Fund managers White Shoe Boston GMO – founded by Jeremy Grantham – are pulling the spotlight this year with their “equity dislocation” investment strategy. This strategy, unveiled almost exactly two years ago, buys the cheapest “value” stocks, then bets against the most expensive “growth” stocks.
This “equity dislocation” portfolio gained a stunning 21% from October 31, 2021 to October 30, 2022, according to GMO reports. That’s up 13% since January 1.
Its average returns over 2 years have been 15% per year.
In case you’ve been living under a rock lately, that’s very different from virtually anything in the market today, including US and international stocks and bonds – which are down, in many cases at two digits.
The bad news for the GMO strategy is that the “equity dislocation” strategy is not available to the rest of us. It is an institutional fund and you would need to invest millions just to get in. Since it’s a hedge fund, they won’t even tell us much about what it buys and sells. (Regulators discourage hedge funds from sharing too much information with us peasants, lest it overload our mere brains and drive us crazy)
The good news? We are not completely in the dark. If you want to follow GMO’s strategy, there is information available that you can – if you wish – use in your 401(k), IRA, or other retirement portfolios.
The GMO strategy involves betting on some stocks and betting against others, a classic “long-short” hedge fund approach that aims to make money no matter what happens to the market, as long as the stocks they own do better than the stocks they own. bet against.
Ordinary investors are going to find it difficult to apply the second half of this strategy, namely betting against expensive stocks, without more complex products. But they can, at least, quite easily embrace the first half and buy the cheap stuff.
GMO revealed the top 5 stocks it held in the portfolio as of October 31: IBM IBM,
Gilead Sciences GILD,
Cigna CI,
Biogen BIIB,
and German car giant BMW BMWYY,
Even better, GMO’s co-head of asset allocation, Ben Inker, just revealed more about where the company is seeing the best deals in the stock markets.
And it changes.
Until recently, according to Inker, GMO’s equity dislocation team bought so-called “value” stocks, meaning stocks that are cheap relative to current fundamentals such as dividends, earnings, etc., and then bet against “growth” stocks, i.e. stocks that are expensive relative to today’s fundamentals, but make big bets on the future.
Today, they’re not just buying “value,” Inker said. They buy what he called “deep value.”
“In the United States, ‘deep value’ (the lowest 20 percent) is the truly dislocated market segment,” he wrote in a third-quarter letter. “The cheapest 20% of the market…is very cheap indeed, still trading at the 4th percentile historically. But the rest of the value universe is far less well positioned.
As a result, he said, the stock dislocation team “is now almost exclusively focused on this cheapest quintile of stocks.”
“The value model is intriguing and has significant implications for long-only portfolios,” Inker wrote. (“Long-only” means the type of portfolios the rest of us typically own that invests in stocks and doesn’t bet against or “short” any). “Looked at in this way, it seems that a US value strategy should avoid ‘low value’ stocks that are marginally cheap relative to the market and focus only on the ‘deep value’ quintile”, he added.
The best investor I’ve ever met, Allan Mecham of Arlington Value in Salt Lake City, Utah, used to joke about the concepts of “value” stocks and “deep value” stocks.
“It’s like asking someone, do you want a good deal – or a really, really good deal?” he used to tell me.
Mecham, a disciple of Warren Buffett, Ben Graham and other “value” gurus, wanted to buy stocks as cheaply as possible. GMOs don’t tell us what they counted as “deep value” these days, although presumably the top 5 stocks listed above do count.
But I asked S&P Global, which calculates major stock indices, about “deep value,” and they directed me to what they call the S&P 500 “Pure Value” Index. This tracks stocks that have the purest or deepest value in the market.
Top 10 holdings in this index, as of November 30: Energy companies Marathon Petroleum MPC,
Valero Energy VLO,
and Phillips 66 PSX,
; Metlife MET insurers,
Allstate ALL,
Prudential financial PRU,
and Everest Re RE,
; the health insurer Cigna CI,
; agribusiness Archer Daniels Midland SMA,
; and Warren Buffett’s Berkshire Hathaway conglomerate BRK.B,
For those who like the easy life, fund company Invesco runs an S&P 500 Pure Value ETF RPV,
which invests in the index and charges a fee of 0.35% per year. There is of course no guarantee that this fund, or this index, will replicate the positive half of the GMO investment strategy.
Nor, for that matter, that the strategy will continue to beat the market.
Whether it outperforms, say, a simple stock market index is another matter. History offers reason to be skeptical. But it’s your money, and it’s your choice.
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