Return drivers are the fundamental economic or behavioral forces that cause an investment to generate positive or negative returns over time. Identifying and understanding genuine return drivers — as opposed to spurious historical correlations — is the foundation of sustainable investment strategy design. A strategy built on a genuine, persistent return driver will continue to generate returns even as market participants become aware of it (because the driver reflects deep behavioral or structural forces). A strategy built on data mining will fail when its historical correlation to returns proves to have been coincidental.

The Major Systematic Return Drivers

Academic and empirical research has identified several return drivers with evidence of genuine persistence across markets and time periods. Equity risk premium: compensation for bearing equity market risk over the long run, reflected in the excess return of stocks over cash historically. Momentum: the tendency for recent price winners to continue outperforming — driven by investor underreaction, herding, and information diffusion dynamics. Value premium: the tendency for cheaply priced assets to outperform expensive ones over long horizons. Carry: the return from holding higher-yielding assets financed by lower-yielding ones, prevalent in currency and fixed income markets. Volatility risk premium: the tendency for implied volatility to exceed realized volatility, providing a return to options sellers over time.

Evaluating Return Drivers

The quality of a return driver is evaluated by its persistence (has it worked over long historical periods?), its pervasiveness (does it work across multiple markets and asset classes?), its robustness (does it work across variations in implementation methodology?), and its theoretical basis (is there a compelling behavioral or economic reason why it should continue to work even after discovery?). Return drivers that meet all four criteria are the most valuable foundations for systematic investment strategies.

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