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Ben Inker on Value and Asset Allocation (Podcast) · Masters in Business

• 0:02
  Speaker 1: This is Master's in Business with Barry Ridholts on Bloomberg Radio.
• 0:07
  Speaker 1: This week on the podcast, I have an extra special guest.
• 0:10
  Speaker 1: His name is Ben Inker, and he is the head
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  Speaker 1: of asset allocation at famed hedge fund GMO, located up
• 0:17
  Speaker 1: in Boston. They manage about sixty billion dollars. Inker is
• 0:23
  Speaker 1: Jeremy Grantham's right hand man, and we had a fascinating
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  Speaker 1: and nuanced conversation about all things value related. I was
• 0:33
  Speaker 1: especially intrigued about his take on why we are measuring
• 0:39
  Speaker 1: intangibles from companies and whether that's intellectual property or various
• 0:45
  Speaker 1: other assets they hold that make them less capital intensive
• 0:50
  Speaker 1: and therefore potentially more valuable. Was intriguing. They they've done
• 0:56
  Speaker 1: some fascinating research that really is very interesting. He explains
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  Speaker 1: how and why value has underperformed what he thinks is
• 1:04
  Speaker 1: going to happen going forward. We go over a handful
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  Speaker 1: of different sectors of the economy of the world and
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  Speaker 1: and talk about specific stocks. If you are at all
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  Speaker 1: interested in either value or asset allocation or anything along
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  Speaker 1: those those um lines, you'll find this to be an
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  Speaker 1: absolutely fascinating conversation. So, with no further ado, my sit
• 1:28
  Speaker 1: down with GMOs. Ben Inker VI is Masters in Business
• 1:34
  Speaker 1: with Barry Ridholtz on Boomberg Radio. My special guest this
• 1:39
  Speaker 1: week is Ben Inker. He is GMO's head of asset allocation.
• 1:44
  Speaker 1: During the dot com implosion, the GMO aggressive long short strategy,
• 1:49
  Speaker 1: which was long undervalued stocks and short overvalued stocks, achieved
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  Speaker 1: an eighty percent cumulative net return for clients. The firm
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  Speaker 1: is led by Jeremy Grantham, currently manages about sixty billion dollars.
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  Speaker 1: Then Incher, Welcome to Bloomberg. Well, thanks very much for
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  Speaker 1: having me. Very so, your current role is head of
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  Speaker 1: GMO's asset allocation team. How did you arrive at that position?
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  Speaker 1: Tell us a little bit about your career path. Well,
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  Speaker 1: I have been at GMO for the entirety of my
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  Speaker 1: professional career. I joined GMO in I was hired as
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  Speaker 1: a research analysts working for Jeremy Grantham. Um And since
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  Speaker 1: Jeremy was the person who was kind of most focused
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  Speaker 1: on top down acid allocation stuff at GMO, well, I
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  Speaker 1: did a lot of different kinds of research over the
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  Speaker 1: first you know, eight or ten years of my career.
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  Speaker 1: I was the person who had done the most work
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  Speaker 1: on AFID allocation as our business in Athidelic Asian grew.
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  Speaker 1: I was, you know, his assistant portfolio manager, and then
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  Speaker 1: the portfolio manager, and then over time the head of
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  Speaker 1: the team. That's the short form. Interesting, So you started
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  Speaker 1: early nineties, which was quite an interesting decade to cut
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  Speaker 1: your teeth on. How did your early experiences during that
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  Speaker 1: era shape your views of the market? Yeah, so, I
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  Speaker 1: mean I came at a time when kind of the
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  Speaker 1: forces of let's say, mean reversion had shown themselves to
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  Speaker 1: be powerful. We've seen in the eighties, you know, when
• 3:45
  Speaker 1: both bonds and stocks got to ludicrously cheap levels that
• 3:49
  Speaker 1: they recovered. We had just experienced a pretty extraordinary bubble
• 3:55
  Speaker 1: and the bursting of it in Japan uh in the
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  Speaker 1: late eighties and into the early nineties. So one of
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  Speaker 1: the things I got early on was this um kind
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  Speaker 1: of strong understanding and belief that markets can do crazy things,
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  Speaker 1: but over time they do eventually come back, whether that's
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  Speaker 1: because they have gotten absurdly cheap or absurdly expensive. You know.
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  Speaker 1: I then got to participate in the next great bubble,
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  Speaker 1: which was quite painful for us as investors. But then
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  Speaker 1: you got to experience just how crazy, uh, the world
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  Speaker 1: could get. So it was a a fascinating kind of
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  Speaker 1: crucible to h to grow up in as an investor.
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  Speaker 1: So you say that was painful, But in the ends,
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  Speaker 1: ultimately the firm and Grantham's calls ended up being right.
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  Speaker 1: It was a big money maker to the downside. Does
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  Speaker 1: that offset the pain? What do we take away from
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  Speaker 1: when markets go crazy? But ultimately you know, as always
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  Speaker 1: that sort of excess ends and tears. Yeah, I think
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  Speaker 1: you know it is. It is truly the case, um
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  Speaker 1: that Uh. You know, the the market in the short
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  Speaker 1: term may be a voting machine, but in the long
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  Speaker 1: term is a weighing machine. Um. And at the end
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  Speaker 1: of the day, at least four assets that where valuation
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  Speaker 1: is relevant. Uh. And it is astonishing that we live
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  Speaker 1: in a world where there are more assets where valuation
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  Speaker 1: is is not a relevant thing anymore. But for the
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  Speaker 1: vast majority of financial assets out there where valuation is relevant, um,
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  Speaker 1: valuation will eventually out. Um. You know, at the end
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  Speaker 1: of the day, everything is worth the present value of
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  Speaker 1: the future cash flows. Um. And what we have seen
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  Speaker 1: time and time again is the market will forget that. Uh.
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  Speaker 1: And as the market forgets that, it will do some
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  Speaker 1: sort of objectively silly things. Uh. But in the end, UM,
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  Speaker 1: those cash flows or the lack of them, is a
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  Speaker 1: profound discipline to the market, which will pull things back. UM. Now,
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  Speaker 1: the time frame that they're going to pull them back
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  Speaker 1: over is uncertain UM. And one of the things you
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  Speaker 1: know we we lived in in the late nineties events
• 6:45
  Speaker 1: is that while in the end the collapse of that
• 6:48
  Speaker 1: bubble was positive for us, it was positive for our
• 6:53
  Speaker 1: clients because we did manage to make the money for
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  Speaker 1: it and helped GMO grow as a business. The reality
• 7:01
  Speaker 1: is there were a number of other money managers that
• 7:06
  Speaker 1: saw what we saw and did some of the things
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  Speaker 1: we did, and for whatever reason couldn't hold off either
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  Speaker 1: the firm, the firms themselves folded, or the people who
• 7:20
  Speaker 1: were doing the what I call right thing um were
• 7:25
  Speaker 1: eventually told by their bosses, we can't stand this pain anymore.
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  Speaker 1: Either you change what you are doing, or we are
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  Speaker 1: going to change the person in charge of uh of
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  Speaker 1: your area. UM. So yeah, if you have a long
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  Speaker 1: enough time horizon, you can rely on the market eventually
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  Speaker 1: becoming sane again. But I don't think anybody should pull
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  Speaker 1: themselves into thinking taking those bets is easy or is
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  Speaker 1: guaranteed to work out well for the people who do them.
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  Speaker 1: So that raises the question here we are It's markets
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  Speaker 1: have had a fantastic recovery from choose your time frame,
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  Speaker 1: the lows in OH nine, the breakout in the crash,
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  Speaker 1: and recovery in Where are we in the market cycle?
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  Speaker 1: There's obviously a lot of valuation questions, a ton of fraud,
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  Speaker 1: but also a ton of of fiscal stimulus and very
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  Speaker 1: very high monetary stimulus. Where are we in the cycle?
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  Speaker 1: It's it is a more difficult question than I'd love
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  Speaker 1: for it to be. I think the evidence of the
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  Speaker 1: fraud is everywhere around us. Um. We are seeing stuff.
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  Speaker 1: Every bit is crazy and in some ways even more
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  Speaker 1: inexplicable than some of the stuff we saw in the
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  Speaker 1: Internet bubble. Um. But if one thinks back to the
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  Speaker 1: Internet bubble, right, we had all time high valuations for
• 9:02
  Speaker 1: the S and P five coexisting with real interest rates
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  Speaker 1: of four right the inflation index bonds in the US
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  Speaker 1: the tips yielded over four UM. So the alternative to
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  Speaker 1: investing inequities that had never traded at such high valuations
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  Speaker 1: UM was low risk assets that offered really good perspective
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  Speaker 1: returns today, that is absolutely not the case. We know
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  Speaker 1: low risk assets, whether it has been engineered by central
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  Speaker 1: banks or whether it is a more natural um outgrowth
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  Speaker 1: of the economy, low risk assets are offering extraordinarily low
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  Speaker 1: returns UM. And what I wish I knew the answer
• 9:51
  Speaker 1: to was whether those incredibly low rates are sustainable h
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  Speaker 1: or not. UM. If they're sustainable, then the difference between
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  Speaker 1: now and two thousand is that the general level of
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  Speaker 1: risky assets from a valuation perspective probably makes sense. UM.
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  Speaker 1: The extraordinary gap between kind of the secular growth names
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  Speaker 1: versus value names still doesn't make sense. Even if you
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  Speaker 1: believe that you know the S and P S valuation
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  Speaker 1: or h M s c I world valuation is sustainable,
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  Speaker 1: that gap doesn't make sense UM. But it may be
• 10:40
  Speaker 1: that the overall market on average makes sense if if
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  Speaker 1: inflation is truly permanently gone as a meaningful risk in
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  Speaker 1: the developed world. UM. I don't know the answer to that,
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  Speaker 1: but I will say one of the things I have
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  Speaker 1: been surprised by, on average over the last twenty years
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  Speaker 1: is that even in those times where you would have
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  Speaker 1: expected inflation to be UM accelerating, it's been pretty tame um.
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  Speaker 1: So I don't know whether the market has to fall
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  Speaker 1: from here. I do think even if the market level
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  Speaker 1: makes sense, we've got a speculative bubble going on, and
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  Speaker 1: that speculative bubble will have to break. But whether the
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  Speaker 1: breaking of that speculative bubble is associated with, you know,
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  Speaker 1: the market falling by as it did in two thousands,
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  Speaker 1: or whether it's going to be driven by a strong
• 11:50
  Speaker 1: outperformance by value stocks which are simply not priced to
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  Speaker 1: deliver the low return and that are sustainable, if low
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  Speaker 1: risk assets are going to permanently lose your money after inflation.
• 12:08
  Speaker 1: I just don't have the perfect answer. So you write
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  Speaker 1: very thoughtful quarterly or so letters that that I enjoy,
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  Speaker 1: And I don't recall if this was December's quarter or
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  Speaker 1: October quarter, but a couple of quarters ago you had
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  Speaker 1: explained as some of the tech stocks keep rallying, as
• 12:27
  Speaker 1: some of the valuations continue to stretch, no one could
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  Speaker 1: really guess where this ends. But the most likely ends
• 12:35
  Speaker 1: will be when the FED starts to tighten and raise rates.
• 12:38
  Speaker 1: First of I am I oversimplifying that or is that
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  Speaker 1: more or less right? And do you still hold that
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  Speaker 1: sort of belief? You know it is not. It won't
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  Speaker 1: surprise you at all to hear that. The most common
• 12:52
  Speaker 1: question I am getting from the clients these days is
• 12:55
  Speaker 1: what's the catalyst? What's going to be the trigger for
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  Speaker 1: the turn here? Um? So one thing we have absolutely
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  Speaker 1: done is gone back and looked at the profound turning
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  Speaker 1: points and markets and tried to see, Okay, well, what
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  Speaker 1: was the catalyst in two thousand? What was the catalysts
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  Speaker 1: in Japan? What was the catalyst in the US? Sometimes
• 13:20
  Speaker 1: there is a catalyst, but a surprising amount of the time,
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  Speaker 1: even in retrospect, there doesn't seem to be one. Right.
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  Speaker 1: The catalyst for the cracking of the Internet bubble in
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  Speaker 1: two thousand, I don't know. I mean, I was certainly there,
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  Speaker 1: I was staring at the market, um, But even twenty
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  Speaker 1: years later, I can't tell you exactly what it was.
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  Speaker 1: Let me flow the theory at you on that, because
• 13:52
  Speaker 1: I was also there and watching the I l X
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  Speaker 1: and the Bloomberg terminal all the time. And I have
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  Speaker 1: a very vivid recollection of the first or second week
• 14:03
  Speaker 1: of March two thousand and remember we had that giant
• 14:07
  Speaker 1: y two K concern and there was a ton of
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  Speaker 1: of hardware purchased in anticipation of that, and you very quickly.
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  Speaker 1: I don't remember if it was Dell that had a
• 14:19
  Speaker 1: terrible quarter pre announced or Intel. It might it might
• 14:24
  Speaker 1: have been Dell, like the first week of March. I
• 14:27
  Speaker 1: think there was their window to announce that their previous
• 14:31
  Speaker 1: guidance was gonna be wrong. So it could have been
• 14:33
  Speaker 1: like March eighth, two thousand. It's funny how all these
• 14:36
  Speaker 1: things have been happening around March oh eight and and
• 14:41
  Speaker 1: uh uh was the oh nine was the bottom and
• 14:44
  Speaker 1: oh eight was to March two thousand was the top,
• 14:46
  Speaker 1: and then again the bottom in But is that the
• 14:50
  Speaker 1: sort of thing that is a credible precipitent or is
• 14:55
  Speaker 1: it really just the reveal and the collapse would happen otherwise,
• 15:01
  Speaker 1: you know, I don't know. Certainly. The basic thing the
• 15:06
  Speaker 1: market was getting wrong in two thousand, um was this
• 15:13
  Speaker 1: belief in incredibly strong continued growth in corporate profits. Um.
• 15:21
  Speaker 1: If you look at what people were saying. Sure, there
• 15:23
  Speaker 1: was the Dow six thousand argument that was basically saying
• 15:29
  Speaker 1: there should be no equity risk treamum. But if you
• 15:32
  Speaker 1: look at what analysts were saying and how analysts were
• 15:36
  Speaker 1: assuming decent returns going forward was you know, expected earnings
• 15:42
  Speaker 1: growth had never really been higher, so they were expecting
• 15:47
  Speaker 1: something like annualized earnings growth. Now they always overpredict earnings growth,
• 15:52
  Speaker 1: but that was some of the highest levels ever. Um.
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  Speaker 1: You know, the the reality of what was going on.
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  Speaker 1: The funny thing is, in March we had this extraordinary
• 16:14
  Speaker 1: day and I'm sure you remember it as vividly as
• 16:16
  Speaker 1: I do, where the market in the morning collapsed like
• 16:22
  Speaker 1: twelve or four uh, and then in the afternoon made
• 16:26
  Speaker 1: this extraordinary recovery to wind up down I don't know
• 16:30
  Speaker 1: one or two um. And it was this kind of
• 16:34
  Speaker 1: intra day volatility that hadn't been seen well more or
• 16:39
  Speaker 1: less ever, um. And that was maybe kind of a
• 16:46
  Speaker 1: shot across the bow. If if you look at what
• 16:49
  Speaker 1: happened um across two thousand, you know, the first group
• 16:57
  Speaker 1: to really crack was the pure internet startups uh. And
• 17:04
  Speaker 1: then a little bit later in my memory this was
• 17:07
  Speaker 1: really late spring, early summer, was the hardware names uh,
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  Speaker 1: you know, including Dell. UH. Software guys held out farther
• 17:20
  Speaker 1: until the fall um UM. But then they cracked UM.
• 17:28
  Speaker 1: And maybe it was as simple as disappointing earning UM,
• 17:35
  Speaker 1: but it wasn't obvious at the time that it was
• 17:40
  Speaker 1: disappointing earnings numbers, And I certainly don't remember a change
• 17:43
  Speaker 1: in the you know, the general tenor of market commentary
• 17:51
  Speaker 1: UM as being around this sudden realization that that earnings
• 18:00
  Speaker 1: weren't going to be there. Quite interesting. So let's talk
• 18:03
  Speaker 1: a little bit about the forecasts that you guys make
• 18:07
  Speaker 1: on a regular basis, the seven year forecasts. What are
• 18:10
  Speaker 1: the primary inputs into that seven year forecast that let
• 18:15
  Speaker 1: you conclude US stocks are likely to deliver negative real
• 18:20
  Speaker 1: returns over the next seven years. The basic underlying idea
• 18:25
  Speaker 1: behind the forecast UH that goes back to when we
• 18:29
  Speaker 1: started publishing them in the mid nineties, is that the market,
• 18:36
  Speaker 1: it spends very little time looking normal UM, but UM
• 18:43
  Speaker 1: over time goes through normal reasonably often. So in principle,
• 18:48
  Speaker 1: what we're really saying is, look, we don't know exactly
• 18:51
  Speaker 1: what the future is going to hold, but let's assume
• 18:53
  Speaker 1: that it's some uncertain point in the future we'll call
• 18:57
  Speaker 1: it seven years from now. Everything looks normal, So the
• 19:00
  Speaker 1: p of the market looks normal, profitability looks normal UM,
• 19:04
  Speaker 1: and the return we're going to get between now and
• 19:06
  Speaker 1: then is going to be driven by whatever earnings growth
• 19:10
  Speaker 1: will occur, whatever income we're going to get from that asset,
• 19:15
  Speaker 1: and then either a gain or a loss associated with
• 19:20
  Speaker 1: these reverting to normal and profitability reverting to normal. Now,
• 19:26
  Speaker 1: one thing that has changed about the forecast um is
• 19:30
  Speaker 1: we do now have two different scenarios that we are
• 19:34
  Speaker 1: explicitly using. One of them is kind of the traditional
• 19:39
  Speaker 1: one that we started choosing in, which is that fair
• 19:44
  Speaker 1: value is the long term normal, so the stock market
• 19:48
  Speaker 1: should be trading around sixteen times normalized earnings, bond yields
• 19:53
  Speaker 1: will be somewhere between two percent and three percent above inflation, uh,
• 19:58
  Speaker 1: kind of the old aisle assumption of where equilibrium is.
• 20:06
  Speaker 1: More recent years, we've built in another scenario, which we
• 20:10
  Speaker 1: also consider to be a reasonable one. It's predicated on
• 20:16
  Speaker 1: the idea that interest rates have permanently from those levels.
• 20:21
  Speaker 1: We used to call that scenario hell um. We now
• 20:25
  Speaker 1: call it partial mean reversion. We stopped calling it hell
• 20:29
  Speaker 1: maybe because we were offending some people, but mostly because
• 20:31
  Speaker 1: we were confusing them because our forecasts in hell are
• 20:35
  Speaker 1: generally better than our forecasts otherwise, because the allowable valuation
• 20:42
  Speaker 1: in a world where interest rates have permanently fallen is higher.
• 20:46
  Speaker 1: So for any given level of the market, if equilibrium
• 20:49
  Speaker 1: valuation is higher, the return will be higher UM. Now Today,
• 20:55
  Speaker 1: particularly for the US, even in that low interest rate environment,
• 21:03
  Speaker 1: today's valuations were stocked in the US really look too high.
• 21:09
  Speaker 1: In the rest of the world, that's less true. Uh.
• 21:13
  Speaker 1: And if interest rates are truly permanently low, you know,
• 21:16
  Speaker 1: the emerging market in general are probably trading at a
• 21:21
  Speaker 1: very reasonable valuations. But in the US, even if we
• 21:24
  Speaker 1: make that adjustment, we come to the conclusion that the
• 21:28
  Speaker 1: that the market is overvalued um. And that's I would
• 21:33
  Speaker 1: say the last couple of years we have generally said
• 21:37
  Speaker 1: that is more true for large gaps than small caps UM.
• 21:42
  Speaker 1: But among the extraordinary things that happened, despite an environment
• 21:47
  Speaker 1: that was unquestionably worse for smaller cap companies, the Russell
• 21:53
  Speaker 1: two thousands outperformed. And so at this point we think
• 21:57
  Speaker 1: even even the small caps in the US are are
• 22:00
  Speaker 1: likely to be a significant haven. And then our performance
• 22:05
  Speaker 1: really came in the last few months of the year,
• 22:07
  Speaker 1: didn't it. Yeah, And in the trigger in terms of
• 22:11
  Speaker 1: the catalyst of performance, the obvious catalyst on that performance
• 22:15
  Speaker 1: was the vaccine news and that vaccine news was unquestionably
• 22:19
  Speaker 1: wonderful news for humanity and wonderful news on a perspective
• 22:25
  Speaker 1: basis for the global economy. Um. But wow, it was
• 22:30
  Speaker 1: an awfully big move in these stocks, particularly given that
• 22:37
  Speaker 1: they weren't all that cheap to begin with. So it
• 22:41
  Speaker 1: was a move that directionally made sense, but from our perspective,
• 22:46
  Speaker 1: the scale of the move was just inexplicably large. So
• 22:54
  Speaker 1: you mentioned emerging markets which have been cheap for quite
• 22:58
  Speaker 1: a while. What are your what's on developed x US?
• 23:02
  Speaker 1: Is the rest of the developed world as pricey as
• 23:05
  Speaker 1: US equities? Uh? No, The valuations are lower in the
• 23:10
  Speaker 1: rest of the world. Now, some of that is driven
• 23:14
  Speaker 1: by the fact that UM I T is a smaller
• 23:19
  Speaker 1: piece of the rest of the world. UM industrial set
• 23:24
  Speaker 1: and information technology firms do probably deserve to trade at
• 23:29
  Speaker 1: higher valuations than kind of more traditional love But even
• 23:32
  Speaker 1: when you adjust for that, UM, we do see a
• 23:37
  Speaker 1: big gap between what a company would trade at in
• 23:40
  Speaker 1: the US and what that company would trade at if
• 23:44
  Speaker 1: it were somewhere else in the world. UM. So we
• 23:47
  Speaker 1: see the non US developed markets looking cheaper than the US.
• 23:52
  Speaker 1: UM we don't see them looking by any means dirt cheap.
• 23:58
  Speaker 1: The place that I think is most intriguing today in
• 24:02
  Speaker 1: the developed world UH is actually Japan UM, where the
• 24:08
  Speaker 1: valuations are reasonably low UM. And it is a place
• 24:14
  Speaker 1: where it is easy to imagine that profitability can improve
• 24:23
  Speaker 1: in a sustainable way UM because if you look at
• 24:28
  Speaker 1: you know, the return on capital in Japan, it's been
• 24:31
  Speaker 1: lower than that of the rest of the world for
• 24:33
  Speaker 1: the last forty years. And in principle, there is nothing
• 24:37
  Speaker 1: that stopped these companies from doing some of the same
• 24:41
  Speaker 1: things that companies in the rest of the world have
• 24:44
  Speaker 1: done UM and being able to really improve that UH.
• 24:49
  Speaker 1: And so you know, the simple math is if you
• 24:51
  Speaker 1: have two stock markets trading at the same pe and
• 24:56
  Speaker 1: one of them has significant scope for earnings growth real
• 25:00
  Speaker 1: to the other, well that that one is cheaper UM.
• 25:03
  Speaker 1: So within the rest of the developed world, UM, we
• 25:09
  Speaker 1: are intrigued by Japan today because of the potential for
• 25:15
  Speaker 1: kind of significant earnings and profitability growth over the next
• 25:19
  Speaker 1: five or ten years UM. But for really cheap markets um.
• 25:27
  Speaker 1: UH we think you can find more in the emerging
• 25:31
  Speaker 1: world than in the developed world today. Let me stay
• 25:34
  Speaker 1: with Japan for a few moments. Historically, not big stock
• 25:39
  Speaker 1: by backs, at least not compared to the US, And
• 25:44
  Speaker 1: there's always a little bit of currency risk of dollar
• 25:47
  Speaker 1: versus yen. How do you incorporate the currency risk into
• 25:51
  Speaker 1: your thesis? I mean, there's always currency risk whenever you're
• 25:56
  Speaker 1: buying an asset that's denominated in another currency. We find
• 26:00
  Speaker 1: is in the longer run, UH, that risk tends to
• 26:03
  Speaker 1: dissipate because let's imagine you buy Japanese stocks and the
• 26:07
  Speaker 1: yen really fall, so you're taking this this loss in
• 26:11
  Speaker 1: the nearer term. The good news once that has happened
• 26:16
  Speaker 1: is Japanese companies are now going to be really competitive
• 26:21
  Speaker 1: relative to their global peers because of what's happened to
• 26:24
  Speaker 1: the end um. So what we what we tend to
• 26:27
  Speaker 1: find is as your time horizon lengthens, uh, the extra
• 26:32
  Speaker 1: risk associated with the currency tends to fall away. Because
• 26:37
  Speaker 1: countries that experience a fall in their currency normally experience
• 26:43
  Speaker 1: better than average earning scrowth, and companies that experience a
• 26:47
  Speaker 1: rise in their currency experience subpar earning scrow. So it
• 26:52
  Speaker 1: kind of comes out in the wash. And that's more
• 26:55
  Speaker 1: strongly true in the developed world than it is in
• 26:57
  Speaker 1: the emerging world, because the emerging world sometimes you know,
• 27:02
  Speaker 1: a following currency can turn into a currency crisis, which
• 27:07
  Speaker 1: is more problematic for for the companies. But in the
• 27:10
  Speaker 1: developed world, I don't get that worried about UM the currencies.
• 27:17
  Speaker 1: Most of the time. I do get nervous if I'm
• 27:19
  Speaker 1: buying into a country where the currency is at a
• 27:23
  Speaker 1: given point in time substantially overvalued. UM. That doesn't seem
• 27:28
  Speaker 1: to be true of Japan today. UM. You know the
• 27:31
  Speaker 1: risk in Japan, I would say the primary risk is
• 27:35
  Speaker 1: if they don't get that religion, if they don't start
• 27:39
  Speaker 1: paying more money out to shareholders, if they don't do
• 27:44
  Speaker 1: some rationalization of their capital structures, they're not going to
• 27:50
  Speaker 1: improve UM and the returns will be black. UM. But
• 27:59
  Speaker 1: we are seeing the evidence that both at the at
• 28:03
  Speaker 1: the macro level, the government is trying to push these
• 28:06
  Speaker 1: companies to change, and we're seeing on the ground that
• 28:10
  Speaker 1: more and more company management is receptive to hearing about
• 28:17
  Speaker 1: this and receptive to making moves in the right direction. Interesting.
• 28:24
  Speaker 1: You mentioned emerging markets, and we tend to speak of
• 28:27
  Speaker 1: them like they're monolithic block, but they're really very very
• 28:33
  Speaker 1: specific countries with different risks and different potential upside. What
• 28:38
  Speaker 1: do you see in the emerging market space that is
• 28:42
  Speaker 1: especially interesting or something that you're less interested in. Yeah,
• 28:47
  Speaker 1: you're You're absolutely right. Emerging markets is not this monolithic saying.
• 28:52
  Speaker 1: From my perspective, that's really part of its charm. Um.
• 28:55
  Speaker 1: These countries all have very significant risks associated with them,
• 29:01
  Speaker 1: but in a lot of cases those risks are very idiosyncratic.
• 29:07
  Speaker 1: You know, Turkey has problems, Russia has problems, China has problems.
• 29:12
  Speaker 1: They do not have the same problems by any stretch
• 29:16
  Speaker 1: of the imagination. Uh. And so the kind of thing
• 29:20
  Speaker 1: that could prove to be a real challenge for Turkey
• 29:24
  Speaker 1: might actually be something that works out pretty well for
• 29:28
  Speaker 1: Russia or Korea or Brazil. So what we find is
• 29:34
  Speaker 1: when people think about the risks in emerging they tend
• 29:37
  Speaker 1: to focus on, oh my god, what if this really
• 29:40
  Speaker 1: bad thing happens in this country. And the good news
• 29:43
  Speaker 1: is you can invest across you know, thirty odd different
• 29:46
  Speaker 1: countries and the same thing is unlikely to blow through
• 29:52
  Speaker 1: all of them. But it is still the case that
• 29:56
  Speaker 1: the come countries that wind up really cheap. Um, there's
• 30:02
  Speaker 1: almost always a pretty good reason for that. Uh. And
• 30:06
  Speaker 1: so the diversification of being able to invest in a
• 30:11
  Speaker 1: wide array of them is incredibly important. So for example,
• 30:15
  Speaker 1: today Russia is very cheap um and that's not just
• 30:21
  Speaker 1: because of the energy stocks. In fact um, you know,
• 30:25
  Speaker 1: our Emerging markets team really likes Russia today, but there
• 30:31
  Speaker 1: their favorite stocks are not really in the energy space.
• 30:36
  Speaker 1: The markets cheap. The markets cheap partially because you know,
• 30:40
  Speaker 1: on um Russia is a bit of a you know,
• 30:48
  Speaker 1: pariah state at this point, given some of their their misbehavior,
• 30:52
  Speaker 1: and people don't really like investing there. The levels of
• 30:57
  Speaker 1: corporate governance from the standpoint of tection of outside shareholders stinks,
• 31:03
  Speaker 1: and their economy isn't in great shape. Okay, those are
• 31:06
  Speaker 1: all pretty good reasons for the stocks to be cheap,
• 31:11
  Speaker 1: but at the same time they're also avenues for which
• 31:16
  Speaker 1: some improvement could lead to quite good returns. So what
• 31:20
  Speaker 1: I'm hearing you describe is sort of a corruption discount,
• 31:25
  Speaker 1: which raises the question, does that unusually high level of
• 31:32
  Speaker 1: corruption within the Russian economy and government does that need
• 31:37
  Speaker 1: to improve to see Russian stocks do better? Something probably
• 31:44
  Speaker 1: needs to improve, Uh, for Russian stocks to do better,
• 31:49
  Speaker 1: an improvement in the kind of the level of corruption
• 31:52
  Speaker 1: and the and the level of corporate governance will help UH.
• 32:00
  Speaker 1: And while it's not a guarantee by any means, it
• 32:04
  Speaker 1: is fascinating that kind of UH. In recent quarters, I
• 32:10
  Speaker 1: have been getting UM uh kings, whether it is email
• 32:19
  Speaker 1: or voicemails UM from UH, from from consulting companies representing
• 32:28
  Speaker 1: some of the big Russian state owned enterprises who are
• 32:36
  Speaker 1: UM canvassing UH current and former shareholders to understand what
• 32:43
  Speaker 1: kind of governance improvements they would like to see. UM.
• 32:48
  Speaker 1: It's not that, you know, gas Prom has suddenly become
• 32:51
  Speaker 1: a paragon of corporate governance, but it is fascinating. UM.
• 32:57
  Speaker 1: They do care enough to at least want to know
• 33:01
  Speaker 1: what either people who have hold them or have held
• 33:04
  Speaker 1: them in the past would like to see them do. UM.
• 33:09
  Speaker 1: And and again you know, one of the things that
• 33:11
  Speaker 1: Argent Davetcha, who has been our head of emerging markets
• 33:16
  Speaker 1: going back into the early nineties, the extraordinary returns that
• 33:22
  Speaker 1: you can get periodically in emerging do not tend to
• 33:26
  Speaker 1: come when things are good and become great. They come
• 33:31
  Speaker 1: when things were absolutely horrible and become nearly bad. UM.
• 33:36
  Speaker 1: The scope for better corporate governance UM in a place
• 33:42
  Speaker 1: like Russia. Man, they don't have to jump over that
• 33:46
  Speaker 1: high a hoop for things to get better. UM, and
• 33:50
  Speaker 1: given the very substantial discounts that investors are currently demanding
• 33:55
  Speaker 1: for these assets, uh, a little bit of improvement would
• 33:59
  Speaker 1: go along, right. Quite quite interesting. So you guys are
• 34:03
  Speaker 1: known as not only contrarians, but value investing, and we
• 34:08
  Speaker 1: see value go through regular periods of under an overperformance.
• 34:13
  Speaker 1: It's it's been pretty cyclical. But you described this past
• 34:18
  Speaker 1: decade as quote truly a hellish time. What's going on
• 34:23
  Speaker 1: with value investing? Yeah, well that is that is a
• 34:27
  Speaker 1: question that we have spent an extraordinary amount of time
• 34:31
  Speaker 1: trying to analog. One of the things we really like
• 34:34
  Speaker 1: to do, UH, when looking at any asset, whether it's
• 34:38
  Speaker 1: been doing well or poorly, is not just look at
• 34:42
  Speaker 1: what its returns have been, but try to understand where
• 34:46
  Speaker 1: those returns have come from. UH. And value at this
• 34:51
  Speaker 1: point famously has underperformed as a stock selection technique since
• 34:55
  Speaker 1: about two thousand seven. So we've got a thirteen year
• 34:58
  Speaker 1: period of value underperforming. UM was particularly spectacular year for
• 35:04
  Speaker 1: that it was the worst single year for value relative
• 35:08
  Speaker 1: to growth in history UM. But even before that, value
• 35:12
  Speaker 1: had been under performing. Now the question is why I
• 35:16
  Speaker 1: would say the common the common received wisdom is, well,
• 35:22
  Speaker 1: the reason why value has underperformed is because they have
• 35:25
  Speaker 1: proved to be value traps. The growth stocks have grown
• 35:30
  Speaker 1: in a way that is, uh, you know, qualitatively different
• 35:34
  Speaker 1: than what had happened before, and these guys have just
• 35:36
  Speaker 1: fundamentally been a disaster. If we look under the surface
• 35:40
  Speaker 1: at where the returns have come from, we find that's
• 35:43
  Speaker 1: actually not true. Value stocks have certainly undergrown the market. Now,
• 35:49
  Speaker 1: they undergrew the market in the period in which value
• 35:53
  Speaker 1: one um as well. If we look from two thousand six,
• 35:58
  Speaker 1: which was a period when the value outperformed the market
• 36:01
  Speaker 1: by about two and a half points a year in
• 36:02
  Speaker 1: the US, value stocks still undergrew the market by about
• 36:06
  Speaker 1: five points a year. So how can you win if
• 36:09
  Speaker 1: you're undergrowing by five points a year. Well, there's a
• 36:13
  Speaker 1: couple of ways. Um. One of them is more income.
• 36:18
  Speaker 1: One of the reasons why value stocks don't grow as
• 36:21
  Speaker 1: much as because those companies pay out more of their
• 36:24
  Speaker 1: earnings to shareholders. UM, So you get more income out
• 36:28
  Speaker 1: of value. But the other important piece of the return
• 36:33
  Speaker 1: to value in the long run comes from the fact
• 36:36
  Speaker 1: that value isn't a static strategy. You're not just buying
• 36:40
  Speaker 1: a group of stocks and holding them for the next decade.
• 36:43
  Speaker 1: You are buying a group of stocks because they look
• 36:45
  Speaker 1: cheap today, and you are refreshing that group of stocks
• 36:50
  Speaker 1: over time, and that rebalancing, that refreshing of that portfolio
• 36:56
  Speaker 1: has been very additive to returns to value you over time.
• 37:01
  Speaker 1: That's even been true in this more recent period. So
• 37:06
  Speaker 1: the rebalancing effect always accrues in favor of value and
• 37:10
  Speaker 1: helps make up for the fact that the value stocks undergrow.
• 37:13
  Speaker 1: If we look at the underperformance of value, and since
• 37:18
  Speaker 1: two thousand seven, the value half of the market has
• 37:21
  Speaker 1: underperformed the overall market by about a point and a
• 37:24
  Speaker 1: half a year. As we break that down, the relative
• 37:29
  Speaker 1: valuation piece of that return um, which is to say,
• 37:35
  Speaker 1: the amount of the return that came from the fact
• 37:39
  Speaker 1: that value stocks traded at a different discount to the
• 37:43
  Speaker 1: market at the end of the year than they did
• 37:45
  Speaker 1: at the beginning of the year, has been has cost
• 37:48
  Speaker 1: you two points a year. So more than of the
• 37:52
  Speaker 1: underperformance of value has come from the fact that value
• 37:55
  Speaker 1: has been getting cheaper. And the thing about that is
• 37:59
  Speaker 1: a source of return is it's not a sustainable one, right.
• 38:03
  Speaker 1: You can't have a group of stocks have its valuations
• 38:07
  Speaker 1: go in the same direction forever, you get kind of
• 38:11
  Speaker 1: absurd things eventually, UM. And we do think that because
• 38:18
  Speaker 1: that valuation discount has gotten to the point where it's
• 38:22
  Speaker 1: some of the widest we have ever seen. UM, we
• 38:25
  Speaker 1: have a hard time believing it's going to spend the
• 38:27
  Speaker 1: next five or ten years getting still wider. And if
• 38:31
  Speaker 1: it were to just stay where it is and the
• 38:35
  Speaker 1: other sources of return for value stayed where they are,
• 38:40
  Speaker 1: value would win. So we think under the surface, and
• 38:44
  Speaker 1: this is the same kind of analysis we did that
• 38:47
  Speaker 1: had us confident in value in two thousands, under the surface,
• 38:54
  Speaker 1: the value effect is still there, UM, but it's hidden
• 38:59
  Speaker 1: by this changing valuation UM. So we think if we
• 39:04
  Speaker 1: could get stable valuation gap between value and growth, value
• 39:09
  Speaker 1: would win. We also think that the gap between value
• 39:13
  Speaker 1: and growth has gotten extraordinarily wide. UM. It is trading
• 39:20
  Speaker 1: at kind of seventy wider UM then it has on
• 39:27
  Speaker 1: average over the last forty years, Which is to say,
• 39:31
  Speaker 1: if value was going to move to the same relative
• 39:34
  Speaker 1: valuation versus growth stock that it's traded on average over
• 39:38
  Speaker 1: the last forty years, value stock deserved to beat growth
• 39:41
  Speaker 1: by seventy percentage points. But we don't need to assume
• 39:45
  Speaker 1: that that's going to happen in order for value to
• 39:47
  Speaker 1: win going forward. We just need this pattern to stop.
• 39:55
  Speaker 1: And frankly, one of the things that gives us confidence
• 39:57
  Speaker 1: that this pattern is going to stop is just how
• 40:02
  Speaker 1: crazy some of the market action has been in recent months. M.
• 40:08
  Speaker 1: Jeremy Grantham, our firm's founder, has written about that and
• 40:12
  Speaker 1: and uh and and talked about it in interviews. This
• 40:17
  Speaker 1: is what we believe to be a full fledged speculative
• 40:21
  Speaker 1: bubble um, and those events have a tendency to end
• 40:29
  Speaker 1: themselves in a space of months, usually more than years.
• 40:35
  Speaker 1: So let's stick with that idea. I have some other
• 40:38
  Speaker 1: value questions for you, but I want to stick with
• 40:40
  Speaker 1: the bubble issue. Back in Alan Greenspan made his famous
• 40:47
  Speaker 1: irrational Exuberance speech, and lots of people were discussing how
• 40:53
  Speaker 1: bubbly and frothy the market had become and how valuations
• 40:57
  Speaker 1: had gotten so extended. But the market powered higher another
• 41:01
  Speaker 1: four years, So arguably nine wasn't the ninth inning. It was,
• 41:06
  Speaker 1: you know, the fifth or sixth inning. Are you suggesting
• 41:10
  Speaker 1: we're closer to the ninth inning here? And that this
• 41:13
  Speaker 1: is a full throated bubble everywhere or is it more
• 41:17
  Speaker 1: pockets of froth and this could still go for years
• 41:22
  Speaker 1: and not not weeks or months. Well, I'd say the
• 41:26
  Speaker 1: scale of what has been going on in recent months
• 41:30
  Speaker 1: is really quite qualitatively different from what we saw in
• 41:37
  Speaker 1: ninety six or seven. It does have kind of much
• 41:42
  Speaker 1: stronger parallels to what we saw in nine or early
• 41:46
  Speaker 1: two Thousand's right, Yes, we saw I think Netscape went public, uh,
• 41:54
  Speaker 1: and there was some fascination with that, um, But we
• 41:57
  Speaker 1: didn't have a huge swath of internet companies going public.
• 42:04
  Speaker 1: We didn't see you know, huge amounts of capital having
• 42:09
  Speaker 1: moved into that space or uh kind of being fascinated
• 42:17
  Speaker 1: um by h companies that traditional measures didn't didn't look
• 42:23
  Speaker 1: all that appeeling. That took quite a while to happen.
• 42:28
  Speaker 1: But I'd say about you know, this market is Look,
• 42:34
  Speaker 1: we are eleven years into a bowl market here. Uh.
• 42:41
  Speaker 1: It's not the case that um that that what's going
• 42:47
  Speaker 1: on now is something new from the standpoint of rising valuations.
• 42:54
  Speaker 1: What I'd say is new and different and something that
• 42:58
  Speaker 1: we weren't seeing and hill certainly in the US, UM
• 43:05
  Speaker 1: is we moved kind of away from the fascination with
• 43:14
  Speaker 1: the giant Oligopolis and Monopolis to more fascination with companies
• 43:24
  Speaker 1: where the proponents of them are telling us, look, what
• 43:29
  Speaker 1: you're missing is you are trying to value this company
• 43:32
  Speaker 1: on traditional security analysis, and traditional security analysis doesn't matter anymore.
• 43:38
  Speaker 1: Um And that's to me, that's a different statement than
• 43:43
  Speaker 1: the the accurate statement and people were making about say
• 43:47
  Speaker 1: Amazon a few years ago, which was, yeah, Amazon doesn't
• 43:50
  Speaker 1: look like it's very profitable, but of course it must
• 43:53
  Speaker 1: be profitable. Look at the way it is growing, and
• 43:56
  Speaker 1: look at the way it is it is funding that
• 43:59
  Speaker 1: growth when out having to raise capital. That must mean
• 44:03
  Speaker 1: under the surface they are actually quite a profitable company
• 44:08
  Speaker 1: and the accounting is just not keeping up with that.
• 44:11
  Speaker 1: That is true, and that helps explain how some of
• 44:16
  Speaker 1: these companies have done extraordinary things. But if we talk
• 44:21
  Speaker 1: about you know, a tesla, if we talk about a
• 44:25
  Speaker 1: door dam, if we talk about you know, a quantum
• 44:28
  Speaker 1: scape where the company management was saying, look in we
• 44:32
  Speaker 1: think we might be making a billion dollars and it
• 44:36
  Speaker 1: was priced at you know, at the peak in December
• 44:42
  Speaker 1: something like eighty times those twenty eight company forecast earnings.
• 44:49
  Speaker 1: Um Man, That's that's not the same thing as saying
• 44:53
  Speaker 1: the accounting is wrong is saying we're in a new
• 44:58
  Speaker 1: world where evaluation doesn't matter. UM, and I make the
• 45:03
  Speaker 1: argument that that kind of mentality UM leads to a
• 45:11
  Speaker 1: level of well, let's stupidity in the pricing of assets
• 45:17
  Speaker 1: that will prove to be unsustainable in a finite period
• 45:24
  Speaker 1: of time. Quite interesting. Last question on the value thesis.
• 45:31
  Speaker 1: You know, when we look at historical ways to measure value,
• 45:34
  Speaker 1: price to book is something that's that's really come under
• 45:38
  Speaker 1: attack over the past couple of years. What do you
• 45:42
  Speaker 1: think the best way to define value and try and
• 45:46
  Speaker 1: capture the value premium actually is. Yeah, So it is
• 45:53
  Speaker 1: one of the fascinating things about these episodes. UM. There's
• 46:02
  Speaker 1: almost invariably a significant amount of truth to the complaints
• 46:07
  Speaker 1: that people have with whatever asset it is that has
• 46:10
  Speaker 1: been performing poorly. Price the book is a profoundly flawed
• 46:17
  Speaker 1: measure at this point. UM. Its laws come from two
• 46:21
  Speaker 1: basic issues, UM, that are much more prevalent now than
• 46:28
  Speaker 1: they were thirty or forty years ago. The first is
• 46:31
  Speaker 1: the changing way that corporations are doing their investment. UM.
• 46:35
  Speaker 1: You know, forty years ago, if most corporate investment was
• 46:38
  Speaker 1: in the form of building a new factory, UM, you know,
• 46:43
  Speaker 1: putting up a new building something like that. That kind
• 46:47
  Speaker 1: of investment is recognized as investment under GAP accounting and
• 46:55
  Speaker 1: under the foreign version the I s B accounting. UM.
• 47:01
  Speaker 1: The investments that corporations are more likely to make today
• 47:05
  Speaker 1: in intangible assets through R and D and similar kind
• 47:10
  Speaker 1: of UH spending are not properly treated by the accounting standards,
• 47:17
  Speaker 1: so they don't show up as assets on corporate balance
• 47:20
  Speaker 1: sheets unless a corporation has bought another company whose assets
• 47:27
  Speaker 1: were predominantly about intangible and then it shows up as goodwill.
• 47:32
  Speaker 1: So we've got this issue that for lots of companies,
• 47:36
  Speaker 1: a lot of the investments that they make aren't properly capitalized,
• 47:40
  Speaker 1: don't show up on the balance sheet at all. And
• 47:42
  Speaker 1: then we've compounded that with the rise of stock buy backs.
• 47:48
  Speaker 1: And in the case of a stock buy back, if
• 47:50
  Speaker 1: a company buys back it's stock at a price to
• 47:55
  Speaker 1: book greater than one UH, it's book value has a
• 47:58
  Speaker 1: tendency to implode. So one thing that is increasingly prevalent
• 48:04
  Speaker 1: today is you have um perfectly solvent companies with negative
• 48:10
  Speaker 1: book values. So today I think, for example, McDonald's has
• 48:15
  Speaker 1: negative book value. That does not mean that McDonald's is
• 48:18
  Speaker 1: in any danger of going bankrupt anytime soon. It means
• 48:23
  Speaker 1: that the price the book has really become flawed. UM.
• 48:27
  Speaker 1: So if you're buying UM companies on the basis of
• 48:31
  Speaker 1: price to book, you've got a problem. UM. You've got
• 48:35
  Speaker 1: a particular problem with the growthier company because those are
• 48:41
  Speaker 1: the ones who have been doing the most investment that
• 48:44
  Speaker 1: has not been properly capitalized. So you're going to systematically
• 48:49
  Speaker 1: underestimate the value of all of them UM, and you're
• 48:52
  Speaker 1: also going to get screwed up valuations for anybody who
• 48:55
  Speaker 1: has has been buying that stock. UM. We think if
• 49:01
  Speaker 1: you're going to be a sensible value investor, you have
• 49:04
  Speaker 1: to adjust for that UM. Now, if you're buying your
• 49:08
  Speaker 1: stocks when at a time, the right way to do
• 49:11
  Speaker 1: it is to build a discount count the cash flow
• 49:14
  Speaker 1: model about what the future is going to look like.
• 49:17
  Speaker 1: If you're going to be a more traditional a what
• 49:20
  Speaker 1: people tend to think of as a quantitative investor, what
• 49:26
  Speaker 1: we think you have to do is you have to
• 49:27
  Speaker 1: go back through time and reclassify those expenditures which should
• 49:34
  Speaker 1: have been understood as investment and start putting them on
• 49:38
  Speaker 1: the balance sheet. UM. So what we've done is we've
• 49:43
  Speaker 1: gone back over the last fifty years UM, and we
• 49:47
  Speaker 1: have rebuilt the income statement and balance sheet for every
• 49:51
  Speaker 1: company in our database so that we're at least starting
• 49:54
  Speaker 1: from the economically meaningful valuation. UH. Now, from then we
• 50:02
  Speaker 1: have gone on to build a discounted cash flow model
• 50:06
  Speaker 1: to try to understand the future of these companies. UM.
• 50:10
  Speaker 1: But the key as act and the frustrating thing about
• 50:16
  Speaker 1: talking about value today. I truly believe value as a
• 50:22
  Speaker 1: style really out of favor, that it deserves to outperform.
• 50:27
  Speaker 1: I also believe that you know, the be priced the
• 50:33
  Speaker 1: book and even PE based style indices are a really
• 50:39
  Speaker 1: poor way of getting at that, and they have way
• 50:44
  Speaker 1: too many effective data errors showing up as either very
• 50:49
  Speaker 1: cheap companies or very expensive companies. UM. So I love
• 50:53
  Speaker 1: value today, I'm I'm scared in somewhat skeptical of that
• 51:00
  Speaker 1: is represented in the value indusees quite fascinating. So we've
• 51:04
  Speaker 1: been discussing intangibles and I want to spend a little
• 51:08
  Speaker 1: more time focusing on that. So we've seen the rise
• 51:12
  Speaker 1: of asset light companies, lots of intangible assets, R and D, patents, processes, etcetera.
• 51:22
  Speaker 1: And these tend to not only generate high profit margins,
• 51:26
  Speaker 1: but we've seen multiples rising over time. How can an
• 51:31
  Speaker 1: investor take advantage of this gap between the way we
• 51:37
  Speaker 1: account for those assets and how they perform in the market. Well,
• 51:42
  Speaker 1: that's always one of the kind of challenges of of
• 51:48
  Speaker 1: of security analysis. UM. Even if this stuff was accounted
• 51:53
  Speaker 1: for properly. UM, there is a difference between the patent
• 51:59
  Speaker 1: that accome money has been given that turns out to
• 52:03
  Speaker 1: be worth next to nothing uh and those rare patents
• 52:07
  Speaker 1: UM that embody intellectual property that is going to be
• 52:13
  Speaker 1: absolutely fantastically valuable. So it's not, you know, generically possible
• 52:19
  Speaker 1: to get this right all the time. UM. But I
• 52:23
  Speaker 1: do think it's really helpful UM to try to get
• 52:29
  Speaker 1: as close as you can to the economic truth here
• 52:32
  Speaker 1: to answer the question of, well, is this a company
• 52:38
  Speaker 1: that is trading at you know whatever what what like
• 52:43
  Speaker 1: Amazon looks to be a few years ago four hundred
• 52:47
  Speaker 1: times earnings UM? Or is it the case that those
• 52:51
  Speaker 1: earnings numbers are really wrong um, and and the valuation
• 52:55
  Speaker 1: is more reasonable UM. I think you can get closer
• 53:01
  Speaker 1: to that, UM. But I think it's also the case
• 53:05
  Speaker 1: that that you you hit upon kind of the key
• 53:09
  Speaker 1: distinction between the fairly rare company that turns out to
• 53:17
  Speaker 1: be extraordinary, uh, and most of the rest of the
• 53:24
  Speaker 1: corporate system, which is, there are some companies that have
• 53:29
  Speaker 1: shown an ability to have a return on capital much
• 53:33
  Speaker 1: higher than the average company and to maintain that for
• 53:38
  Speaker 1: an extended period of time. Let's talk about some of
• 53:41
  Speaker 1: those companies. When we look at the SMP five hundred,
• 53:45
  Speaker 1: the six largest companies now make up about of that index,
• 53:51
  Speaker 1: and they're all big cap tech companies. Can you maintain
• 53:56
  Speaker 1: a sort of bearish view on the market without being
• 54:00
  Speaker 1: embarish on those companies that at least so far have
• 54:04
  Speaker 1: have proven to be absolutely extraordinary, Well, they have proven
• 54:08
  Speaker 1: to be absolutely extraordinary. One of the things that it
• 54:13
  Speaker 1: is important to keep in mind, um is um you
• 54:20
  Speaker 1: can maintain your status as an extraordinary company without maintaining
• 54:26
  Speaker 1: extraordinarily high levels of growth. So I'll come up with
• 54:30
  Speaker 1: kind of a very simple case. Let's take Google or
• 54:35
  Speaker 1: Alphabet a truly extraordinary company. Uh. You know, their monopoly
• 54:39
  Speaker 1: on search, although I'm sure they would argue they do
• 54:43
  Speaker 1: not have a monopoly on search, but their extraordinary power
• 54:46
  Speaker 1: in in search has led them to be able um
• 54:51
  Speaker 1: to make uh, wonderful amounts of money and very high
• 54:58
  Speaker 1: returns on capital on advertising um. And they have seen
• 55:02
  Speaker 1: extraordinary growth over the last ten or fifteen years now.
• 55:07
  Speaker 1: But at the end of the day, you called them
• 55:09
  Speaker 1: a technology company, and they sort of are. But another
• 55:13
  Speaker 1: way of thinking about them is they are a company
• 55:16
  Speaker 1: that is funded by advertising revenues. And if we go
• 55:20
  Speaker 1: back fifteen years ago when they were a tiny piece
• 55:24
  Speaker 1: of global advertising revenue, the fact that advertising revenue doesn't
• 55:28
  Speaker 1: grow that fast, it grows approximately in line with GDP
• 55:33
  Speaker 1: wasn't a big deal. If you are fifty basis points
• 55:36
  Speaker 1: of the market and you believe you can get to
• 55:39
  Speaker 1: be you know, of the market, Well, that is a
• 55:44
  Speaker 1: twentyfold increase um, and whether that market has grown materially
• 55:50
  Speaker 1: or not is irrelevant, because you've grown twentyfold either plus
• 55:54
  Speaker 1: a little bit because the market's grown or mine. It's
• 55:56
  Speaker 1: a little bit because the markets shrunk. Now, Uh, Google
• 56:02
  Speaker 1: and Facebook are pretty material parts of global advertising spend um,
• 56:10
  Speaker 1: and their ability to outgrow advertising gets harder and harder.
• 56:16
  Speaker 1: Right that It is certainly not the case if you
• 56:20
  Speaker 1: have gone from ten percent of that market, well, if
• 56:23
  Speaker 1: you've gone from half a percent of that market to
• 56:25
  Speaker 1: ten percent of the market, you're not going to be
• 56:27
  Speaker 1: able to grow your share twentyfold. Again, the best you
• 56:31
  Speaker 1: can do is of that market, and as your share grows,
• 56:35
  Speaker 1: it becomes more and more of the case that the
• 56:37
  Speaker 1: stuff you don't have is advertising that is spent differently
• 56:41
  Speaker 1: for a very good reason. Um So, I'd say with
• 56:45
  Speaker 1: all of these companies, they're as their scale grows as
• 56:50
  Speaker 1: a percent of the economic activity that they are capitalizing on,
• 56:57
  Speaker 1: their ability to achieve extraordinary growth uh deteriorates. Um So
• 57:03
  Speaker 1: Google will not grow over the next ten years the
• 57:06
  Speaker 1: way it grew over the last ten years. The other
• 57:09
  Speaker 1: piece that they are now fighting against is they are
• 57:13
  Speaker 1: such big, dominant companies, um that what they do has
• 57:17
  Speaker 1: a real impact on the global economy, and some of
• 57:20
  Speaker 1: those impacts are not necessarily so positive. So they have
• 57:24
  Speaker 1: a regulatory risk um that I don't know exactly how
• 57:31
  Speaker 1: much of that is going to materialize in limitations of
• 57:35
  Speaker 1: their business model, limitations of their profitability. But man, you've
• 57:39
  Speaker 1: got to keep it in mind. Um. Yes, these companies
• 57:43
  Speaker 1: have done extraordinarily well, but if we look over the
• 57:47
  Speaker 1: last three years or four years or so. You know,
• 57:50
  Speaker 1: Apple has done great, Um, but Apple four years ago
• 57:54
  Speaker 1: was trading at thirteen times earnings and it's now trading
• 57:57
  Speaker 1: in approximately thirty nine times earnings. So three of that
• 58:03
  Speaker 1: return comes from a tripling of pe. Now, that's not
• 58:08
  Speaker 1: exactly right because economically their p s are a little
• 58:11
  Speaker 1: bit different from the stated numbers. UM. But in general,
• 58:16
  Speaker 1: what I'd say about the tech giants is they're not
• 58:20
  Speaker 1: going to grow the way they've grown historically. UM. They
• 58:24
  Speaker 1: might be facing some idiosyncratic risks that had hit them
• 58:30
  Speaker 1: and don't hit you know, technology firms as a whole. Um.
• 58:36
  Speaker 1: And the bad news is, in general their valuations are
• 58:38
  Speaker 1: a lot higher than they were just a few years ago. UM.
• 58:42
  Speaker 1: That is not the recipe for wonderful returns out of them.
• 58:45
  Speaker 1: But on the other hand, I don't think those are
• 58:49
  Speaker 1: the stupidest valued companies out there. Right of the largest
• 58:54
  Speaker 1: companies in the US, you know, Apple, Microsoft, they look
• 59:00
  Speaker 1: ends is to us. But maybe they're twice fair value.
• 59:02
  Speaker 1: Maybe they're one and a half times fair value. That's expensive,
• 59:05
  Speaker 1: but that's not stupid. Stocks like Netflix or Zoom are
• 59:12
  Speaker 1: Are they in that category? Also? Um? Some of them
• 59:16
  Speaker 1: have gotten two levels that we consider to be very
• 59:21
  Speaker 1: dangerously expensive. Not all of them, but we can find
• 59:27
  Speaker 1: a significant cohort of companies that look to be trading
• 59:34
  Speaker 1: five times fair value, ten times fair value, twenty times
• 59:36
  Speaker 1: fair value or more. Um. Normally you don't see very
• 59:42
  Speaker 1: many of those companies, and today we see quite a
• 59:46
  Speaker 1: wide array of them. Um. So we do think that
• 59:50
  Speaker 1: there are more crazily valued companies today then we've seen,
• 59:55
  Speaker 1: certainly in the US since uh, the Internet bubble. Quite interesting.
• 1:00:00
  Speaker 1: I'm going to shift gears here and I want to
• 1:00:03
  Speaker 1: address your founder, Jeremy Grantham, who has been outspoken about
• 1:00:09
  Speaker 1: climate change. How does GMO approach the idea of either
• 1:00:14
  Speaker 1: E S G investing or or low carbon investing. Yeah,
• 1:00:20
  Speaker 1: it's uh, it's kind of a fascinating challenge for us
• 1:00:26
  Speaker 1: because on the one hand, we absolutely agree with Jeremy that, uh,
• 1:00:33
  Speaker 1: climate is this overwhelming challenge for mankind uh, and that
• 1:00:39
  Speaker 1: as a society we don't seem to generally understand how
• 1:00:46
  Speaker 1: big these impacts will be. So you know, from an
• 1:00:51
  Speaker 1: E S D perspective, the environmental stuff absolutely matters, and
• 1:00:55
  Speaker 1: it is going to matter profoundly as time goes forward.
• 1:00:59
  Speaker 1: But at the same time, as valuations driven investors, UH,
• 1:01:05
  Speaker 1: we believe there's kind of an appropriate price for everything UM.
• 1:01:11
  Speaker 1: And even though you know oil companies are likely to
• 1:01:15
  Speaker 1: face tough times ahead UH and may well be in
• 1:01:20
  Speaker 1: the case in a situation where they're not even going
• 1:01:23
  Speaker 1: to be able to produce all of their current reserves UM,
• 1:01:28
  Speaker 1: there is a price at which they are a decent
• 1:01:30
  Speaker 1: investment anyway. UM. So what we have tried to do
• 1:01:34
  Speaker 1: in our models is make adjustments where we know how
• 1:01:41
  Speaker 1: to quantify UM for those environmental UH metrics that strike
• 1:01:51
  Speaker 1: us as being problematic for the future of a company
• 1:01:55
  Speaker 1: from kind of a risk or future earnings perspective, and
• 1:01:59
  Speaker 1: also understanding particularly on the governance side of things, where
• 1:02:05
  Speaker 1: poor governance UM means worse outcomes for shareholders. UM. Where
• 1:02:15
  Speaker 1: I think we are ramping up our activity is going
• 1:02:21
  Speaker 1: beyond that into uh more corporate engagement, which is tough,
• 1:02:28
  Speaker 1: particularly on the on the quantitative side UM. Quantitative managers
• 1:02:34
  Speaker 1: are used to not really interfacing with company management UM.
• 1:02:41
  Speaker 1: And we vote our proxies, and we try to vote
• 1:02:43
  Speaker 1: our proxies in a sustainable way UM. But the question
• 1:02:47
  Speaker 1: is how can we get these companies to do better
• 1:02:54
  Speaker 1: UM And that's a significant effort in the firm. We
• 1:03:00
  Speaker 1: hired a group into the firm UH, a former independent
• 1:03:07
  Speaker 1: investment firm called the Usonian who they they are fundamental
• 1:03:12
  Speaker 1: UH stock pickers in Japan and one of the things
• 1:03:15
  Speaker 1: that they have specialized in is a form of friendly
• 1:03:20
  Speaker 1: engagement with management. UM. You know, corporate activism in Japan
• 1:03:26
  Speaker 1: can have this very bad taste in the mouths for
• 1:03:32
  Speaker 1: corporate management, where certain foreigners have come in and you know,
• 1:03:37
  Speaker 1: tried to strong arm management into really changing their ways.
• 1:03:42
  Speaker 1: What they have found is that if you can find
• 1:03:45
  Speaker 1: a constructive way to talk to management about things they
• 1:03:51
  Speaker 1: can do two improve um the way the outside eide
• 1:04:00
  Speaker 1: world understand what they're actually doing uh and relatively small
• 1:04:04
  Speaker 1: things they can do to improve their actual uh you know,
• 1:04:11
  Speaker 1: impact on the environment, they can be pretty receptive to it. UM.
• 1:04:15
  Speaker 1: So we're trying to learn from their example UH and
• 1:04:19
  Speaker 1: do that more broadly. But it's it is still a
• 1:04:23
  Speaker 1: work in progress. Quite interesting. I know I only have
• 1:04:27
  Speaker 1: you for a limited amount of time, so let's jump
• 1:04:30
  Speaker 1: to our favorite questions that we ask all of our guests,
• 1:04:34
  Speaker 1: starting with what are you streaming these days? Tell us
• 1:04:37
  Speaker 1: your favorite Netflix or Amazon Prime shows that you might
• 1:04:41
  Speaker 1: be watching. Uh. Well, my my wife and I have
• 1:04:45
  Speaker 1: been really enjoying UH loop in on on Netflix. It's
• 1:04:49
  Speaker 1: not that original, I think it's now one of the
• 1:04:52
  Speaker 1: top the top shows at the momentum, but kind of
• 1:04:57
  Speaker 1: wonderful uh uh, kind of escapist um entertainment. We've also
• 1:05:04
  Speaker 1: been watching spy Craft um, which is about the kind
• 1:05:09
  Speaker 1: of the technologies that uh spies have used over the
• 1:05:14
  Speaker 1: years to get their information. Um. And one thing I
• 1:05:18
  Speaker 1: have definitely uh watched of late that admittedly this wasn't
• 1:05:24
  Speaker 1: on Netflix, but this has been a difficult uh period right.
• 1:05:29
  Speaker 1: I mean, certainly as a value manager, it's no fun
• 1:05:32
  Speaker 1: when your stocks are not participating in uh in the
• 1:05:35
  Speaker 1: bull market, but just in general life has not been
• 1:05:39
  Speaker 1: as much fun as we've been stuck at home. Um.
• 1:05:42
  Speaker 1: And And one show that I particularly appreciated during the
• 1:05:46
  Speaker 1: fall is just a nice way to feel a little
• 1:05:48
  Speaker 1: bit better for half an hour was Ted Lasso on
• 1:05:53
  Speaker 1: on on Apple TV. It was delightful. Yeah, and and
• 1:05:57
  Speaker 1: just filled with in general pleasant people, uh, you know,
• 1:06:04
  Speaker 1: just people you kind of want to have a beer with.
• 1:06:06
  Speaker 1: I'm with you on that I have I have a
• 1:06:09
  Speaker 1: hard time with They're a handful of shows that I
• 1:06:13
  Speaker 1: know people really like, and I've tried them out and
• 1:06:16
  Speaker 1: none of the characters are redeemable. Why why do I
• 1:06:19
  Speaker 1: want to spend an hour with the people I wouldn't
• 1:06:22
  Speaker 1: want to spend five minutes in an elevator with. So
• 1:06:26
  Speaker 1: the next question, I assume I know what the answer
• 1:06:29
  Speaker 1: is going to be, but I'm gonna ask it anyway.
• 1:06:31
  Speaker 1: Who are your mentors who helped to shape your career? Well,
• 1:06:37
  Speaker 1: certainly Jeremy Grantham UH is first and foremost among them.
• 1:06:41
  Speaker 1: I've had the privilege of getting to learn from him
• 1:06:45
  Speaker 1: for close to thirty years. UM. But I would say
• 1:06:48
  Speaker 1: I've I've been extraordinarily blessed on the on the mentor
• 1:06:53
  Speaker 1: side of things, because before I got UH to g
• 1:06:59
  Speaker 1: m O UM, I had some utterly extraordinary teachers who
• 1:07:08
  Speaker 1: really UH taught me lessons on investing UM that absolutely
• 1:07:14
  Speaker 1: resonate to today. UM. Kind of my thesis adviser when
• 1:07:21
  Speaker 1: I was an undergraduate UH was David Swinson, Manager Revealed Endowments.
• 1:07:27
  Speaker 1: And I've had the further blessing of being able to
• 1:07:31
  Speaker 1: be on the investment committee there UH for the last
• 1:07:35
  Speaker 1: decade or so, and so both learned from him early
• 1:07:39
  Speaker 1: on and have learned from him more recently. UM. But
• 1:07:43
  Speaker 1: for kind of my traditional investing in finance underpinnings UM.
• 1:07:52
  Speaker 1: The two other finance professors that I was fortunate enough
• 1:07:56
  Speaker 1: to have we're James Tobin uh and Ob Chiller. So
• 1:08:02
  Speaker 1: I have been extraordinarily blessed uh in terms of being
• 1:08:07
  Speaker 1: able to learn from absolutely brilliant and uh and groundbreaking
• 1:08:13
  Speaker 1: investment thinkers uh all throughout my career Tobin, Schiller, Swanson Grantham. Yeah,
• 1:08:21
  Speaker 1: you could do worse than that. UM. Let's go to
• 1:08:24
  Speaker 1: everybody's favorite question. Tell us what you're reading these days?
• 1:08:28
  Speaker 1: What are some of your favorite books and what are
• 1:08:30
  Speaker 1: you enjoying currently? Yeah. In terms of my uh my,
• 1:08:34
  Speaker 1: my kind of long term favorite books, I would say
• 1:08:38
  Speaker 1: the book that I come back and reread every few
• 1:08:42
  Speaker 1: years and enjoy it every single time. UM is a
• 1:08:47
  Speaker 1: Short History of Nearly Everything by Bill Bright UM. And
• 1:08:51
  Speaker 1: I have loved much of what what Bill has has
• 1:08:56
  Speaker 1: written over the years. UM. But what I particularly love
• 1:09:00
  Speaker 1: about that book is it's an exploration of how we
• 1:09:06
  Speaker 1: came to know the things we know about the world. UH.
• 1:09:10
  Speaker 1: And I find that um and absolutely uh fascinating topic
• 1:09:18
  Speaker 1: and never gets old for me. UM. In terms of
• 1:09:26
  Speaker 1: what I am reading today, I am rather embarrassingly uh
• 1:09:31
  Speaker 1: sort of between between books um. Uh. Most recently I
• 1:09:40
  Speaker 1: was going through UM A a fun book. It's one
• 1:09:47
  Speaker 1: of those uh kind of classics where you don't understand
• 1:09:51
  Speaker 1: how they managed to pack as much in UM as
• 1:09:55
  Speaker 1: they did. But p h Gombris a little story of
• 1:10:00
  Speaker 1: the world UM and again UH, wonderful kind of primer
• 1:10:06
  Speaker 1: on how the world has got to be? Uh. Where
• 1:10:10
  Speaker 1: we are? You mentioned the Brison book. I literally this
• 1:10:13
  Speaker 1: weekend just finished reading his book at home, and like
• 1:10:17
  Speaker 1: all his works, at every page is just a delight.
• 1:10:21
  Speaker 1: I don't know how else to describe it. And our
• 1:10:23
  Speaker 1: last two questions, what sort of advice would you give
• 1:10:27
  Speaker 1: to a recent college grad who was interested in going
• 1:10:30
  Speaker 1: into investing as a career. I guess the first thing
• 1:10:35
  Speaker 1: I would say is, if you're interested in going into
• 1:10:38
  Speaker 1: investing as a career, make sure you actually love the
• 1:10:43
  Speaker 1: act of investing, in the act of doing research. UM.
• 1:10:49
  Speaker 1: Getting into it because you're hoping to make a lot
• 1:10:52
  Speaker 1: of money or because there seems to be some glamour
• 1:10:57
  Speaker 1: in it, UM is allows the reason to do anything. UM.
• 1:11:06
  Speaker 1: For one thing, you never know what the future will hold, UM.
• 1:11:09
  Speaker 1: But I will say the the people who, um I
• 1:11:14
  Speaker 1: think I've had the most satisfying careers and I watched
• 1:11:19
  Speaker 1: UM are the people who are doing the stuff they
• 1:11:23
  Speaker 1: really enjoy. And that is I think more important than anything. Uh.
• 1:11:29
  Speaker 1: Investing can be a ton of fun because you're continually
• 1:11:33
  Speaker 1: trying to solve problems. On the other hand, it's also
• 1:11:38
  Speaker 1: in industry where you are going to be wrong a
• 1:11:42
  Speaker 1: lot um. And if you can't handle that emotionally, if
• 1:11:49
  Speaker 1: those times when you are wrong cause you to start
• 1:11:54
  Speaker 1: doubting your self worth, um, you're going to burn out. UH.
• 1:12:00
  Speaker 1: So you've got to love investing as craft. UM. You've
• 1:12:07
  Speaker 1: also got to have the right kind of emotional mindset um,
• 1:12:13
  Speaker 1: or you'd be better off doing something with kind of
• 1:12:17
  Speaker 1: less uh manic depressive highs. Interesting and our our final question,
• 1:12:24
  Speaker 1: what do you know about the world of value investing
• 1:12:27
  Speaker 1: today that you wish you knew thirty years or so
• 1:12:30
  Speaker 1: ago when you first got started. The thing I wish
• 1:12:35
  Speaker 1: I had known how to do, and it is something
• 1:12:38
  Speaker 1: that I continually have to remind myself to do is
• 1:12:45
  Speaker 1: whenever you are talking to someone who thinks you are
• 1:12:50
  Speaker 1: dead wrong about investing. Make sure to listen very carefully
• 1:12:56
  Speaker 1: to what they have to say, UM, because as there's
• 1:13:01
  Speaker 1: probably some truth to what they are saying. And even
• 1:13:06
  Speaker 1: if you believe in your heart of heart a kind
• 1:13:08
  Speaker 1: of value investing as a philosophical um underpinning is the
• 1:13:15
  Speaker 1: right way to do it, that doesn't mean UM, people
• 1:13:20
  Speaker 1: aren't raising perfectly valid challenges UH to the way you
• 1:13:26
  Speaker 1: and others are expressing. That quite fascinating. Thanks Ben for
• 1:13:31
  Speaker 1: being so generous with your time. We have been speaking
• 1:13:34
  Speaker 1: with Ben Inker. He is the head of asset Allocation
• 1:13:38
  Speaker 1: at GMO. If you enjoy this conversation, well, be sure
• 1:13:42
  Speaker 1: and check out any of our nearly four hundred prior discussions.
• 1:13:47
  Speaker 1: You can find that at iTunes, Spotify, wherever you feed
• 1:13:51
  Speaker 1: your podcast fix. We love your comments, feedback and suggestions
• 1:13:56
  Speaker 1: right to us at m IB podcast at Bloomberg Net.
• 1:14:00
  Speaker 1: Give us a review on Apple iTunes. You can sign
• 1:14:04
  Speaker 1: up for our daily morning reads. You'll find those at
• 1:14:08
  Speaker 1: Rid Halts dot com. Check out my weekly column that's
• 1:14:11
  Speaker 1: at Bloomberg dot com slash Opinion. Follow me on Twitter
• 1:14:16
  Speaker 1: at Rit Halts. I would be remiss if I did
• 1:14:19
  Speaker 1: not thank the crack staff that helps us put these
• 1:14:21
  Speaker 1: conversations together each week. Tim Harrow is my audio engineer.
• 1:14:26
  Speaker 1: Michael Boyle is my producer. A Tick of val Bron
• 1:14:30
  Speaker 1: is our project manager. Michael Batnick is our head of research.
• 1:14:34
  Speaker 1: I'm Barry rid Halts. You've been listening to Master's Business
• 1:14:38
  Speaker 1: on Bloomberg Radio.