argue that unhedged foreign bonds belong in diverslfied portfolios. Eaker and Grant [ 19911 state that the empirical failure of uncovered interest rate parity and the success of naive currency strategies suggest that international diversification of fixed-income portfolios is potentially beneficial. We take it as a given that global bonds should be an active investment class. But how do we measure the risk/expected return relation? There is an extensive literature on the domestic side that identifies bond attributes that explain the cross-section ’ of expected returns. For example, Litterman and Scheinkman [1991] and Scheinkman and Weiss [1991] propose a factor model for U.S. Treasury bonds. They interpret their factor loadings as proxies for interest rate sensitivity, term structure sensitivity, and volatility. But in looking at bonds within the U.S., they hold country risk constant. In their examination of corporate bonds in the U.S., Bennett, Esser, and Roth [1994] document a pos-

Conquering Misperceptions about Commodity Futures Investing

Long-only commodity futures returns have been very disappointing over the last decade, leading some to wonder if it was a mistake to invest in commodities. The poor performance is the result of poor “income returns” and not of falling commodity prices. This observation may be surprising for many commodity investors who were not aware, who misperceived, they were making a bet on income returns, a return building block similar to a stock’s dividend yield or a bond’s yield. For investors seeking an inflation hedge, it may be surprising that the historical linkage of commodity returns with inflation seems to be the result of a connection between commodity income returns and inflation, not, as commonly misperceived, commodity price returns and inflation. It may be surprising that the value of commodity investments is smaller than the market capitalization of Facebook, a potentially striking misperception for investors seeking a portfolio diversifier with abundant capacity. There has been no change in the way that price returns and income returns drive the total returns of stocks, bond and commodities. What has changed is that maybe a good number of commodity investors now realize that they were operating outside of their “circle of competence” and did not have a sense of what future price and income returns could be and would be.See our earlier papers on commodity investing:The Strategic and Tactical Value of Commodity Futures - http://ssrn.com/abstract=650923.The Golden Dilemma - http://ssrn.com/abstract=2078535.The Golden Constant - http://ssrn.com/abstract=2639284.An Impressionistic View of the ‘Real’ Price of Gold Around the World - http://ssrn.com/abstract=2148691.

The Risk and Expected Returns of African Equity Investment

Table 5.1 shows that historically, countries in Africa have lagged the economic performance of the rest of the world. Real gross domestic product growth averaged 2.2 per cent from 1978 to 1985, and 2 per cent from 1986 to 1993. This is slightly lower than the growth rates experienced in the developed world, and much lower than the rate of growth in Asia. Africa, and Sub-Saharan Africa in particular, has also carried relatively high debt loads. Africa represents about 8 per cent of developing world gross domestic product, and 15 per cent of developing world total debt. The numbers for Sub-Saharan Africa are 3.4 per cent and 8.6 per cent respectively. Generally, low levels of economic growth and high debt levels have not been associated with thriving equity markets.

An Impressionistic View of the 'Real' Price of Gold Around the World

The “real” price of gold in the U.S. is historically high, relative to its history as an actively tradable asset. But what about the real price of gold in other countries? It turns out that, in our impressionistic sample of 23 countries, the real price of gold is high everywhere. The real price of gold is high in “troubled” countries as well as in “safe” countries. If the real price of gold is a barometer of perceived troubles then there is trouble everywhere. Or, alternatively, gold is just expensive everywhere. This research is motivated by our earlier paper, Erb and Harvey (2012), The Golden Dilemma.