Fear, Not Risk: Rethinking the Equity Premium with Rob Arnott and Ed McQuarrie
Rob Arnott and Ed McQuarrie challenge a foundational assumption of modern finance: that risk drives returns. For 60 years, Capital Asset Pricing Model has treated investors as equally averse to losses and gains—obviously false, yet academically convenient because the math is tractable.
Fear actually operates bidirectionally. Fear of loss versus fear of missing out. Ed's 19th-century data demolished "stocks for the long run"—an entire century produced no equity premium. Rob's factor analysis shows value and size outperform without higher volatility, contradicting risk-based explanations. The celebrated 1950-2000 equity run? Half came from dividend yields collapsing from 8% to 1%—multiple expansion, not growth.
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What We Cover in This Conversation
Why CAPM's symmetric risk assumption persists despite being obviously false
Ed's 19th-century data: A century with no equity premium
Fear of loss vs. fear of missing out as bidirectional drivers
Factor premiums that exist independent of volatility
How much of 1950-2000 gains came from multiple expansion vs. growth
Academic resistance and the convenience of tractable mathematics
Target date funds: Markovitzian creatures ignoring behavioral reality
Tobin's two-fund solution for addressing actual investor fears
Current yield spreads and what they imply about expected returns
Nonstationarity and building "roughly right" portfolios
Key Takeaways
Fear is bidirectional, not unidirectional. Investors fear losing money and fear missing gains. When fear of missing out dominates, expected returns can turn negative even as perceived risk remains high.
The 19th century produced no equity premium. Ed's data covering 1803-1900 shows patient equity investors weren't systematically rewarded, destroying the "stocks for the long run" narrative's universality.
Factor premiums don't correlate with volatility across periods. Value and size produce higher returns without consistently higher standard deviation, invalidating traditional risk-based explanations for their existence.
Target date funds solve the wrong problem. Built to minimize standard deviation rather than address fear of loss, they leave investors exposed when liquidity is needed during downturns.
Timestamps
00:00 - Introductions: Contrarian research and questioning consensus
05:00 - Core thesis: Fear, not risk, drives asset pricing
07:00 - Ed's 19th-century data: Century with no equity premium
12:00 - The risk premium conundrum: If stocks always win, where's the risk?
14:00 - Fear of loss vs. fear of missing out
18:00 - Factor investing: Why value and size work without higher volatility
20:00 - Rob's exhibit: Factor returns show no consistent risk-return relationship
28:00 - Academic frustration: Why CAPM's false assumptions persist
32:00 - Target date funds as Markovitzian creatures
34:00 - Tobin's two-fund theory adapted for behavioral reality
37:00 - Historical yields: 1950 vs. 2000 vs. today
43:00 - Rapid-fire questions
About Rob Arnott
Rob Arnott is founder and chairman of Research Affiliates, pioneer of smart beta and fundamental indexing. He's authored 150+ articles, served as Financial Analyst Journal editor-in-chief, and received Graham and Dodd Awards and the ETF Lifetime Achievement Award. Research Affiliates strategies manage approximately $150 billion worldwide.
About Ed McQuarrie
Ed McQuarrie is Professor Emeritus of Marketing at Santa Clara University with a PhD in social psychology from the University of Cincinnati. His Financial Analyst Journal paper on 19th-century returns received Graham and Dodd recognition.
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Disclaimer
The content of "Treussard Talks" is for informational and educational purposes only and should not be considered financial advice. The views expressed are those of the host and guests and do not necessarily reflect the opinions of Treussard Capital Management or its affiliates. Consult your own financial advisor before making any investment decisions. For full disclosures, visit treussard.com.