BOSTON Frothy markets have pummeled GMO LLC in the past, but the money management firm should emerge relatively unscathed from Wall Streets current bull run, Chairman Jeremy Grantham contends.
Despite performance results last year that were the third worst in the firms 28 years, GMO should avoid the crush of client defections it suffered in 1998 and 1999, he said.
Every frothy market is different in detail and different in client response, and the current one should prove much more benign, Mr. Grantham said in a recent interview.
Between 1998 and 1999, GMOs assets under management slumped to $20 billion from $30 billion, even as equity markets were surging. The firm lost 17% of its assets from terminations and another 28% from reductions in existing mandates, as clients turned to competitors less reticent about buying speculative Internet and technology stocks.
That pain has long since given way to enormous gain. By the end of 2006, GMOs assets under management had rebounded to a record $141 billion, after the markets collapse between 2000 and 2002 vindicated the firms mantra that lofty valuations inevitably fall back toward historic means.
But net inflows in 2006 slowed to $4.2 billion (after averaging $10 billion a year in the prior three years), as GMOs cautious stance left its U.S. strategies lagging the Standard & Poor 500 stock indexs 15.8% surge.
GMOs U.S. core strategy, with $10.6 billion in assets under management, trailed its S&P 500 benchmark by 5.6 percentage points in 2006. GMOs growth strategy lagged its Russell 1000 Growth benchmark by 6.2 percentage points last year, while the intrinsic value strategy fell eight points short of the Russell 1000 Value and the small-midcap growth strategy trailed its Russell 2500 benchmark by 5.3 points.
That rough patch was accompanied by an increase in client defections. According to Atlanta-based eVestment Alliance, while GMO still enjoyed net inflows, the firm lost 47 accounts with combined assets of $3.2 billion. Thats less than half the $7.5 billion eVestment Alliance said GMO gained in 2006, but well above the firms combined gross outflows for the prior five years.
The U.S. core strategy saw a net loss of 19 clients and net outflows of $667 million while the firms growth strategy lost a net seven clients with $703 million.
While declining to confirm the eVestment Alliance data, Mr. Grantham said GMOs latest outflows share little in common with the performance-related account losses of 1998 and 1999.
Decisions by sophisticated clients to take money off the table from some of GMOs strongest performing asset classes, on the belief that they have only limited scope for further near-term gains, account for much of the past years outflows, he said.
Mr. Grantham said that for 2007 GMO has a better than 50-50 chance of underperforming again. Even so, he predicts relatively modest fallout in terms of client defections.
For one thing, GMOs underperforming U.S. equity strategies account for less than 15% of the firms predominantly international business. And the limited scope for lower-quality U.S. stocks to further close the profit margin gap with their high-quality cousins makes it unlikely GMOs strategies will fall further behind their benchmarks this year, he said. There would be something fundamentally out of whack with the capitalist system if current record profit margins arent whittled away by competition, Mr. Grantham said.
Another advantage: this time around GMO has a 26-person global client service team, up from just a few people at the start of 2000. Despite GMOs faith in its story, many clients walked away in 1998 and 1999 because we had no hand-holders, Mr. Grantham said. What we had was desperate portfolio managers who would go out on demand, and try to put as many fingers in as many dikes as they could find, and not enough fingers.
Now we try to let everyone know exactly what is happening why its happening and why it might turn, he said. Clients accept that even good investors have bad patches when markets shift in a way thats beyond their control, he noted.
Investment consultants agree, saying the torrid runs over the past decade, first by growth stocks and then by value stocks, have left institutional investors more committed to maintaining style diversification, even when doing so involves temporary pain.