Jeremy Grantham and Ben Inker have a long track record of successfully calling market bubbles, but their investment strategy can take a long time to play out.
Finding a truly exceptional asset manager is challenging, even for the most sophisticated investor. A clear and differentiated strategy, strong track record, history of great calls and willingness to learn are just a few of the indicators that tell the story. Competitiveness, confidence and conviction are also important, but, in the end, investing with anyone is a bet on risk.
Most investment managers try to work around these concerns by leading with the opportunities they see in the market or pointing to lofty end goals for those that invest with them. It’s not often, then, that you go into a meeting with an asset manager and they open with risks: risks to the market, risks to your investments and, indeed, risks to your career if you follow their ideas all the way through. But that’s what you get with Grantham, Mayo, Van Otterloo & Co., the Boston-based shop co-founded by famed value investor Jeremy Grantham.
Using an approach created by the British-born Grantham, GMO’s managers look at asset valuation trends over the entire history of the market and use those as the basis for determining fair value. Within those historical trends GMO has identified a consistent pattern: Asset classes have average values that don’t really change much over time. Valuations may go up or down for certain periods, but they always come back to the mean. Because the firm sees markets through this mean-reversion lens, GMO tracks how bubbles are forming and the risks if they burst. The firm’s managers invest by looking for low-risk, cheap assets that are likely to perform well as bubbles form and easy to get out of just before the inevitable happens. The firm’s seven-year forecast, which it releases publicly, provides a live snapshot of how markets are changing over time.
Over its 39-year history, GMO has built a reputation for being the smartest guys in the room when it comes to long-term value, having successfully called all of the bubbles in recent memory — but that comes at the expense of almost everything else. When you walk through GMO’s front door, you’ll find an outlier not just among value shops but among investment firms. There are no fancy presentations touting a wealth of golden opportunities, no branded golf balls to take away. What you get instead feels a bit more like a visit to a think tank, with researchers who are on the brink of their next great discovery and only want investors willing to stay on until they find it.
“The reason you don’t see a lot of money chasing long-term value strategies, particularly strategies like ours, is career risk,” says Ben Inker, GMO’s co-head of asset allocation. He’s tasked with running a strategy that relies on high economic growth periods to work well. The heir to Grantham’s quantitative models, Inker has been at GMO since graduating from Yale University in 1992 with a BA in economics. He took over day-to-day operations for the firm’s asset allocation team in 2009.
GMO has famously shied away from marketing, and even from going out of its way to keep clients when times are tough. Instead, it sticks to the firm’s investment strategy at all costs. But it’s been a difficult market for value investors in recent years as the post–financial crisis rally sent equity prices to new highs and low interest rates made picking cheap bonds nearly impossible. Now Inker finds himself leading a familiar two-front war: managing unhappy clients and overpriced markets. Performance across most of GMO’s core strategies, which Inker runs, is flat to negative. The Benchmark-Free Allocation strategy, the firm’s largest by asset size at $27.3 billion, was up 0.63 percent this year through May. That’s a slight rebound for the strategy, which ended 2015 down 4.17 percent, but hardly indicative of a recovery trend. The flagship strategy’s annualized return over the past three years is just 0.80 percent.HT: Alpha Ideas July 26 linkfest
“When it comes to challenging markets, we focus on reminding our clients that short-term underperformance happens,” says Inker, who has a calm but determined air. “The hard part is these conversations often take place just before markets start to look good to us in terms of investment opportunities.”
With volatility affecting valuations and market shocks like Brexit compounding losses, Inker may turn out to be right, but it’s an open question whether developed markets can form bubbles as they did in the past. With central banks pumping up stocks as a matter of policy, the recent rally hasn’t had the strength of previous ones and is nowhere near bubble territory.
“Mean reversion might not work as clearly as it did in the past,” says Matthew McLennan, head of the global value team at New York –based, $94 billion First Eagle Investment Management. According to McLennan, some managers have adjusted their metrics for judging value, moving away from traditional benchmarks like the price-earnings ratio and focusing instead on cash flow or more-subjective measures like intrinsic value to find short-term opportunities and performance fixes in reaction to changes in markets. “We’re dealing with a low-growth, high-regulation environment, and it’s not clear that will change,” he adds.
The lag in performance at GMO has caused a handful of U.S. public pensions invested across its strategies to put the firm on watch lists or terminate relationships completely. Firmwide assets sit at $99 billion, down from last year, when they hovered near $115 billion, and off substantially from 2007’s peak of $155 billion, according to Morningstar....MORE
