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The Idolatry of Interest Rates Part II / The Idolatry Companion
Report

The Idolatry of Interest Rates Part II / The Idolatry Companion

Financial Heresy / Potential Utility in an Equity Risk Premium Framework

GMO, 2015

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Editorial Rating

8

Qualities

  • Innovative

Recommendation

Depending on whether you trust in professional asset managers or in a combination of index funds and FinTech algorithms, you likely believe that investing is either complex or simple. In an industry in which past performance is no guarantee of future returns, it is helpful to understand on what those sober professionals and FinTech entrepreneurs are basing their decisions. Asset allocation experts James Montier and Ben Inker take opposing sides on two of the most hallowed investing concepts, the natural rate of interest and the equity risk premium. Though never giving investment advice, getAbstract suggests this intriguing though complex challenge to investors everywhere.

Summary

The real interest rate is a function more of central bank policy than of natural market forces. If no equilibrium real interest rate exists, any model of investment returns based on future interest rate developments is at a severe disadvantage. If interest rates don’t move toward equilibrium, then anticipating the future levels of interest rates is akin to judging the future decisions of central bankers who may not even have taken office yet. Building investment plans on such a weak foundation is dangerous. The present value of an equity investment is the sum of its future cash flows, discounted at some interest...

About the Authors

James Montier works for investment management firm GMO, where Ben Inker is the co-head of asset allocation.