As far as the comment about CAPM. I think Baker, like most of the industry, has misquoted it. CAPM says that a rational investor should ***require*** a higher return to take on more risk (or volatility). That is very different from saying they will ***receive*** a higher return. Many investors have interpreted CAPM this way. It has very educated investors buying risky assets to increase expected returns, which has the expected returns of those assets dropping, which leads to less risky assets outperforming (especially on a risk adjusted basis).

I hear, way to often, very experienced and educated people saying that expected returns are too low so we need to take on more risk to achieve our return expectations. In my opinion that is exactly the opposite of what we should do when expected returns are too low and I think Bakers research validates my approach. When expected returns are high it may be a different conversation, and taking on additional risk may be worthwhile (at least it has been in my portfolio).

In short, we often look at the return we want (or need) and take the lowest amount of risk needed to achieve our goals. Alternatively we should be looking at the payoff for taking risk and deciding whether or not we are receiving adequate compensation. Until we change our point of reference, lower volatility securities will continue to outperform.