White shoe Boston fund managers GMO — founded by Jeremy Grantham — is shooting out the lights this year with its “equity dislocation” investment strategy. This strategy, unveiled almost exactly two years ago, buys the cheapest “value” stocks and then bets against the most expensive “growth” ones.
This “equity dislocation” portfolio has earned a stunning 21% from Oct. 31, 2021 until Oct. 30, 2022, according to GMO reports. It’s up 13% since January 1.
Its average returns over 2 years have been 15% a year.
In case you’ve been living under a rock lately, that is wildly different from pretty much anything else in the marketplace today, including U.S. and international stocks and bonds — which are down, in many cases by double-digits.
The bad news for GMO’s strategy is that the “equity dislocation” strategy is not available to the rest of us. It’s an institutional fund and you would need to invest millions just to get in the door. As it’s a hedge fund, they won’t even tell us much about what it’s buying and selling. (Regulators discourage hedge funds from sharing too much information with us peasants, lest it overload our simple brains and drive us crazy)
The good news? We’re not completely in the dark. If you want to follow GMO’s strategy, there is information available that you can — if you want — put to 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, so long as the stocks they own do better than the stocks they are betting against.
Ordinary investors are going to be hard put to apply the second half of that 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 owned in the portfolio, as of October 31: IBM IBM, -0.33%, Gilead Sciences GILD, +1.29%, Cigna CI, +1.16%, Biogen BIIB, -0.98% and German car giant BMW BMWYY, +0.50%.
Even better, GMO’s co-head of asset allocation, Ben Inker, has just revealed more about where the firm sees the best bargains in stock markets.
And it’s changing.
Until recently, according to Inker, GMO’s equity dislocation team was buying so-called “value” stocks, meaning stocks cheap in relation to current fundamentals such as dividends, earnings and so on, and then betting against “growth” stocks, meaning stocks that are expensive in relation to today’s fundamentals, but which are big bets on the future.
Today they’re not just buying “value,” Inker said. They’re buying what he called “deep value.”
“Within the U.S., ‘deep value’ (the cheapest 20%) 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 versus history. But the rest of the value universe is much less attractively positioned.”
As a result, he said, the equity dislocation team is now “focusing almost exclusively on this cheapest quintile of stocks.”
“The pattern within value is an intriguing one that does have some meaningful implications for long-only portfolios,” Inker wrote. (“Long-only” means the kind of portfolios the rest of us typically own, which invest in stocks and do not bet against or “short” any). “Looked at in this way, it seems as if a value strategy in the U.S. should be avoiding the ‘shallow value’ stocks that are mildly cheap relative to the market and focusing solely on the ‘deep value’ quintile,” he added.
The best investor I’ve ever met, Allan Mecham at Arlington Value in Salt Lake City, Utah, used to make a 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 cheap as he could get them. GMO doesn’t tell us what they counted as “deep value” these days, although presumably, the top 5 stocks listed above count.
But I asked S&P Global, which calculates major stock market indexes, about “deep value,” and they directed me to something they call the S&P 500 “Pure Value” index. This tracks the stocks that are the purest, or deepest, value in the market.
The top 10 holdings in this index, as of November 30: Energy companies Marathon Petroleum MPC, -1.66%, Valero Energy VLO, -3.76% and Phillips 66 PSX, -1.28% ; insurers Metlife MET, +0.34%, Allstate ALL, -0.88%, Prudential Financial PRU, -0.05% and Everest Re RE, +0.95% ; health insurer Cigna CI, +1.16% ; agribusiness Archer Daniels Midland ADM, +0.43% ; and Warren Buffett’s conglomerate Berkshire Hathaway BRK.B, +0.10%.
To those who like an easy life, fund company Invesco runs an S&P 500 Pure Value ETF RPV, -0.17% that invests in the index and charges 0.35% a year in fees. 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 carry on beating the market.
Whether it will outperform, say, a simple stock market index is another matter. History offers grounds to be skeptical. But it’s your money, and it’s your choice.
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