In the latest indication of the troubles facing the active management industry, iconic asset manager Jeremy Grantham, and his Boston money management firm, Grantham Mayo Van Otterloo, have seen an unprecedented slump in assets under management as a result of failing to generate return on par with the market, leading to mass investor defections.
As the WSJ first reported, Grantham "has been out of step with the market several times during the firm’s four decades. GMO has usually rebounded, with the 78-year-old investor earning acclaim with asset-bubble calls ahead of Wall Street busts in 2000 and 2008." However, this time a recovery may probe problematic as the firm is "going through one of its roughest periods" and as a result assets under management have tumbled to about $80 billion, according to someone close to the matter, down from a peak of $124 billion in June 2014, a drop of 35% in two and a half years. The drop in assets has forced the firm to fire about 10% of its workforce, cutting some 65 jobs, in June last year.
The reason for GMO's underperformance has been Grantham's overarching skepticism about the viability of the market rally: "Bearish about what it sees as high valuations of U.S. stocks, GMO’s flagship mutual fund, the GMO Benchmark Free Allocation fund, has largely missed out on the latest rally in U.S. stock indexes."
The skepticism means that the firm has generally underinvested at a time when all central banks have stepped in to avoid any notable market declines or corrections. According to the WSJ, GMO held about 7% of its assets in U.S. stocks as of the end of September, with 27% in cash, 16.9% in developed markets outside the U.S. and 20% in “alternative” strategies such as global “macro” investing, according to the firm. WSJ adds that GMO also had over 20% in emerging-market stocks and bonds—an investment that did nicely earlier in 2016 but has suffered in recent months following broad selloffs in credit securities.
As a result, the GMO Benchmark Free Allocation fund rose 3.4% in 2016, compared with a gain of about 5.7% for its peers, according to fund tracker Morningstar Inc., and a gain of 12% for the S&P 500, including dividends. The firm says the fund tries to beat inflation, which rose less than 2% over the past year.
“GMO has taken a lot of risk off the table, they think a lot of areas in the market are overvalued,” says Leo Acheson, a senior analyst at Morningstar. “They’ve definitely seen outflows, but they’ve been in this position before and looked bad for periods” before rebounding, he said.
Grantham's quarterly investing letter, which he co-authors with GMO's head of asset allocation, Ben Inker, is eagerly anticipated by many investors for the value approach they share. Over the past few years it has expressed a recurring skepticism about the sustainability of the market, although Grantham has noted on several occasions that his target for the S&P is above 2,200 above which he expects the stock bubble would burst.
Some more details:
Mr. Grantham’s following in the investment world began to develop in the late 1990s, when GMO adopted a cautious stance on popular-but-expensive tech stocks. Performance suffered and clients bolted; Mr. Grantham and his colleagues were rewarded when tech shares crashed and GMO’s results rebounded in the early 2000s. Mr. Grantham and his team also were cautious ahead of 2008’s credit crisis, and they got bullish in early 2009, before the current rally began.
Some GMO funds have done better than the benchmark fund. The GMO Emerging Country Debt fund gained nearly 14% last year, including dividends, while the GMO Emerging Markets Fund gained 16.4%.
Still, the firm’s outlook appears out of step with a market that has climbed over the past few years and rallied sharply since the presidential election. In June 2015, Mr. Grantham said the Federal Reserve had artificially compressed interest rates, sending the market toward what he termed “bubbleland.”
In November, Mr. Inker wrote to clients that “almost all asset classes are priced at valuations that seem to guarantee returns lower than history.” Mr. Inker added that “from today’s valuation levels, there are no good outcomes for investors.”
GMO’s troubles are hardly isolated, and are shared by other value-oriented investors who have underperformed in recent years as growth stocks climbed. If the market hits a rough period, GMO’s caution will look prescient once again, and clients likely will return. “Expensive markets have historically provided very poor risk-reward trade-offs,” Mr. Inker says. “Our belief in the power of value has not wavered, it does not make sense to chase expensive markets ever higher.”
For now, however, investors are clearly disappointed and are rushing to allocate funds to other, better performing managers. Per the WSJ, Some clients say they’re unwilling to wait for GMO’s turnaround. Ventura County Employees’ Retirement Association withdrew its $211 million investment in GMO late in 2016. Among the reasons listed in an internal Ventura document: GMO’s job cuts and personnel changes, the shift in investment approach at the global-equity fund and GMO’s lagging long-term performance.
“GMO is a deep-value investor that takes a really long-term view,” said Dan Gallagher, chief investment officer of the Ventura County Employees’ Retirement Association. “But the board felt it was time for a change.”
The lackluster results have led to some changes. In June, GMO said it would reduce its reliance on fundamental stock picking by one of its four equity teams and shift to a more-quantitative approach, resulting in departures of two top GMO executives. A similar approach has been taken by other fundamental investors, most recently Dan Loeb's Third Point, who splurged $2 million in December to hire a new head of quant trading.
It remains to be seen when active management will return as a preferred asset allocation category; for now the exodus away from it and into passive investing strategies continues to accelerate with every passing week.