Jeremy Grantham, chairman of Grantham Mayo Van Otterloo, Boston, saw his firm lose money in the bull market but had it well-positioned for the bear market because of his belief the bull's bubble eventually would burst. He did not get lulled by the 1990s bull market, nor does he think the bear market has taken its last bite. To a contrarian like Mr. Grantham, that isn't necessarily a bad thing. In an interview with reporter Dave Kovaleski, the renowned value investor talks about Gabriel, the five things he knows about investing, and his place in the investment universe.
Q Why did you recently consider the acquisition route?
A We were approached by a lot of firms over the years. Once or twice, we fairly seriously considered selling and we always came up with, sometimes at the last minute, better reasons not to. Five or six years ago, I personally became very nervous about the market and consequently very nervous about the investment management business.
Looking forward to what appeared to be bad times, it occurred to me that we should give serious consideration to doing what investment bankers refer to as the impossible, a minority deal.
I felt that minority interest made sense, not particularly for me, because I already had my money and I could take the risk, but for my other partners. When we polished up the deal, we went to the rest of the partnership and two things happened. One, the rest of partnership said, "OK, let's assume you're right, this is a good deal, these are dangerous times, I'd still rather be independent." The other thing that happened was that we bounced back from bad times, benefiting from our now professional marketing and client service. It became quite clear that although I was right, horribly right, we as a firm will be able to buck the trend and have a rising profit and a rising asset base into a declining market.
Q Can you survive as a midsized independent firm?
A If you want to be a firm, prepared to make pretty big bets in extremely unusual situations, you've got to be independent ... The rich parent is not someone you can fall back on in terms of deriving the courage to make tough bets. The rich parent wants to have a steady flow of income from its subsidiaries.
Q You've said since the mid-'90s that the market is overvalued. What did you see that others didn't?
A It's what they didn't want to see. If you look at the history books, the p/e average is 14, and ranges from seven to 21. It peaked at 21 in 1929 and 21 in 1965. This time it completely shattered that range and went to 36 times. That's like a Himalayan Peak coming out of the plain. You don't have to be clever to see it. You have to be blind not to see it.
I've been around the country giving my stump speech since 1995 and I've been collecting votes ... I've now asked 1,359 full-time equity professionals a simple question: How many believe that the p/e on the S&P 500 in the next 10 years will pass downwards through 17.5 times? In all of those meetings, I collected seven people who felt the p/e would stay at a permanently higher plateau than 17.5. I collected some 1,350 who thought it would come down through 17.5. No one in the audience objected to the conclusion that that would guarantee a fairly severe bear market. The people who did the dirty work knew there'd be a bear market and the people in charge of running the business were saying that they thought the market was reasonable or indeed would go up.
I like to tell my story about the archangel Gabriel. The archangel comes down to a fund manager and says, `You've been a very good boy and I'm allowed to give you some really useful information - the probability distribution of the S&P 500 for the next 12 months. The probability distribution is 70% that cash will beat stocks and 30% that stocks will beat cash.' What does he do? I don't think there is anyone in our industry who doesn't know exactly what he does. He puts cash in his own account and leaves (the fund) 100% invested in equities because nobody in this business, or almost nobody, is willing to bet their career on a 30% chance of failure.
Q You've been called a fearless investor. What makes you fearless?
A I have more belief in mean reversion than anyone else ... I have something almost approaching complete faith. Anything less than that and you couldn't stand the pain...
Q Are portfolio managers today too timid?
A Career risk is much greater because measurement is more careful, subdivisions are more numerous, everyone's specialty is more carefully defined and more carefully watched. Style drift gets you shot. What do you expect? In the old days, you gave your money to the gentleman from Morgan Guaranty Trust and if you wanted to build up a little bit of cash and a few long bonds, he did. He didn't have to go and agonize with the committee three times; he didn't have two consultants telling him he was deviating from his benchmark ... That's what used to be classified as money management. Then it became stocks for one guy and bonds for the other, and then foreign stocks for one guy and then U.S. stocks for the other and then large-caps for one guy and small caps for the other, and then small-cap value for one guy and small-cap growth for the other. The more divisions you have, the more inflexibility you have. The more inflexibility you have, the more deviations from fair value.
Q To what do you attribute the strong performance over the last few years?
A Five things I know about the market: One, the market is gloriously inefficient; two, the manifestations of the inefficiency are that they horribly emphasize comfort and discomfort; three, they extrapolate today's conditions forever so if inflation is low, they will assume that inflation will be low forever; four, the real world is mean reverting, so you have a huge creative tension between the behavioral-driven world and the real world, driven by mean reversion.
The problem is, rule No. 5, we're all governed by career risk and business risk, which means that even though you know points 1 to 4, you don't know what the hell to do about it, and if you do anything about it, you're liable to pay a very high price. That's 98% of anything I know in five quick points.
Q How long do you plan to continue doing what you're doing?
A I'll quit when it's not fun. There was never a more exciting five or six years in my professional life than the last five or six years, which is not surprising since from where I'm coming from, one should live for the great deviations, and this was the mother of all deviations. Yes it was unbelievably painful for two or three years, and outrageously pleasurable for two or three years.
Q Ever get the urge to say I told you so?
A I have an irresistible urge to kick quite a few of the parties involved, starting at the top, with Greenspan and running all the way down to analysts for not having the integrity to insist on saying what they really believe and investment firms for not telling the clients what the bulk of the internal people really believe. I've already conceded it's not very gentlemanly to kick them when they're down, but a lot of players in this game really do deserve a good kick.
Jeremy Grantham,
chairman, Grantham Mayo & Van Otterloo & Co. LLC, Boston
Assets under management: $26 billion
employees: 200
Performance (through Nov. 30):
Return (benchmark)
GMO U.S. core:
1 year -15.4% (-16.5%)
3 year -6.1% (-11.1%)
gmo emerging markets:
1 year 11.7% (8.1%)
3 year -1.4% (-7.7%)
gmo foreign fund:
1 year -2.5% (-12.5%)
3 year -4.7% (-13.9%)
Benchmarks (respectively): s&p 500; ifc investible composite; msci eafe
