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Tom Hancock on Quality Stocks and Launching ETFs · Masters in Business

• 0:02
  Speaker 1: This is Master's in Business with Barry rid Holds on
• 0:06
  Speaker 1: Bloomberg Radio.
• 0:10
  Speaker 2: This week on the podcast, I have an extra special guest.
• 0:15
  Speaker 2: I love finding these people who are just absolute rock
• 0:19
  Speaker 2: stars within their space that most of the investing public
• 0:23
  Speaker 2: probably is not familiar with, haven't heard about them. Maybe
• 0:27
  Speaker 2: they're a little below the radar or institutionally facing, and
• 0:32
  Speaker 2: so the average investor is unaware of them. You certainly
• 0:35
  Speaker 2: are familiar with GMO. Jeremy Grantham shop with Mayo and
• 0:40
  Speaker 2: Ottolou his partners. That shot was founded in nineteen seventy seven.
• 0:45
  Speaker 2: The person who heads their focus and quality strategies this
• 0:51
  Speaker 2: gentleman named Tom Hancock. He also helps run some of
• 0:55
  Speaker 2: their mutual funds and helped put together their first ETF
• 0:59
  Speaker 2: and he as really quite an astonishing track record. The
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  Speaker 2: Quality Fund mutual fund that GMO runs, that symbol gq
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  Speaker 2: et X, it's just crushed it over the past decade,
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  Speaker 2: thirteen point six percent a year, way over both its
• 1:15
  Speaker 2: index and its benchmark. It's in the top one percent
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  Speaker 2: of its peers Morning Star, five star, gold rated, just
• 1:25
  Speaker 2: really really interesting. And Tom has helped with the introduction
• 1:30
  Speaker 2: of GMO's first retail product the Quality ETF stock symbol QLTY.
• 1:38
  Speaker 2: GMO has been institutionals since they launched in nineteen seventy seven.
• 1:43
  Speaker 2: This is the first time they're putting out a product
• 1:46
  Speaker 2: for retail, and Tom explains what goes into quality stock selection,
• 1:52
  Speaker 2: why they went to the ETF. You wouldn't be surprised
• 1:55
  Speaker 2: to learn the tax consequences of owning a mutual fund
• 1:59
  Speaker 2: is a part of it. Really fascinating guy, tremendous track record,
• 2:03
  Speaker 2: unusual background comes from computer science and software and pivoted
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  Speaker 2: into quantitative investing. I found this conversation to be really
• 2:14
  Speaker 2: fascinating if you're at all interested in focused portfolios, the
• 2:19
  Speaker 2: concept of quality as a sub sector, undervalue, and just
• 2:25
  Speaker 2: how you build a portfolio, and a track record that's
• 2:29
  Speaker 2: tough to be. I think you'll find this conversation as
• 2:33
  Speaker 2: fascinating as I did. With no further ado my discussion
• 2:37
  Speaker 2: with GMOs. Tom Hancock, Thanks, Perry, it's great to be here.
• 2:42
  Speaker 2: So you have a really interesting and unusual background. Let's
• 2:45
  Speaker 2: start there. Computer science bachelors from RPI in eighty five,
• 2:51
  Speaker 2: PhD in computer science from Harvard in ninety two. What
• 2:55
  Speaker 2: was the career plan?
• 2:57
  Speaker 1: Yeah, well it wasn't doing investing quality stocks in the
• 3:01
  Speaker 1: early days, that's for sure. I actually come from a
• 3:04
  Speaker 1: very academic family. My father was a university professor. My
• 3:09
  Speaker 1: mother worked as an editor. Her father had been a
• 3:11
  Speaker 1: university professor. You have doctors in the family. I actually
• 3:14
  Speaker 1: don't know that anyone in my family actually had a
• 3:16
  Speaker 1: job at a private, for profit, traditional company. Ever, I'm
• 3:21
  Speaker 1: the first, so I'm kind of the black sheep, So
• 3:24
  Speaker 1: that's where I started from. In fact, the fact that
• 3:26
  Speaker 1: I actually went into computer science rather the more liberal
• 3:29
  Speaker 1: arts discipline, was a little bit non traditional, let's say.
• 3:32
  Speaker 1: And I think that was kind of an early wise
• 3:35
  Speaker 1: decision that I give myself credit for. Is back in
• 3:37
  Speaker 1: high school, I was really interested in history and stuff,
• 3:40
  Speaker 1: but I didn't really want to be a historian, So
• 3:43
  Speaker 1: it's like, what do I actually like to do as
• 3:45
  Speaker 1: opposed to think was interesting? And that's where at the
• 3:47
  Speaker 1: time your computer programming was becoming a thing. I really
• 3:50
  Speaker 1: loved it. That led me down that track, and really,
• 3:54
  Speaker 1: while I had a software engineering job, I was always
• 3:56
  Speaker 1: sort of pointing toward a research career. And then at
• 4:00
  Speaker 1: some point after my PhD school studies, we could get
• 4:03
  Speaker 1: into that if you like, but I kind of decided
• 4:05
  Speaker 1: to switch, and finance was kind of what was available
• 4:07
  Speaker 1: for me at that point.
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  Speaker 2: Yeah, let's lead up to that transition. Software engineer at IBM,
• 4:12
  Speaker 2: then you get your PhD. Then research at SEMENS, which
• 4:16
  Speaker 2: seems to be more of a technological position than a
• 4:19
  Speaker 2: finance position. What was your focus within tech?
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  Speaker 1: I worked the area in which I studied in graduate school,
• 4:27
  Speaker 1: and then worked at SEMENS, which, as you say, it's
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  Speaker 1: a research lab, think like Bell Labs, IBM, Watson, that
• 4:32
  Speaker 1: kind of think tank environment. I worked on machine learning,
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  Speaker 1: which is a sub field of of course, artificial intelligence.
• 4:40
  Speaker 1: So the nineties, Yeah, that was a nineties So artificial
• 4:43
  Speaker 1: intelligence is a it's an area that's been around for
• 4:45
  Speaker 1: a long time. I think the term was coined in
• 4:47
  Speaker 1: the nineteen fifties. But I was doing it, at least,
• 4:50
  Speaker 1: I should say, working on a small part of it
• 4:53
  Speaker 1: back in the nineties in graduate school is at a
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  Speaker 1: fairly theoretical way. A Semens who was with more applications
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  Speaker 1: in mind.
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  Speaker 2: So, so how does the transition to finance take place? It
• 5:05
  Speaker 2: seems like maybe you're going to tack into researcher academia.
• 5:10
  Speaker 2: How did you find your way to both finance and GMO.
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  Speaker 1: Yeah, so there's two parts of that. One is just
• 5:16
  Speaker 1: sort of why not the academic track, and then by
• 5:19
  Speaker 1: the finance part. So the why not the academic track
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  Speaker 1: was in academia, I was doing very theoretical stuff that
• 5:26
  Speaker 1: was very maybe intellectually interesting, but understood by increasingly few
• 5:31
  Speaker 1: people in the world. So I just sort of wanted
• 5:33
  Speaker 1: to be something that was a little more relevant, and
• 5:35
  Speaker 1: I thought maybe the research lab would provide that, and
• 5:39
  Speaker 1: for various reasons, it still didn't feel like that. So
• 5:41
  Speaker 1: it was I was basically looking for something that was relevant.
• 5:45
  Speaker 1: You know, I want to be loved like everyone white,
• 5:46
  Speaker 1: So I want to do something that I can talk
• 5:47
  Speaker 1: to people about and they don't want to be loved.
• 5:49
  Speaker 2: Do you want to go into finance? That's one or
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  Speaker 2: the other.
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  Speaker 1: Well, so, at least the other with finance, which wasn't
• 5:56
  Speaker 1: certainly an opportunistic element to that, Like what kind of
• 5:59
  Speaker 1: industry he hires people that values fancy academic degrees that
• 6:04
  Speaker 1: don't have necessary a lot of developed specific skills and finance,
• 6:08
  Speaker 1: I said, management consulting is any of the other thing,
• 6:10
  Speaker 1: at least at that time, was the other career trajectory.
• 6:13
  Speaker 1: Just my personality more of an math oriented introvert. Finance
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  Speaker 1: was the natural fit for GMO particularly. I got really
• 6:21
  Speaker 1: lucky when I was in graduate school, so I was
• 6:24
  Speaker 1: at Harvard. Harvard has a smaller computer science department. We
• 6:27
  Speaker 1: do a lot down the river at MIT, and I
• 6:29
  Speaker 1: went to a research group there. I was headed by
• 6:31
  Speaker 1: Ron Revest, who's perhaps known to some as you are
• 6:34
  Speaker 1: behind RSA cryptography, but he also worked in machine learning
• 6:38
  Speaker 1: in this area. And he ran this research group of
• 6:41
  Speaker 1: scruffy grad students and postdocs that I would go to.
• 6:44
  Speaker 1: But there was this one guy who came from downtown
• 6:46
  Speaker 1: who wore a suit, and no one quite knew who
• 6:48
  Speaker 1: he was. I asked, so, who's that guy? You think
• 6:50
  Speaker 1: he's a banker, And he was a very smart guy.
• 6:54
  Speaker 1: My mental image was that he worked in the back
• 6:57
  Speaker 1: of a bank approving mortgage applications. He was really frushtra
• 7:00
  Speaker 1: and this was his intellectual outlook. It turns out that
• 7:02
  Speaker 1: was not what he was. He was a guy named
• 7:04
  Speaker 1: Chris Darnell who was the start of the quantitative research
• 7:07
  Speaker 1: effort at GMO. He was Jeremy Grantham's right hand man
• 7:11
  Speaker 1: in the early eighties, but he was just he also
• 7:14
  Speaker 1: came for an academic family. He had broad interests. He
• 7:17
  Speaker 1: came to this group. I'm not even quite sure how
• 7:19
  Speaker 1: he found it, honestly, but in any case, when I
• 7:21
  Speaker 1: was sort of casting around at places to look, that
• 7:25
  Speaker 1: connection was rekindled and that was my entree into GMO.
• 7:28
  Speaker 2: Really really interesting. And you joined GMO in nineteen ninety five,
• 7:32
  Speaker 2: you've been there ever since. That's kind of unusual these
• 7:36
  Speaker 2: days in finance to stay with one firm, for Gee,
• 7:39
  Speaker 2: it's almost thirty years. What makes GMO so special? What's
• 7:44
  Speaker 2: kept you there for three decades?
• 7:46
  Speaker 1: It's been a great place to work, obviously, I've thought so.
• 7:49
  Speaker 1: I think GMO felt very familiar to me when I
• 7:52
  Speaker 1: joined as a smaller firm I think maybe sixty people
• 7:55
  Speaker 1: at the time. It's very much of a intellectual debate,
• 8:00
  Speaker 1: academic kind of vibe. It felt very comfortable to me,
• 8:04
  Speaker 1: and the firm's grown. I've kind of grown with it.
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  Speaker 1: I think one of the things that kept me engaged
• 8:09
  Speaker 1: is I've actually done different things, so kind of as
• 8:12
  Speaker 1: we're alluding to, and as you'd think, my background is
• 8:14
  Speaker 1: very much on the quantitative side. Now I do fundamental
• 8:16
  Speaker 1: side research portfolio management.
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  Speaker 2: So you joined GMO, there's sixty people. Thirty years, they've
• 8:24
  Speaker 2: grown tremendously. How big is GMO today versus when you joined,
• 8:29
  Speaker 2: and what was that process like to experience all that growth?
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  Speaker 1: Yeah, I think it's about five hundred people today. The
• 8:36
  Speaker 1: book are in Boston, which is where I sit, but
• 8:38
  Speaker 1: we have investment offices in San Francisco, in London, in
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  Speaker 1: Singapore and Sydney, Australia, so it's a global firm of
• 8:48
  Speaker 1: the One of the things, these are things. When I
• 8:52
  Speaker 1: started at GMO, it was really just investment people almost
• 8:56
  Speaker 1: and all the sort of compliance, clients, service, legal kind
• 9:02
  Speaker 1: of everything was done sort of on the side by
• 9:05
  Speaker 1: investment people. And gradually we hired we professionalized.
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  Speaker 2: Over time, you've become an enterprise. It's ten x what
• 9:14
  Speaker 2: it once was in terms of headcount, it's much bigger
• 9:17
  Speaker 2: in terms of assets. And I can tell you from
• 9:21
  Speaker 2: personal experience US finance people, we're not great at accounting, legal, compliance,
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  Speaker 2: all the detailer and stuff that keeps a firm running.
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  Speaker 1: The trick is we're not great, but we think we are.
• 9:32
  Speaker 1: So that's where we get into trouble.
• 9:33
  Speaker 2: That's that's a lot that's really true. We hear a
• 9:37
  Speaker 2: lot about Jeremy grantham thoughts on markets, but much less
• 9:41
  Speaker 2: on how the firm is managed, how this growth came about,
• 9:47
  Speaker 2: and the culture as a business. Tell us a little
• 9:50
  Speaker 2: bit about GMO as a cultural enclave up in Boston.
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  Speaker 1: Yeah. Well, one thing to start with there is the
• 9:58
  Speaker 1: name GM and O and it's three people, and people
• 10:00
  Speaker 1: know Jeremy Grantham, I think very well, but that Dick
• 10:03
  Speaker 1: Mayo and Ike van Ottolou are the other two. And
• 10:06
  Speaker 1: that's relevant to your question because from the very early
• 10:08
  Speaker 1: days before I was there, they kind of operated separate
• 10:11
  Speaker 1: investment teams. Dick Mayo was a traditional, i'd say, portfolio
• 10:16
  Speaker 1: strong portfolio manager focused on US stocks. Ike was similarly
• 10:20
  Speaker 1: international stocks, and Jeremy is kind of the go everywhere,
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  Speaker 1: top down, big ideas guy, and that a bit of
• 10:27
  Speaker 1: that culture. Dick and ike An both retire now, but
• 10:29
  Speaker 1: a lot of that culture of different investment teams that
• 10:32
  Speaker 1: do things a little bit differently is very much part
• 10:35
  Speaker 1: of GMO. There is not one central view to the firm.
• 10:40
  Speaker 1: Jeremy is a very strong, powerful persona and very deep thinker.
• 10:47
  Speaker 1: Jeremy's never really been a portfolio manager, his role has
• 10:50
  Speaker 1: always been, in my experience, at least, it has always been
• 10:52
  Speaker 1: much more of a gadflaw. He makes you think about things,
• 10:55
  Speaker 1: he makes suggestions, he pushes you to come to your
• 10:58
  Speaker 1: own conclusion. He leads you to watch. But he's not
• 11:01
  Speaker 1: a hands on the portfolio person.
• 11:04
  Speaker 2: Huh. Really interesting. We had him down sometime last year,
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  Speaker 2: came by our offices and spoke, and I very much
• 11:10
  Speaker 2: get the sense he has no interest in retiring. He
• 11:14
  Speaker 2: loves what he does. He is very plugged into everything
• 11:18
  Speaker 2: that's going on. He's gonna do this forever, isn't he?
• 11:23
  Speaker 1: That would be my guess. Yeah, I think he probably
• 11:25
  Speaker 1: will outlast me in the industry. He is one of
• 11:28
  Speaker 1: the smartest people I've ever met and one of the
• 11:31
  Speaker 1: most driven people I've ever met. He has a I
• 11:35
  Speaker 1: think and hope along professional life span ahead of him.
• 11:38
  Speaker 1: I would say he is a little bit less focused
• 11:41
  Speaker 1: on what you might call the day to day of
• 11:42
  Speaker 1: investing at GMO, and he does a lot of stuff outside.
• 11:45
  Speaker 1: He's very involved with the Grantham Foundation, his charitable organization,
• 11:49
  Speaker 1: both on their mission but also on the investing side
• 11:52
  Speaker 1: of managing their portfolio.
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  Speaker 2: So that raised a really interesting question. He's a big
• 11:56
  Speaker 2: picture guy. He's always looking for what risks and what
• 12:00
  Speaker 2: black swans might be coming at us that the investment
• 12:03
  Speaker 2: community either hasn't found yet or isn't paying attention to.
• 12:08
  Speaker 2: How do you translate that thirty thousand foot view as
• 12:11
  Speaker 2: to what's going on in the world to something like
• 12:16
  Speaker 2: quality and focused investing or is it really just there
• 12:19
  Speaker 2: to sort of help you create a framework for looking
• 12:22
  Speaker 2: at the universe.
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  Speaker 1: Well, when I say he's a big picture guy, don't
• 12:25
  Speaker 1: necessarily mean just that he's investing is to make macro calls.
• 12:29
  Speaker 1: I mean more than he steps back from the fray
• 12:32
  Speaker 1: a bit and thinks about the big ideas and what
• 12:35
  Speaker 1: really matters, and that whole idea around quality investing. That's
• 12:40
  Speaker 1: kind of Jeremy from the nineteen eighties early eighties and
• 12:44
  Speaker 1: saying bangs say, hey, you know, I cut my teeth
• 12:47
  Speaker 1: as he and Digmeo did on that traditional deep value investing.
• 12:51
  Speaker 1: But we're missing something here with these higher quality companies.
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  Speaker 1: How should we think about that? How can you invest
• 12:56
  Speaker 1: about that? How can we improve our process? So that
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  Speaker 1: sort of philosopha call outside and around the box thinking
• 13:03
  Speaker 1: is kind of what really led to us having a
• 13:05
  Speaker 1: quality oriented strategy.
• 13:07
  Speaker 2: And quality is really a sub section of value. Is
• 13:11
  Speaker 2: that is that what you're suggesting, it's.
• 13:13
  Speaker 1: An improvement of value or refinement on the definition of value.
• 13:17
  Speaker 1: And people use these terms loosely, of course, and these
• 13:20
  Speaker 1: all fall under the rubric of fundamental investing and buying
• 13:24
  Speaker 1: companies that are great over long term at great prices.
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  Speaker 1: But the idea that companies that can compound at high
• 13:30
  Speaker 1: rates of return and deserve premium multiples you should be
• 13:32
  Speaker 1: willing to pay for them is the root of it.
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  Speaker 2: The quality funds ticker gq ETX has returned thirteen point
• 13:41
  Speaker 2: six percent a year over the past decade, putting it
• 13:44
  Speaker 2: in the top one percent of its peers. So let's
• 13:48
  Speaker 2: talk a little bit about what goes into that sort
• 13:51
  Speaker 2: of performance. What are the core themes at GMO around
• 13:57
  Speaker 2: focus and quality? Tell us a little bit about what
• 14:00
  Speaker 2: differentiates GMO from the way other value investors invest.
• 14:05
  Speaker 1: If you're think about value investors, value investors traditionally are
• 14:09
  Speaker 1: people who kind of know the price of everything and
• 14:11
  Speaker 1: the value of nothing right. They're much too focused on
• 14:14
  Speaker 1: ratios around trailing fundamentals and not on the plus side
• 14:18
  Speaker 1: future growth opportunities. On the negative side, maybe competitive threat.
• 14:22
  Speaker 1: So bringing the quality idea into that, thinking about what
• 14:26
  Speaker 1: companies have a long trajectory to grow and to grow
• 14:30
  Speaker 1: at high return on capital, that's the key thing. Also
• 14:33
  Speaker 1: differentiating between growth that's just sort of throwing money at
• 14:37
  Speaker 1: the wall and seeing a little bit come back to
• 14:39
  Speaker 1: you versus very efficient growth. That's the key to quality investing.
• 14:43
  Speaker 1: I could maybe flip that around a little bit since
• 14:46
  Speaker 1: I think, particular post two thousand and two thousand and nine,
• 14:49
  Speaker 1: the quality style of investing has become a lot more popular,
• 14:52
  Speaker 1: certainly sending people talk a lot about the difference between
• 14:56
  Speaker 1: our approach and a lot of quality managers is they're
• 15:00
  Speaker 1: really quality growth managers. So the quality but at a
• 15:03
  Speaker 1: reasonable price, or you could interpret that is not just
• 15:06
  Speaker 1: chasing the companies everybody knows are high quality, but finding
• 15:08
  Speaker 1: a few maybe more neglected names That quality to reasonable
• 15:12
  Speaker 1: price is a little bit of a different style than
• 15:15
  Speaker 1: I see most people practicing out there.
• 15:17
  Speaker 2: So let's get into some of the definitions of this.
• 15:20
  Speaker 2: How does GMO define quality?
• 15:24
  Speaker 1: Yeah, so we think about quality first off, the ability
• 15:26
  Speaker 1: to deliver high returns on investment going forward. Then what
• 15:29
  Speaker 1: enables that you have to have some asset ability, capability
• 15:34
  Speaker 1: that competitors can't equally duplicate. I mean traditionally could have
• 15:38
  Speaker 1: been like a physical asset or brand. Of course, these
• 15:40
  Speaker 1: days in an IT world as much more about network
• 15:43
  Speaker 1: effects of platform companies and such. But you have to
• 15:47
  Speaker 1: have that special sauce that's not reproducible. It has to
• 15:51
  Speaker 1: be doing something that's relevant, Like you want to avoid
• 15:53
  Speaker 1: the trap of companies that do one thing well and
• 15:56
  Speaker 1: that thing's not growing, so they just try to do
• 15:57
  Speaker 1: other stuff. And then management does also come into play.
• 16:01
  Speaker 1: I do keep a strong balance sheet? Are you prudent?
• 16:04
  Speaker 1: Do you invest when you should? Return capital when you should?
• 16:06
  Speaker 1: And so as those assets, the relevance and then capital
• 16:09
  Speaker 1: discipline are the key components for us.
• 16:11
  Speaker 2: Given that definition of quality, has that evolved or changed
• 16:15
  Speaker 2: over time or has that been pretty much the definition
• 16:18
  Speaker 2: going back to the eighties or nineties.
• 16:20
  Speaker 1: That's been pretty much the definition going back to the
• 16:22
  Speaker 1: eighties and nineties. And I told you kind of the
• 16:24
  Speaker 1: fundamental definition. There's also quantitative metrics that we look at.
• 16:28
  Speaker 1: Those have evolved, but always within that capabilit cluster of
• 16:33
  Speaker 1: high returns on investment stability across the economic cycle. Or
• 16:36
  Speaker 1: consistent and strong balance sheets. What has changed over that period, too,
• 16:42
  Speaker 1: is what kinds of companies best meet that threshold. So
• 16:45
  Speaker 1: if you go back to the eighties and nineties, we're
• 16:47
  Speaker 1: talking about like the Cokes and Procter and Gambles and
• 16:49
  Speaker 1: Johnson Johnson, right, and big consumer and healthcare and now
• 16:53
  Speaker 1: those are still there, but a lot more of the
• 16:55
  Speaker 1: big tech companies, the fang companies, more growth companies.
• 17:00
  Speaker 2: So for a long time it looked like Apple was
• 17:04
  Speaker 2: a value stock, even as it became big and bigger
• 17:07
  Speaker 2: than giants. But when we look at what people call
• 17:10
  Speaker 2: the Magnificent seven, are you seeing any real value there?
• 17:15
  Speaker 2: Companies like Microsoft and Nvidia and Netflix, I assume are
• 17:19
  Speaker 2: quality companies by your definition, but are they quality at
• 17:23
  Speaker 2: a reasonable price?
• 17:24
  Speaker 1: All the names you mentioned are quality companies, we believe,
• 17:27
  Speaker 1: we don't all We don't hold all of them. It's
• 17:29
  Speaker 1: the prices vary. If you think about Meta and Alphabet,
• 17:33
  Speaker 1: those are kind of the value stocks.
• 17:35
  Speaker 2: And the band right there, well they got you laughed
• 17:36
  Speaker 2: over the past couple of years before last year's recovery.
• 17:40
  Speaker 1: Yeah, and we also hold Microsoft and Apple. Apple is
• 17:45
  Speaker 1: actually an interesting case study because we used them as
• 17:47
  Speaker 1: an example of our investment at our investment conference fifteen
• 17:50
  Speaker 1: years ago about what a high quality company isn't and
• 17:53
  Speaker 1: then Steve Jobs turned the round in the iPhone and
• 17:55
  Speaker 1: so forth with as the rest is history. The point
• 17:58
  Speaker 1: is we were very wrong about them, and we were
• 18:00
  Speaker 1: late to the party. But the party had such long
• 18:04
  Speaker 1: it's such a long party that it's okay to be
• 18:06
  Speaker 1: late to it. You see. We still had a really
• 18:07
  Speaker 1: good time with that company, which I think is a
• 18:09
  Speaker 1: little bit of a lesson for quality investing. You don't
• 18:11
  Speaker 1: have to be the first one in the door. There.
• 18:14
  Speaker 1: These themes run for a long time, and if you're
• 18:16
  Speaker 1: willing to admit your wrong and change your stripes is
• 18:19
  Speaker 1: you can still make money.
• 18:20
  Speaker 2: So there were a few come at GMO, Warren Buffett
• 18:23
  Speaker 2: were quote unquote late to Apple, but did exceedingly well
• 18:27
  Speaker 2: with that. So you don't have to be at the
• 18:29
  Speaker 2: there at the IPO, you don't have to be there
• 18:32
  Speaker 2: when they crash in the dot com implosion. As long
• 18:35
  Speaker 2: as the growth rate is there and the value is reasonable,
• 18:39
  Speaker 2: there's an opportunity.
• 18:41
  Speaker 1: Yep. And speaking of the dot com employes like Microsoft,
• 18:43
  Speaker 1: via a case study where we in previous strategies. We'd
• 18:47
  Speaker 1: held Microsoft for a very long time. That's where the
• 18:49
  Speaker 1: valuation could help us in the dot com bos So
• 18:51
  Speaker 1: Microsoft now is thirty times earn it was over fifty
• 18:54
  Speaker 1: in two thousand and I don't think it was a
• 18:56
  Speaker 1: much better company than it's a pretty good company now.
• 18:58
  Speaker 1: Rh there's great company. You have to at some point
• 19:02
  Speaker 1: be willing not to hold the stock. And yes, actually
• 19:04
  Speaker 1: Microsoft by this point is outperformed since the peak of
• 19:07
  Speaker 1: the cycle, but took a long long time for that
• 19:09
  Speaker 1: to happen.
• 19:10
  Speaker 2: Well, the Boomer era was not where they really shined.
• 19:14
  Speaker 2: New ceo seems to have done a great job over
• 19:16
  Speaker 2: the past what is it five years the doll you's
• 19:19
  Speaker 2: been there for.
• 19:20
  Speaker 1: Yeah, at least that I think at this point we
• 19:23
  Speaker 1: held through the but and actually added in the Ballber era,
• 19:25
  Speaker 1: So that would be our taking the view that at
• 19:28
  Speaker 1: least in this case turned out to be right. That
• 19:30
  Speaker 1: is something companies can fix if the core assets there,
• 19:34
  Speaker 1: you know, the core network effects of everybody using their products,
• 19:37
  Speaker 1: they're being so entrenched in IT systems departments around the world.
• 19:41
  Speaker 1: That was still there. The easiest thing almost to fix.
• 19:44
  Speaker 1: As a CEO, So if his stock's training at thirteen
• 19:47
  Speaker 1: times earnings and has all these great characteristics, and you
• 19:50
  Speaker 1: think the CEO can change, that can be a great time.
• 19:52
  Speaker 2: To roll the bum out, bring someone else in, and
• 19:54
  Speaker 2: the rest is history. So I love this quote of
• 19:57
  Speaker 2: yours on the backwardization of risk. Quote. The expectation is
• 20:02
  Speaker 2: that achieving higher returns requires taking more risk. But higher
• 20:08
  Speaker 2: quality stocks have outperformed lower quality stocks by a considerable
• 20:14
  Speaker 2: margin despite being less risky.
• 20:17
  Speaker 1: Explain, yeah, and that's that's a point that Jeremy Grantham
• 20:22
  Speaker 1: kind of observed very long time ago and is emphasizing
• 20:25
  Speaker 1: for a long time. And actually pen Inkers ahead of
• 20:27
  Speaker 1: our a s allocation group, just wrote a very interesting
• 20:30
  Speaker 1: piece on that too. This idea that at the big
• 20:33
  Speaker 1: picture level, stocks versus bonds things kind of behave what
• 20:36
  Speaker 1: you'd expect. You get more return, but there's more risk
• 20:39
  Speaker 1: associated with it. But if you look within asset classes,
• 20:42
  Speaker 1: that hasn't been true just empirically, Like why is it?
• 20:45
  Speaker 1: It's perplexing really that high quality companies which have been safer, right,
• 20:50
  Speaker 1: they do better in recessions and such have you've not
• 20:53
  Speaker 1: had to pay for that with lower return. And that's
• 20:56
  Speaker 1: that was really the core of Jeremy's observation about quality
• 21:00
  Speaker 1: stocks and why it's not just that quality is this
• 21:02
  Speaker 1: silver bullet just beats the market all the time. I'm
• 21:04
  Speaker 1: sure we necessarily believe that's true. But it does improve
• 21:08
  Speaker 1: your portfolio with lower risk without having to give up return.
• 21:11
  Speaker 2: So the obvious answer is value makes a big difference
• 21:15
  Speaker 2: within quality stocks. Is that what leads to the lower
• 21:20
  Speaker 2: downside in a market dislocation? If you're buying it right,
• 21:25
  Speaker 2: there's less room to fall.
• 21:26
  Speaker 1: Right in isolation, Quality on average gives you downside protection.
• 21:30
  Speaker 1: Certainly did in two thousand and seven eight, for example,
• 21:33
  Speaker 1: but then it didn't in when the tech bubble burst.
• 21:35
  Speaker 1: It didn't last year in twenty twenty two, right. Then.
• 21:38
  Speaker 1: The reason for that is a lot of the quality
• 21:39
  Speaker 1: stocks are really expensive. So the trade off, compromise or
• 21:42
  Speaker 1: combination of value in quality is what we think gives
• 21:45
  Speaker 1: you that best downside protection, but without having to give
• 21:48
  Speaker 1: up too much on the upside too.
• 21:50
  Speaker 2: Huh. So let's dive into the details of GMO's quality strategies.
• 21:55
  Speaker 2: In twenty twenty two, core quality and quality value outperformed
• 22:01
  Speaker 2: the S and P five hundred by a wide margin.
• 22:04
  Speaker 2: Twenty twenty two was a down nineteen percent. I think
• 22:07
  Speaker 2: in the S and P five hundred. But last year
• 22:10
  Speaker 2: twenty twenty three, core quality and quality value slowed, but
• 22:15
  Speaker 2: quality growth boomed somewhat different environment, and quality growth was
• 22:20
  Speaker 2: where all the games were had. Is this a purposeful
• 22:25
  Speaker 2: style diversification within quality? How do you think about core quality,
• 22:30
  Speaker 2: quality value and quality growth.
• 22:32
  Speaker 1: Yeah, when we think about the opportunity set for us
• 22:35
  Speaker 1: of high quality companies, there are, as you say, really
• 22:38
  Speaker 1: different kinds of companies within that quality is neither growth
• 22:41
  Speaker 1: nor value, can find both within it. And so when
• 22:43
  Speaker 1: we talk about quality growth, I think tech stocks, core quality,
• 22:47
  Speaker 1: think defensive coke, consumer staples, value, think some of the
• 22:50
  Speaker 1: more cyclical names. We like the fact that there are
• 22:55
  Speaker 1: high quality companies in all these areas, and generally we
• 22:57
  Speaker 1: find them attractive, and we like the fact, as you
• 23:00
  Speaker 1: point out, they tend to work at different parts of
• 23:02
  Speaker 1: the market cycle. And so, yes, it is deliberate that
• 23:05
  Speaker 1: we have exposure across these not that you know, if
• 23:08
  Speaker 1: it's nineteen ninety nine, we're probably not going to have
• 23:10
  Speaker 1: much quality growth. So it's not a fixed allocation, but
• 23:14
  Speaker 1: it does gives us diversification, and because we're familiar with
• 23:18
  Speaker 1: stocks across this spectrum. It also gives us the ability
• 23:21
  Speaker 1: to rebalance, and that's one of the things that we've
• 23:23
  Speaker 1: been quite successful with over the last few years. Is
• 23:26
  Speaker 1: not just that we hold both these kind of companies,
• 23:28
  Speaker 1: but we've been leaning against the wind to buy the
• 23:31
  Speaker 1: growth stocks. At the end of twenty twenty two, the
• 23:34
  Speaker 1: value stocks. More recently, just rebalancing has had a lot
• 23:37
  Speaker 1: of value.
• 23:38
  Speaker 2: Really interesting. You mentioned Ben Anker, who I know publishes
• 23:42
  Speaker 2: pretty regularly. You publish on a regular basis. Also, not
• 23:47
  Speaker 2: too long ago, you put something out Quality for the
• 23:50
  Speaker 2: Long Run, a little play on Professor Siegel's Stocks for
• 23:53
  Speaker 2: the Long Run. Tell us a little bit about the
• 23:55
  Speaker 2: valuation discipline quality investing offers and why that's so important
• 24:01
  Speaker 2: when so many stocks have had such a great run
• 24:03
  Speaker 2: up over the past couple of quarters.
• 24:05
  Speaker 1: Yeah, I think that's maybe a mistake I've made in
• 24:08
  Speaker 1: my career has been too rooted in looking at what
• 24:12
  Speaker 1: did well over the last few quarters, and if a
• 24:13
  Speaker 1: stock did really well, thinking oh, it must be expensive.
• 24:16
  Speaker 1: Whereas the reality of it, markets are efficient enough that
• 24:19
  Speaker 1: the vast majority of our performance is driven by truly
• 24:22
  Speaker 1: improved fundamental results. So we have to be with that
• 24:27
  Speaker 1: level of humility. I think the other thing to think
• 24:29
  Speaker 1: about is that if you're a long term investor, getting
• 24:34
  Speaker 1: the valuation exactly right matters less you know, they've beenessing.
• 24:38
  Speaker 1: The entry exit point is less important if you're going
• 24:40
  Speaker 1: to hold for five plus years, which is kind of
• 24:42
  Speaker 1: what our ambition is to do with our stocks, But
• 24:46
  Speaker 1: in extremists, which is the Microsoft in the two thousand example,
• 24:50
  Speaker 1: and maybe some other AI related stocks today, it really
• 24:54
  Speaker 1: does matter. You really, like the long time where you
• 24:56
  Speaker 1: have to hold to make up that valuation whole is
• 24:59
  Speaker 1: so long that you just really shouldn't be involved. It's
• 25:02
  Speaker 1: kind of basical philosophy.
• 25:03
  Speaker 2: Another research piece you put out I found kind of
• 25:05
  Speaker 2: intriguing Quality investing for greed and fear. Explain that.
• 25:10
  Speaker 1: I mean, the fear part is kind of what we've
• 25:12
  Speaker 1: been talking about, like if you're worried about market downturns,
• 25:16
  Speaker 1: quality is a good sleep at night investment. And I
• 25:18
  Speaker 1: think I laugh about is every time we think about
• 25:20
  Speaker 1: writing an annual letter or something like that someone wants
• 25:23
  Speaker 1: to write and these uncertain times that we're now in today,
• 25:26
  Speaker 1: it's like, yeah, when is that not ever been the case? Right?
• 25:30
  Speaker 1: The people are always worried, and so quality is always
• 25:33
  Speaker 1: good for that constituency. The only thing I'd say is
• 25:36
  Speaker 1: if when those worries come to pass, if you hold
• 25:39
  Speaker 1: quality stocks that you really believe in, you're less likely
• 25:41
  Speaker 1: to sell at the wrong moment. So there's that psychological
• 25:44
  Speaker 1: advantage to them that goes beyond just statistical analysis of
• 25:48
  Speaker 1: return periods over time. And the greed is the quality
• 25:52
  Speaker 1: is not just a defensive portfolio. If then, of the
• 25:54
  Speaker 1: market's going down, you hold cash, right, you don't hold
• 25:56
  Speaker 1: high quality stocks. So the greed part is that high
• 26:00
  Speaker 1: quality companies do participate in the upmarket. And so if
• 26:04
  Speaker 1: you think, you know, AI is a great thing, if
• 26:06
  Speaker 1: you think GLP ones are fantastic, if you think there's
• 26:08
  Speaker 1: innovation going on all around the world and you want
• 26:10
  Speaker 1: to participate in it, we think high quality companies are
• 26:13
  Speaker 1: a great way to do that.
• 26:14
  Speaker 2: I have a recollection, and I think it was the
• 26:17
  Speaker 2: onion Our long national nightmare of peace and prosperity is
• 26:20
  Speaker 2: finally over was a two thousand headline, and it's true,
• 26:25
  Speaker 2: how often can you say, well, thank goodness, we live
• 26:28
  Speaker 2: in times where there's no uncertainty and everything is rational.
• 26:33
  Speaker 1: When we say that run for the hills.
• 26:34
  Speaker 2: That's exactly right. GMO has released last quarter their first
• 26:40
  Speaker 2: retail product, an ETF. I love the symbol qlt y.
• 26:46
  Speaker 2: Let's talk a little bit about the ETF and the
• 26:49
  Speaker 2: thinking behind it. GMO has almost exclusively had institutional investors,
• 26:57
  Speaker 2: very high networth family offices. I mentioned the quality mutual funds.
• 27:02
  Speaker 2: That's a five million dollar minimum. What was the thinking behind, Hey,
• 27:06
  Speaker 2: let's do an ETF that anyone could buy for fifty
• 27:09
  Speaker 2: BIPs no minimum.
• 27:10
  Speaker 1: Yeah, you're exactly right. GMO has been an institutional manager.
• 27:14
  Speaker 1: We started in the endowments and foundation space and have
• 27:17
  Speaker 1: gone from then. But as you also said, institutional includes
• 27:21
  Speaker 1: increasingly family offices and wealthy individuals who pay taxes, and
• 27:27
  Speaker 1: so just structurally, the ETF is such a better vehicle
• 27:32
  Speaker 1: to pool clients, and GMO has always been an advocate
• 27:34
  Speaker 1: of pooled investing. You get that, We think is that
• 27:37
  Speaker 1: good a solution, and it allows more portfolio manager focus,
• 27:41
  Speaker 1: not to have separate accounts, and so really the launch,
• 27:44
  Speaker 1: the genesis of having an ETF for us was less
• 27:46
  Speaker 1: about entering the retail market or accessing different clients, and
• 27:50
  Speaker 1: more about better servicing the institutional tax paying clients. That said,
• 27:56
  Speaker 1: we have a lot of respect for individual investors. I
• 27:58
  Speaker 1: think they get a bum wrap among institutional managers. Individual
• 28:02
  Speaker 1: investors can be very sophisticated, discerning, thoughtful, and it's not
• 28:08
  Speaker 1: a segment of the market we want to shy away from,
• 28:10
  Speaker 1: other than just the operational complexity of having lots of
• 28:13
  Speaker 1: small clients, and there the ETF market is matured to
• 28:16
  Speaker 1: a point where we don't really face that complexity, and
• 28:19
  Speaker 1: so we're glad to be able to be a lot
• 28:21
  Speaker 1: more accessible. The other thing i'd say about ETFs, and
• 28:24
  Speaker 1: they've been on our radar screen for a while, of course,
• 28:27
  Speaker 1: but originally they were for no particular reason, but kind
• 28:31
  Speaker 1: of associated with passive or more commoditized quantitative factor strategies.
• 28:36
  Speaker 1: It's really over the last few years that an active
• 28:38
  Speaker 1: strategy in an ETF has been something people would pay
• 28:42
  Speaker 1: any attention to.
• 28:43
  Speaker 2: So I mentioned previously the GMO quality mutual funds top
• 28:48
  Speaker 2: one percent of its peers thirteen point six percent a
• 28:51
  Speaker 2: year for the past decade. How does the quality ETF
• 28:54
  Speaker 2: strategy differ from the mutual fund strategy.
• 28:57
  Speaker 1: Not very much. It's the same investment process, philosophy, team
• 29:01
  Speaker 1: and everything. The one simplification we've made for the ETF
• 29:05
  Speaker 1: is it only we only invest in US companies. So
• 29:08
  Speaker 1: the quality fund is global's opportunity set has had up
• 29:12
  Speaker 1: to twenty percent in non US domicile multinationals, think like
• 29:16
  Speaker 1: the nesls of the world, that kind of company. Whereas
• 29:19
  Speaker 1: the ETF is designed to be a more straightforward S
• 29:23
  Speaker 1: and P five hundred US only equity strategy.
• 29:26
  Speaker 2: And it's concentrated thirty five large cap stocks. Is it
• 29:30
  Speaker 2: limited to what's in the S and P five hundred
• 29:32
  Speaker 2: or is it any US stock?
• 29:34
  Speaker 1: It's not limited to the S and P five hundred.
• 29:37
  Speaker 1: What we'd like tends to be large cap to established,
• 29:39
  Speaker 1: great businesses. So I think it is in fact all
• 29:42
  Speaker 1: stocks are in the S and P five.
• 29:44
  Speaker 2: Hundred and fifty BIPs is not an unreasonable fee structure
• 29:48
  Speaker 2: for an actively managed fund. Tell us the thinking behind
• 29:52
  Speaker 2: this why go? I wouldn't call it a low cost,
• 29:56
  Speaker 2: but it's not a high cost ETF. Some of the
• 29:58
  Speaker 2: other active ETFs are a one hundred BIPs or more.
• 30:01
  Speaker 2: What was the thinking that, Well.
• 30:03
  Speaker 1: We're pricing it similar to how we price our institutional accounts.
• 30:07
  Speaker 1: As I mentioned a lot of our I think initial
• 30:10
  Speaker 1: funds have come from tax paying investment advisors and such.
• 30:14
  Speaker 1: You might have a choice which to use. We wanted
• 30:16
  Speaker 1: to make that a not feed driven choice, but is
• 30:18
  Speaker 1: picking the right vehicle. Another reason why we can keep
• 30:22
  Speaker 1: the costs low is these are very liquid stocks. It's
• 30:25
  Speaker 1: not really capacity constraint around these, so it's not like
• 30:29
  Speaker 1: we have to charge an exceedingly high rate to be
• 30:32
  Speaker 1: a profitable business.
• 30:33
  Speaker 2: And how often do those thirty five stocks turnover? Is
• 30:37
  Speaker 2: there any Hey, we're going to rebalance this once a
• 30:40
  Speaker 2: year or once a quarter, or is it driven on
• 30:42
  Speaker 2: whatever opportunities the quality stock team you work with decides
• 30:48
  Speaker 2: we're gonna get.
• 30:48
  Speaker 1: Rid of X and replace it with Yeah, there's no
• 30:50
  Speaker 1: calendar to it. It's driven by the opportunities as we
• 30:53
  Speaker 1: see them. If we think about the mutual fund, and
• 30:55
  Speaker 1: I don't think there would be any different here. We've
• 30:58
  Speaker 1: been running turnover about twenty percent a year for the
• 31:02
  Speaker 1: last few years, which consistent with my remarks earlier. When
• 31:04
  Speaker 1: we buy a company, we're thinking about holding it for
• 31:06
  Speaker 1: quite some time. In fact, probably about half that turnover.
• 31:10
  Speaker 1: It's not so much new stocks entering or stocks exiting,
• 31:13
  Speaker 1: is more rebalancing around valuation moves in the portfolio.
• 31:16
  Speaker 2: I love the tick of qlty. It's amazing that was
• 31:19
  Speaker 2: even available this late in the ETF world. How did
• 31:24
  Speaker 2: you guys start first thinking about we have clients paying
• 31:27
  Speaker 2: all this phantom tax on the mutual fund side. ETFs
• 31:31
  Speaker 2: really seem to be much more efficient from a tax perspective.
• 31:36
  Speaker 2: Tell us a little bit about the discussions that led
• 31:39
  Speaker 2: up to let's create an ETF.
• 31:42
  Speaker 1: I'm acutely aware of the tax issues as I put
• 31:45
  Speaker 1: the bulk of my investing in our own strategies too,
• 31:48
  Speaker 1: including the mutual fund. Now I'm invested in the ETF.
• 31:51
  Speaker 1: I think it would go back over a decade. Like
• 31:53
  Speaker 1: we were well aware of ETFs for a very very
• 31:56
  Speaker 1: long time, and while we got the best ticker out there,
• 31:59
  Speaker 1: there are there qual the ETFs out there, which your
• 32:01
  Speaker 1: advisors were talking to us as competitors. So we're kind
• 32:04
  Speaker 1: of looking at the competitive landscape and seeing, Hey, what
• 32:07
  Speaker 1: do they do that's different from what we do? Why
• 32:09
  Speaker 1: do we think our approach is better and we're more fundamental,
• 32:13
  Speaker 1: we have the valuation, et cetera. There are a lot of differences.
• 32:15
  Speaker 1: Felt like now was the time, I think largely because
• 32:18
  Speaker 1: of the rise of active ETFs versus pure passive ones.
• 32:21
  Speaker 2: Now, this obviously isn't the exact same holdings as the
• 32:24
  Speaker 2: Quality Funds mutual fund, but I'm going to assume they'll
• 32:29
  Speaker 2: track pretty closely over time. It's the same process. It's
• 32:32
  Speaker 2: some of the favorite ideas from quality go into the ETF.
• 32:36
  Speaker 2: Can we expect similar performance from this?
• 32:39
  Speaker 1: Yeah? My expectations they won't differ is that we've never
• 32:43
  Speaker 1: held more than twenty percent in non US stocks, and
• 32:46
  Speaker 1: all the all the US stocks we hold in the
• 32:48
  Speaker 1: fund we also hold in the ETF at similar weights.
• 32:52
  Speaker 1: They are a couple of new names, so it's not
• 32:53
  Speaker 1: just a carve out, but it's very, very similar in characteristics.
• 32:57
  Speaker 2: So, I know GMO has a variety of offers. You
• 33:00
  Speaker 2: do equities, alts, fixed income. How does the quality screen
• 33:05
  Speaker 2: work with other asset classes besides equities? Can you do
• 33:10
  Speaker 2: that with alts? Can you do that with fixed income?
• 33:12
  Speaker 2: Or is it just specific to value stock investing?
• 33:16
  Speaker 1: Focusing on quality characteristics as well as valuation and sort
• 33:21
  Speaker 1: of quality at a reasonable price sort of big picture
• 33:24
  Speaker 1: is an idea that cuts pretty much across all of
• 33:28
  Speaker 1: GMO's strategies and the different asset classes in which we
• 33:31
  Speaker 1: invest Of course, it means different things. If you're running
• 33:34
  Speaker 1: a merger arms strategy with a short horizon, then long
• 33:37
  Speaker 1: term buy and hold investing like quote we do. But
• 33:41
  Speaker 1: that's there another thing to think about that sort of
• 33:44
  Speaker 1: unite GMO is a firm, is that a lot of
• 33:49
  Speaker 1: our clients come through the door, if you will, in
• 33:52
  Speaker 1: our multi asset class solutions we call ass allocation at GMO.
• 33:56
  Speaker 1: So a lot of the strategies that we've developed over
• 33:58
  Speaker 1: the years at GMO, originally the quality strategy derived from
• 34:04
  Speaker 1: us Jeremy and team Ben Anker and others seeing a
• 34:06
  Speaker 1: top down opportunity in the market US forming a strategy
• 34:11
  Speaker 1: if that's a conventional asset class or at the time
• 34:12
  Speaker 1: a new asset or subasset class like quality investing. That's
• 34:16
  Speaker 1: how a lot of what we do get started. It's
• 34:18
  Speaker 1: why we kind of have a complicated lineup for firm
• 34:21
  Speaker 1: our size, But that does impose a certain i think,
• 34:24
  Speaker 1: intellectual consistency on how we think about the world.
• 34:27
  Speaker 2: So given the success of this first ETF, and given
• 34:31
  Speaker 2: this expertise in all these different areas, the obvious question
• 34:35
  Speaker 2: is what's the next ETF that's going to come out
• 34:38
  Speaker 2: of GMO, or are you guys good with quality and
• 34:41
  Speaker 2: you're not looking for any other retail products.
• 34:45
  Speaker 1: Well, I'm not going to break news on your podcast,
• 34:47
  Speaker 1: but I think, yeah, we do one with the idea
• 34:50
  Speaker 1: certainly that we might do more.
• 34:52
  Speaker 2: If this continues to be successful. All these other asset
• 34:56
  Speaker 2: classes that GMO plays in, some of them are really.
• 35:00
  Speaker 1: Ripe for any Yes, some more ripe than others. But
• 35:02
  Speaker 1: I think there's a lot of opportunity out there. Maybe
• 35:04
  Speaker 1: another way of asking that question is why did we
• 35:05
  Speaker 1: start with this one? And there are a couple obvious reasons.
• 35:08
  Speaker 1: One it is our largest strategy, but another it is
• 35:12
  Speaker 1: US equities, which are kind of the simplest, most liquid
• 35:15
  Speaker 1: asset class. They fit well for the transparency you have
• 35:17
  Speaker 1: an ETF structure, it's the easiest to do the market
• 35:20
  Speaker 1: making around them. So it was a very obvious place
• 35:22
  Speaker 1: for us to start.
• 35:23
  Speaker 2: So the mutual fund is about eight billion dollars or so.
• 35:27
  Speaker 2: Is there any limitation on how big the CTF can get?
• 35:30
  Speaker 2: I'm assuming it's all large cap US stocks. Doesn't seem
• 35:35
  Speaker 2: like there are a lot of constraints on how large
• 35:37
  Speaker 2: this can scale.
• 35:38
  Speaker 1: Yeah, not practical constraints, of course, there's a constraint for everything,
• 35:41
  Speaker 1: but we'd be talking about tens of billions of dollars
• 35:44
  Speaker 1: where capacity would be.
• 35:46
  Speaker 2: Huh, really interesting. So let's talk a little bit about
• 35:48
  Speaker 2: what's going on in value today. I'm impressed by this
• 35:53
  Speaker 2: quote of yours and really curious if it's still true.
• 35:57
  Speaker 2: US deep value stocks are unusually cheap in the US market.
• 36:02
  Speaker 2: In particular, the cheapest twenty percent look cheaper than they
• 36:07
  Speaker 2: ever have in ninety eight percent of the time through history.
• 36:11
  Speaker 2: That's really surprising. And I keep hearing about how expensive
• 36:14
  Speaker 2: stocks are. The bottom quintile of value is as cheap
• 36:18
  Speaker 2: essentially as it ever gets.
• 36:20
  Speaker 1: Yeah, that's a quote that's coming out from our asked
• 36:22
  Speaker 1: allocation team about how they think about positioning equity portfolios.
• 36:25
  Speaker 1: To be maybe nuanced about that we're talking about is
• 36:30
  Speaker 1: the valuation of that relative to the overall market. So
• 36:33
  Speaker 1: it's kind of two sides of the same point. It's
• 36:35
  Speaker 1: not so much that cheap stocks are really really cheap.
• 36:37
  Speaker 1: It's that the spread of valuation ratios is very wide, So.
• 36:41
  Speaker 2: The non value stocks are very expensive.
• 36:44
  Speaker 1: And frankly, I think that is where most of the
• 36:45
  Speaker 1: action is. It's the non value stocks are trading it
• 36:48
  Speaker 1: much higher multiples than they normally have. And when we
• 36:52
  Speaker 1: say deep value, it's almost like to people talk about
• 36:54
  Speaker 1: indus because they divide the world fifty to fifty. There's
• 36:57
  Speaker 1: no magic to that. I think right now, market cap
• 37:00
  Speaker 1: sense market concentration. There are a lot more growth stocks.
• 37:03
  Speaker 1: So to find the true value stocks and making air quotes,
• 37:06
  Speaker 1: you kind of have to go a little bit deeper
• 37:08
  Speaker 1: into the percentiles of market cap than you would typically.
• 37:11
  Speaker 2: And when we're talking about value, you're still discussing with
• 37:15
  Speaker 2: the quality overlay. So you could have quality stocks and
• 37:18
  Speaker 2: the least expensive quality stocks on a valuation basis relatively attractive,
• 37:24
  Speaker 2: but maybe not absolutely attractive. I don't want to put
• 37:27
  Speaker 2: words in your mouth.
• 37:28
  Speaker 1: Yeah, may you apologize for confusing terminology on our part,
• 37:31
  Speaker 1: because when we say deep value any people often think
• 37:33
  Speaker 1: just the lowest price to book stocks out there. In
• 37:36
  Speaker 1: the GMO terminology, that's deep value on a measure of
• 37:40
  Speaker 1: what we call intrinsic value that blends a hefty version
• 37:43
  Speaker 1: of quality into that. So that will include some stocks
• 37:46
  Speaker 1: you hold in the quality and think metas of the
• 37:48
  Speaker 1: world companies like that.
• 37:49
  Speaker 2: Gotcha? So I get the sense you guys don't pay
• 37:52
  Speaker 2: a whole lot of attention to the macro economy or
• 37:57
  Speaker 2: geopolitics or what the Fed's doing. How important are these
• 38:02
  Speaker 2: other aspects to the way you manage assets?
• 38:05
  Speaker 1: Not that important. I think the thought experient for us
• 38:08
  Speaker 1: is if this is something that feels cyclical, that isn't
• 38:11
  Speaker 1: going to affect where the world's going to be five
• 38:13
  Speaker 1: years from now, then we're only going to pay attention
• 38:17
  Speaker 1: to it to the extent that if something happens, we
• 38:20
  Speaker 1: react to it like it can create a dislocation. Right,
• 38:22
  Speaker 1: people might overreact to an interest rate move in our opinion,
• 38:25
  Speaker 1: but we're not going to try to forecast it or
• 38:27
  Speaker 1: pick stocks based on that. You did mention geopolitics in
• 38:31
  Speaker 1: that list. Politics is in my mind a little bit different.
• 38:34
  Speaker 1: And the reason that's a little bit different is I'm
• 38:36
  Speaker 1: not sure that's going to be solved five years from now, right,
• 38:39
  Speaker 1: that could get worse, or the trends that we're on
• 38:42
  Speaker 1: are different from where we've been in the last twenty
• 38:45
  Speaker 1: or thirty years. So that is say, of those things,
• 38:47
  Speaker 1: the one for a scratch our head a little bit more.
• 38:49
  Speaker 1: Not that I'm going to claim we have the answers there,
• 38:51
  Speaker 1: but it is front of mine for us.
• 38:53
  Speaker 2: How do you think about interest rate risk or inflation
• 38:56
  Speaker 2: or the whole transitory versus sticky debate. Does that become
• 39:01
  Speaker 2: a key part of the asset allocation discussion or is
• 39:06
  Speaker 2: it just kind of background noise that everybody else to
• 39:09
  Speaker 2: deal with.
• 39:10
  Speaker 1: More background noise. Jim O is kind of famous for
• 39:13
  Speaker 1: doing seven year forecasts, right, And the reasons we do
• 39:15
  Speaker 1: seven year forecasts is that's sort of the horizon where
• 39:18
  Speaker 1: we feel like, whatever the noise is that's going on now,
• 39:21
  Speaker 1: that'll kind of all be gone. So the philosophy behind
• 39:24
  Speaker 1: those is, eah, seven years from now, things will be
• 39:26
  Speaker 1: kind of normal, and I'm not sure what the path
• 39:28
  Speaker 1: is to get there, but if that's where they're going,
• 39:31
  Speaker 1: this is what that would imply about returns over that horizon.
• 39:34
  Speaker 2: And one of your recent notes you mentioned Jeremy Grantham's
• 39:37
  Speaker 2: super bubble thesis. How do you work in quality as
• 39:42
  Speaker 2: a core equity allocation within the concept that, hey, maybe
• 39:46
  Speaker 2: there's a super bubble going on out there? Is that consistent?
• 39:49
  Speaker 1: Yeah, I'm a humble portfolio manager works from the bottom up,
• 39:53
  Speaker 1: so I'm not really thinking about super bubbles very much. Honestly,
• 39:56
  Speaker 1: I'm thinking about. Are these stocks that we're investing in
• 40:00
  Speaker 1: good quality business price to deliver a good return, and
• 40:03
  Speaker 1: good I mean sort of double digit type return over
• 40:05
  Speaker 1: the next five ish years. So if it turns out
• 40:08
  Speaker 1: this is a super bubble, and I think Jeremy's technical
• 40:11
  Speaker 1: definition of that is a very very big bubble, then
• 40:15
  Speaker 1: quality stocks are going to go down. We'll have been
• 40:17
  Speaker 1: wrong to invest in them. The silver lining is, at
• 40:20
  Speaker 1: least we'll have done better than pretty much anything else
• 40:22
  Speaker 1: out there.
• 40:23
  Speaker 2: Quality will go down less than the rest of the.
• 40:26
  Speaker 1: Indices, particularly quality with a sense of valuation.
• 40:30
  Speaker 2: All right, so let me jump to my favorite questions
• 40:34
  Speaker 2: that I ask all of my guests, starting with what
• 40:38
  Speaker 2: have you been streaming these days? What's been keeping you entertained,
• 40:41
  Speaker 2: either video or audio.
• 40:43
  Speaker 1: I have a twelve year old daughter, and she runs
• 40:45
  Speaker 1: the family with an iron fist, and she likes to
• 40:48
  Speaker 1: still watch TV together. So I've been watching a lot
• 40:50
  Speaker 1: of Survivor episodes. Though unfortunately I actually like those, She's
• 40:53
  Speaker 1: moving on to something else now that I like less. Well,
• 40:55
  Speaker 1: I won't call it out in terms of I listened
• 40:59
  Speaker 1: to a lot of pod cast too. That's where I
• 41:01
  Speaker 1: get a little more sort of I'm sort of embarrassed
• 41:04
  Speaker 1: to say it, but professionally takes a little bit of
• 41:06
  Speaker 1: the place of reading. I love econ Talk, which is
• 41:10
  Speaker 1: sort of theoretical economics debate podcast for fun. I love
• 41:15
  Speaker 1: Judge John Hodgman. There's all kinds of things out there.
• 41:19
  Speaker 1: It's a great world.
• 41:19
  Speaker 2: Yeah, no, it really is. So let's talk a little
• 41:22
  Speaker 2: bit about your career. Who were your early mentors who
• 41:25
  Speaker 2: helped shape the path you've taken professionally.
• 41:30
  Speaker 1: I think in my case, law of the mentors come
• 41:32
  Speaker 1: through kind of my academic career and teachers and professors
• 41:36
  Speaker 1: going back and my high school math teacher, mister Hyde.
• 41:40
  Speaker 1: He was the one who taught the computer programming course.
• 41:42
  Speaker 1: He's the one who sort of encouraged me to take
• 41:44
  Speaker 1: college courses when I was in high school. He also
• 41:47
  Speaker 1: taught me Bridge, which is I don't really play that
• 41:49
  Speaker 1: much anymore, but it is a great game, and let
• 41:51
  Speaker 1: you think a lot of that things in a great way.
• 41:54
  Speaker 1: My PhD advisor at Harvard less Valiant, i'd also pick out.
• 41:59
  Speaker 1: I mentioned Chris Darnell at GM. Rob Soussi was the
• 42:02
  Speaker 1: name of my first manager there. He was a very wise,
• 42:05
  Speaker 1: wise man. If I think about one of the things
• 42:08
  Speaker 1: I gained from these people, to particular the professional ones.
• 42:12
  Speaker 1: It's kind of when to be willing to say no
• 42:15
  Speaker 1: to stuff too. My colleagues now wouldn't believe it, but
• 42:18
  Speaker 1: I used to be probably over accommodating, and maybe I've
• 42:21
  Speaker 1: learned that lesson a bit over learned it.
• 42:23
  Speaker 2: What are some of your favorite books? What are you
• 42:25
  Speaker 2: reading currently?
• 42:27
  Speaker 1: Well, this is the holiday time. I just came back
• 42:30
  Speaker 1: from a long playing flight and I read this really
• 42:34
  Speaker 1: fun detective book that my wife gave me for Christmas.
• 42:37
  Speaker 1: But then I was reading a biography of Samuel Sewell,
• 42:39
  Speaker 1: who's one of the judges at the Salem witch Trials.
• 42:43
  Speaker 1: Actually saw a colonial era figure. It's an interesting book
• 42:46
  Speaker 1: to learn about that era. My favorite book of all time,
• 42:49
  Speaker 1: and it is not even close, is a children's book
• 42:52
  Speaker 1: called The Land of Green Ginger, which is written by
• 42:55
  Speaker 1: the screenwriter the original Wizard of Oz movies. It is
• 42:59
  Speaker 1: a heirical, clever take on the kind of the PostScript
• 43:03
  Speaker 1: to the Aladdin myth from the Arabian Nights, and I
• 43:07
  Speaker 1: recommend all of your listeners if they can find it,
• 43:10
  Speaker 1: which is easy read that book.
• 43:11
  Speaker 2: Huh, really interesting? What sort of advice would you give
• 43:14
  Speaker 2: to a recent college grad interested in a career in
• 43:18
  Speaker 2: investment and finance.
• 43:20
  Speaker 1: So investment finance is actually a very broad area. So
• 43:23
  Speaker 1: the first advice is kind of narrow that down. And
• 43:26
  Speaker 1: the west way to narrow it down is to get
• 43:29
  Speaker 1: exposure to lots of different things. And I think the
• 43:33
  Speaker 1: best way to enable yourself to get exposure is don't
• 43:37
  Speaker 1: focus so much on finance and investment. Just figure out
• 43:39
  Speaker 1: about learning. Learn all sorts of things. Learn math, learn history.
• 43:44
  Speaker 1: You can always learn a trade after that. Don't think, oh,
• 43:47
  Speaker 1: I'm interested in finance, so I'm just going to spend
• 43:49
  Speaker 1: all my time listening to investment podcasts and I'll answer
• 43:53
  Speaker 1: or non tecular ten ks.
• 43:56
  Speaker 2: I don't imagine that anyone's going to listen to a
• 43:58
  Speaker 2: couple of dozen podcasts and so only begin to outperform
• 44:02
  Speaker 2: the benchmarkt It's a little more nuanced than that, isn't it.
• 44:05
  Speaker 1: I think all the great investors talk about reading and
• 44:08
  Speaker 1: how much of their time they spend reading and just learning,
• 44:11
  Speaker 1: and I think that is one of the things I
• 44:12
  Speaker 1: like about the investment industry is you just spend so
• 44:15
  Speaker 1: much of your time just learning about how businesses work.
• 44:18
  Speaker 1: How the world works. You're kind of an observer. You're
• 44:21
  Speaker 1: kind of a miserable critic rather an actual creator of value,
• 44:24
  Speaker 1: but an analyzer of others work.
• 44:26
  Speaker 2: It's almost academic adjacent, given how much reading there is.
• 44:30
  Speaker 2: And our final question, what do you know about the
• 44:32
  Speaker 2: world of investing today? You wish you knew thirty years
• 44:35
  Speaker 2: or so ago when you were first getting started.
• 44:38
  Speaker 1: That appreciation of quality businesses and the value to pay
• 44:41
  Speaker 1: for them. I come my mindset is a little bit
• 44:44
  Speaker 1: more contrarian, and I think from an investing perspective that
• 44:47
  Speaker 1: manifests itself much more in a value orientation or value
• 44:51
  Speaker 1: meaning low multiple underperforming socks cigar butt of philosophy, and
• 44:56
  Speaker 1: I think realizing the value of time and compounding and
• 45:01
  Speaker 1: it's just worth paying up for a higher quality business.
• 45:03
  Speaker 2: To say the very least, thank you Tom for being
• 45:06
  Speaker 2: so generous with your time. We have been speaking with
• 45:09
  Speaker 2: Tom Hancock, head of the Focused Equity team at GMO.
• 45:13
  Speaker 2: If you enjoy this conversation, well check out any of
• 45:16
  Speaker 2: the previous five hundred interviews we've conducted over the past
• 45:20
  Speaker 2: nine years. You can find those at iTunes, Spotify, YouTube,
• 45:26
  Speaker 2: wherever you find your favorite podcasts. Sign up from my
• 45:30
  Speaker 2: daily reading list at ridults dot com. Follow me on
• 45:33
  Speaker 2: Twitter at rid Halts. I would be remiss if I
• 45:36
  Speaker 2: do not thank the crack team who helps us put
• 45:39
  Speaker 2: these conversations together each week. My audio engineer is Kaylie Laparo.
• 45:44
  Speaker 2: Attika of albrun is my project manager. Sean Russo is
• 45:47
  Speaker 2: my head of research. Anna Luke is our producer. I'm
• 45:51
  Speaker 2: Barry Ridholts. You've been listening to Masters in Business on
• 45:56
  Speaker 2: Bloomberg Radio.