As you describe, the expected returns are adjusted for inflation using the 10-year TIPS. But is the 10-year "actual" return similarly deflated somehow? Please note too that the footnote describing how the 10-year return is calculated seems to be missing a link to a previous column.
Yes, 10yr TIPS yield is currently negative and so "adding" this risk-free rate to an expected risk premium lowers the estimate. For instance, assume a 5% risk premium estimate. Adding a -1% risk free rate translates to a 4% expected total return. For comparison, if we used a nominal 10yr rate, which is current positive, the expected return would by higher than presented. Accordingly, expected return estimates can vary, sometimes substantially, depending on the definition of a risk-free rate. By comparison, the relative differences in return estimate are stable regardless of risk-free return estimate.
While this makes sense, it misses my question. (Maybe the question was unclear.) In comparing the expected 10 yr return to the past 10 yr return, it appears that the former is adjusted for the implied inflation (using the 10yr TIPS) while the latter is unadjusted for inflation. This makes the spread between the two seem much larger.
As an example, the 10 yr return for US REITs, as measured by VNQ, shows a nominal 10-yr return of 10.8% but a real return of 8.7% (source: portfolio visualizer.) So the spread between expected and past is actually 3.1 on real terms, which is somewhat less than the 5.0 shown in the post.
Dan M, the 10yr return in the table is total return and it reflects inflation, or so one can argue. If asset X earns 5% over the past 10 years it would seem to me that the asset's return reflects any inflation-adjustment. Or perhaps I'm missing something. So, the question, by what reasoning does an ex post not reflect an inflation component?
I am not sure if the past total return does reflect an inflation adjustment. So I remain confused.
At the risk of restating my previous point, when I look at VNQ's return using Portfolio Visualizer. the CGAR is 10.8% for the last 10-years, ending in October. This closely matches your table for the US REITs. The same site also reveals an inflation-adjusted CGAR for VNQ of 8.7%.
To clarify, total returns include inflation. By contrast, adjusting for inflation in total return will reduce the total return (assuming inflation was >0). Similarly, adding the TIPS yield to a risk premium matches total return. Make sense? As a side note, we can debate if the current TIPS yield, which is negative, is accurate/relevant for estimating future inflation. But that's a separate issue.
Mr. Picerno,
As you describe, the expected returns are adjusted for inflation using the 10-year TIPS. But is the 10-year "actual" return similarly deflated somehow? Please note too that the footnote describing how the 10-year return is calculated seems to be missing a link to a previous column.
Thanks,
DanM
DanM, Here's the link to the introductory piece on expected return: https://etfps.substack.com/p/the-etf-portfolio-strategist-18-august
Yes, 10yr TIPS yield is currently negative and so "adding" this risk-free rate to an expected risk premium lowers the estimate. For instance, assume a 5% risk premium estimate. Adding a -1% risk free rate translates to a 4% expected total return. For comparison, if we used a nominal 10yr rate, which is current positive, the expected return would by higher than presented. Accordingly, expected return estimates can vary, sometimes substantially, depending on the definition of a risk-free rate. By comparison, the relative differences in return estimate are stable regardless of risk-free return estimate.
While this makes sense, it misses my question. (Maybe the question was unclear.) In comparing the expected 10 yr return to the past 10 yr return, it appears that the former is adjusted for the implied inflation (using the 10yr TIPS) while the latter is unadjusted for inflation. This makes the spread between the two seem much larger.
As an example, the 10 yr return for US REITs, as measured by VNQ, shows a nominal 10-yr return of 10.8% but a real return of 8.7% (source: portfolio visualizer.) So the spread between expected and past is actually 3.1 on real terms, which is somewhat less than the 5.0 shown in the post.
Dan M, the 10yr return in the table is total return and it reflects inflation, or so one can argue. If asset X earns 5% over the past 10 years it would seem to me that the asset's return reflects any inflation-adjustment. Or perhaps I'm missing something. So, the question, by what reasoning does an ex post not reflect an inflation component?
I am not sure if the past total return does reflect an inflation adjustment. So I remain confused.
At the risk of restating my previous point, when I look at VNQ's return using Portfolio Visualizer. the CGAR is 10.8% for the last 10-years, ending in October. This closely matches your table for the US REITs. The same site also reveals an inflation-adjusted CGAR for VNQ of 8.7%.
To clarify, total returns include inflation. By contrast, adjusting for inflation in total return will reduce the total return (assuming inflation was >0). Similarly, adding the TIPS yield to a risk premium matches total return. Make sense? As a side note, we can debate if the current TIPS yield, which is negative, is accurate/relevant for estimating future inflation. But that's a separate issue.