Speaker 1: This is Master's in Business with Barry Ridholts on Bloomberg Radio.
Speaker 1: So I was fortunate enough to get invited up to
Speaker 1: GMO in Boston, where I sat with Matt Kadner. Uh.
Speaker 1: He's a member of the asset allocation committee and really
Speaker 1: one of the people who is the right hand man
Speaker 1: to Jeremy Grantham. He has such an unusual background and
Speaker 1: is so interesting. Uh. I don't know what's more fascinating
Speaker 1: the fact that everybody knows GMO and very few people
Speaker 1: have heard of Matt Kadner or he really unique background.
Speaker 1: He comes out of a law firm background, and in
Speaker 1: fact he was in house council for LPL, which is
Speaker 1: a giant UH brokerage firm, and ended up at at
Speaker 1: one of the pre eminent shops value shops in the world.
Speaker 1: Fascinating guy. Matthew enough that I think you can rely
Speaker 1: on his analysis, but sort of right brain squishy enough
Speaker 1: that he can weave an interesting narrative discussion about how
Speaker 1: GMO sets about setting up their entire outlook and their
Speaker 1: asset allocation and portfolio management. It really is quite a
Speaker 1: fascinating conversation. He's tremendously insightful and this is just one
Speaker 1: of those conversations that I don't think you're gonna hear
Speaker 1: anywhere else. So, with no further ado, my sit down
Speaker 1: straight from GMO's offices in Boston, GMOs, Matt Katner. I
Speaker 1: am sitting in a conference room at GMO's office here
Speaker 1: in Boston, overlooking Boston Harbor, and it is a spect
Speaker 1: accular view. And I am sitting with Matt Kadner, who
Speaker 1: is a member of GMO's Asset Allocation Team, where he
Speaker 1: focuses on research and portfolio management. He's been with GMO
Speaker 1: for almost fifteen years. You joined in two thousand four.
Speaker 1: Before that, he was an investment specialist and consultant relations
Speaker 1: manager at Putnam Investments. And even more fascinating, he served
Speaker 1: as in house council for LPL Financial Services. We'll spend
Speaker 1: some time talking about that. That's a really interesting transition
Speaker 1: from legal to law to finance. You went to school
Speaker 1: here in Boston College, and you hail from uh the Midwest.
Speaker 1: You have a j d from St. Louis University, and
Speaker 1: you are a c F a charter holder. Normally, at
Speaker 1: this point, I say, Matt Kadener, welcome to Bloomberg. But instead,
Speaker 1: I'm gonna say thank you for having me here at GMO.
Speaker 1: It's a pleasure. So let's start with that initial fascinating background.
Speaker 1: You're in house counsel for LPL Financial Services, you have
Speaker 1: a j D. You you spent years as an associated
Speaker 1: Melican porter, so so you have you've done pretty much
Speaker 1: the full legal gig. What made you decide, hey, let's
Speaker 1: let's shift to finance. It was pretty simple, Barrier. I
Speaker 1: was just miserable, Okay, the uh you know, I did
Speaker 1: litigation for my legal career. So while I always enjoyed
Speaker 1: advocating for my clients, the adversarial process was pretty miserable.
Speaker 1: And here in Boston, you know, a lot of the
Speaker 1: litigation was pretty brass brass knuckled, and so I just, uh,
Speaker 1: you know, I would take the train into work every
Speaker 1: day and I would look, you know, watch the tea
Speaker 1: coming back out, and just could not wait to be
Speaker 1: on that tea coming back. And so my my father
Speaker 1: in law, he wasn't my father in law at the time,
Speaker 1: but he he has a lot of wisdom, and so
Speaker 1: he said he knew I was miserable, and he said, son,
Speaker 1: if if you enjoy what you're doing, you'll never work
Speaker 1: a day in your life. And so he actually gave
Speaker 1: me the book What Colors Your Parachute and uh, and
Speaker 1: that did a nice job of matching up what I
Speaker 1: enjoyed doing, which with what I thought I was good at,
Speaker 1: and that was finance and and and sales and communicating
Speaker 1: with people. And so I was lucky enough to kind
Speaker 1: of get an opportunity at Putnam where a couple of
Speaker 1: guys Alex Nelson and Kevin Sullivan took took a chance,
Speaker 1: and so I joined them in the fall of two
Speaker 1: thousand and I discovered that you could actually enjoy working.
Speaker 1: That that's fascinating. If memory serves, I believe the data
Speaker 1: point is something like, of all law school grads seven
Speaker 1: years later are no longer practicing attorneys. I'm surprised it's
Speaker 1: that low. Oh really. And and by the way, I'm
Speaker 1: part of that fift I moved on from law years ago,
Speaker 1: and and I couldn't be more thrilled to have, like
Speaker 1: you made the transition of finance. Yeah. I think the
Speaker 1: hardest part was getting my mom to understand that there
Speaker 1: was a better way to make a living. I had
Speaker 1: the same issue with my wife. She's like what what
Speaker 1: do you mean? I married a lawyer. You're gonna become
Speaker 1: a traitor. What are you talking about? This a stable
Speaker 1: income is going away and you can replace it with
Speaker 1: something speculative and risky. That doesn't sound like a smart move.
Speaker 1: So you're at You're at lp L. How do you
Speaker 1: do the transition? You go from LPL to Putnam? Um?
Speaker 1: What was your first gig? What were you doing that? So?
Speaker 1: I was in the d C investment only group, so
Speaker 1: so basically working with institutional clients that had Putnam investments
Speaker 1: on their DC platform. I did that for a couple
Speaker 1: of years and then transitioned over into the consultant relations channel,
Speaker 1: where I was covering the West coast dB consultants. And
Speaker 1: the travel is starting to wear a little bit. My
Speaker 1: wife was pregnant with twins, and I got an opportunity
Speaker 1: to come work at GMO and oh four and GMO,
Speaker 1: you know, had made its way through the bubble, acquitted
Speaker 1: itself very well, very well, very well, you're you're understanding it.
Speaker 1: Not Not only did GMO pretty much called the bubble
Speaker 1: in real time, but they were one of the few
Speaker 1: who turned around and said, hey, this is about as
Speaker 1: bad as it gets things look cheap, feel free to
Speaker 1: start adding equity to your portfolios. Yeah, and they they
Speaker 1: the performance out of the bubble actually, you know, Jeremy
Speaker 1: will talk about you know, generally we don't do well
Speaker 1: in bowl markets, but the performance you know, into the bubble,
Speaker 1: through it and out of it was really spectacular where
Speaker 1: there was a lot of cheap, low quality assets, international
Speaker 1: small cap emerging that just did spectacularly. Cheap low quality
Speaker 1: as opposed to cheap high quality. Correct, high quality doesn't
Speaker 1: get it quite as cheap as the low quality does.
Speaker 1: Is that the thinking, um, well, you know there's a
Speaker 1: price for there's a price for everything, and and high
Speaker 1: quality got pretty expensive kind of into two thousand and
Speaker 1: as the value value tends to be lower in quality,
Speaker 1: and so you know, the value in US and outside
Speaker 1: the US, particularly international small value, particularly e M just
Speaker 1: got really left behind. And so as the market got
Speaker 1: it got its legs and rallied, that stuff was so
Speaker 1: cheap and just was you know, just just took off.
Speaker 1: Let me let me come back to what you just said,
Speaker 1: because it's kind of a fascinating observation. Value tends to
Speaker 1: be low quality. How are you defining quality in my mind.
Speaker 1: I know there are technical definitions and other definitions is
Speaker 1: it and some of involves um the amount of debt,
Speaker 1: the variable crazy things that sometimes happens that may not
Speaker 1: show up on a balance sheet, but constant turnover in
Speaker 1: the executive suite? How do you define value under those circumstances?
Speaker 1: So um, so here value is is basically the cheap
Speaker 1: half of the market, whereas quality is quantitatively low debt,
Speaker 1: high r o E and stable r o E and
Speaker 1: so value because it tends to be in the more
Speaker 1: cyclical sectors, it has more financials, tends to be on
Speaker 1: average lower quality and growthfitions. Correct that that makes a
Speaker 1: lot of sense. So you transition from laws of finance,
Speaker 1: you start at GMO and O four what's your day
Speaker 1: to day? Like? What do you what do you focus on? Well?
Speaker 1: Back then, actually I was. I joined as a client
Speaker 1: relationship manager, and so because GMO was growing, they needed
Speaker 1: more folks to deal with clients, and so I spent
Speaker 1: a lot of time in those early days trying to
Speaker 1: better understand asset allocation because I felt it was my
Speaker 1: edge as a relationship manager that I could go in
Speaker 1: and talk to a client about our seven year forecast
Speaker 1: about how we think about the total portfolio, and I
Speaker 1: guess I spent so much time up talking to the
Speaker 1: asset allocation folks. After several months, they said, hey, you know,
Speaker 1: you seem like you have a lot of interest in
Speaker 1: the stuff. Why don't you join the ASCID allocation team.
Speaker 1: We need somebody out there as a perportolio portfolio strategist
Speaker 1: talking to clients. He seemed like a nice guy. Why
Speaker 1: don't you Why don't you take the gig? Is that
Speaker 1: is that a flu it sort of Um? Is that
Speaker 1: typical of GMO where people move within departments? So was
Speaker 1: that a little bit of an unusual shift? I think
Speaker 1: that was that was a typical for somebody to go
Speaker 1: from the relationship side to the investment side. That's actually
Speaker 1: happened a couple of times since then. GMO tends to
Speaker 1: be a pretty flat place, so that does produce a
Speaker 1: fair amount of fluidity between roles. UM. But I think
Speaker 1: that was just an opportunity to kind of do something
Speaker 1: that I discovered that I really loved, that I thought
Speaker 1: was interesting. I thought would give me an edge, But
Speaker 1: I probably took it to the next level of trying
Speaker 1: to really understand it. So so you go from effectively
Speaker 1: client facing to portfolio managing. How did you educate yourself
Speaker 1: on what works for portfolios what doesn't? Because there's a
Speaker 1: fairly broad and rich literature about everything related to asset
Speaker 1: allocation and portfolio management, although some of it contradicting itself,
Speaker 1: how did you teach yourself what what was the right
Speaker 1: way to do this? You know, I found that the
Speaker 1: way GMO approaches the world is different than a lot
Speaker 1: of other firms, a lot of other academic literature. So
Speaker 1: I basically asked my boss Ben Anker a million questions,
Speaker 1: and I spent a lot of time with Jeremy and
Speaker 1: other members of the team listening, asking questions, trying to
Speaker 1: you know, trying to understand how we approached the world,
Speaker 1: why we did what we did, all in an effort
Speaker 1: to be able to educate clients what we what what
Speaker 1: we did. But I would say most of that education
Speaker 1: was internal as well as you know, there's you know
Speaker 1: a handful of other kind of friends of the firm
Speaker 1: out there that you know, we read. Andrew Smithers in
Speaker 1: the UK wrote a lot of very good pieces that
Speaker 1: seemed to rhyme with what we were doing. So it
Speaker 1: was an education with a limited outside but mostly trying
Speaker 1: to take the wealth of information that my colleagues had
Speaker 1: and digested in a way that that I could use.
Speaker 1: And when you were originally client facing, GMO is or
Speaker 1: almost a hundred percent institutional? Is that is that correct?
Speaker 1: It was almost not quite a hundred percent. We we
Speaker 1: we had a small relationship with Evergreen at the time
Speaker 1: on the retail side, and today, uh, we have a
Speaker 1: relationship with Wells Fargo that that grew into Wacoba, which
Speaker 1: grew into Wells Fargo. So the Wells Fargo absolutely return
Speaker 1: fund is still a big piece of our business. But
Speaker 1: you're you're, you're traditionally known as an institutional shop. The
Speaker 1: vast majority is that of and if memory serves you,
Speaker 1: guys are up to about seventy billion dollars correcting those
Speaker 1: those numbers. So let you mentioned the seven year forecast.
Speaker 1: Let's let's talk about that a little bit, because um,
Speaker 1: Jeremy Grantham has been doing these seven year forecasts for
Speaker 1: as long as I've been in the industry and which
Speaker 1: is about when I started, and he has over that
Speaker 1: own period of time been fairly consistent. Nobody is a right,
Speaker 1: but he's been a whole lot more right than wrong
Speaker 1: over that that period of time. Why seven years? What's
Speaker 1: the significance of seven years um? And how did that
Speaker 1: come about? So the forecast originally when they started where
Speaker 1: that they were a ten year forecast, and so what
Speaker 1: we had heard from clients was, hey, we get that
Speaker 1: year long term, but ten years just just too long.
Speaker 1: And so in actually Ben Inker, the current my boss
Speaker 1: that had acid allocation, he had done this study where
Speaker 1: he had found twenty eight bubbles going back to the
Speaker 1: South Sea Bubble and the remember century, and so at
Speaker 1: some point he just did the math to see how
Speaker 1: long it took for those bubbles to rise and fall.
Speaker 1: And so it turns out that the average of those
Speaker 1: was actually six and a half years, and so we
Speaker 1: converted to a seven year forecast. I automatically assumed it
Speaker 1: was biblical and seven seven fat years got a nice
Speaker 1: ryme to it, for sure. So so that's interesting. So
Speaker 1: that raises that raises a fascinating question. Back in February
Speaker 1: oh nine, right before the market bottomed, Uh, Jeremy comes
Speaker 1: out with a seven year or I should say GMO
Speaker 1: comes out with a seven year forecast, and that forecast
Speaker 1: for US large stocks was close to nine percent a
Speaker 1: year going forward, which, if you remember back to February
Speaker 1: oh nine, was kind of hard to imagine a lot
Speaker 1: of people were hiding under their desks the thought of, Hey,
Speaker 1: you're gonna get eight point nine percent a year for
Speaker 1: the next seven years. Um, no one really believed it.
Speaker 1: It turned out. As bullish as that was at the bottom,
Speaker 1: it was fairly cautious. Over the next seven years, we
Speaker 1: saw over twelve percent returns. So the questions that come
Speaker 1: up from there is, um, are you as bullish today
Speaker 1: as you were back then? What's the outlook going forward?
Speaker 1: And why do you think the market did as exceeded
Speaker 1: your bullish expect stations from pretty much the nature of
Speaker 1: the financial crisis. Yeah. That well, that last one is
Speaker 1: a that's a that's a that's a tough one. So
Speaker 1: I'm going to start with the easier question first, um,
Speaker 1: and then come back. But you know, I think our
Speaker 1: our view today is certainly cautious. That you've been in
Speaker 1: this environment where you've had extraordinary equity returns, where you've
Speaker 1: gotten kind of twenty years worth returns in at ten
Speaker 1: nine or ten year ten year period, and so we
Speaker 1: think that that we believe in mean reversion, there's going
Speaker 1: to be there's going to be a give back to that.
Speaker 1: So I think we are cautious in our outlook in
Speaker 1: that there's just not much return left in markets because
Speaker 1: everything with duration, stocks and bonds have done incredibly well.
Speaker 1: I would contrast this with two thousand seven, where valuations
Speaker 1: were also poor, but you had a wonderful three standard
Speaker 1: deviation housing bubble staring you in the face. You had
Speaker 1: this market narrative of the Great Moderation, that central bankers
Speaker 1: had figured out the rhymes and the rhythms of the
Speaker 1: capitalist cycle, and that recessions were a thing of the past.
Speaker 1: You had just unbelievable stupidity in the credit markets, people
Speaker 1: levying things fifteen times to make two basis points over
Speaker 1: lib or. And so we were very defensive, you know.
Speaker 1: I think Jeremy's term was that there was a bubble
Speaker 1: and risk assets, and we were very defensive, and we
Speaker 1: were very scared in in many ways. The valuation, certainly
Speaker 1: US equity is actually worse today, but we are not
Speaker 1: as defensive as we were in two thousand and seven.
Speaker 1: We don't have an obvious bubble kind of staring us
Speaker 1: in the face. You have some steins of stupidity in
Speaker 1: the credit markets, but as not as nearly as pervasive
Speaker 1: as it was. Give us an example. I mean, everybody
Speaker 1: seems to go to the subprime auto market, but that
Speaker 1: seems to be not the foundation for the rest of
Speaker 1: the economy the way the subprime housing exactly. Yeah, I mean,
Speaker 1: you know, the return with a vengeance of Cuve light lending.
Speaker 1: You know, I would have bet a lot of money
Speaker 1: and lost that. You know, Cuve light Lending would have
Speaker 1: been you know exactly, Yeah, you and me both, I'm shocked.
Speaker 1: That is that a substantial amount of capital at risk
Speaker 1: and that um, I mean, it's a reasonable amount of capital.
Speaker 1: And I think, you know, one of the things that
Speaker 1: is a source of worry is the rise of mutual
Speaker 1: funds and e t f s in high yield and
Speaker 1: the levered loan market, with that market used to be
Speaker 1: dominated by insurance companies. Now it's dominated by mutual funds
Speaker 1: and ETFs, which have obviously the daily liquidity and you know,
Speaker 1: Stein and and some others have had you know, the
Speaker 1: quote that their liquid claims on it liquid investments, and
Speaker 1: so I think that's a potential source of worry liquid
Speaker 1: claims on illiquid investments. That's never a good thing, is it. Uh,
Speaker 1: It's it's okay until it's not, and then it tends
Speaker 1: to end tends to end pretty badly. Well. The last
Speaker 1: time we saw a bit of a run on some
Speaker 1: of the high yield products was two or three years
Speaker 1: ago when one of the funds effectively blew up. Is
Speaker 1: that the concern going forward there'll be some either some
Speaker 1: fund unable to to meet its obligations and that sets
Speaker 1: off the next cascade. What what do you guys think
Speaker 1: is the bigger concern looking out? Um, I think it's
Speaker 1: difficult to figure out, like what that concern is. I
Speaker 1: think that the general concern is there's been a huge
Speaker 1: reach for yield, and people are of the belief that
Speaker 1: these mutual funds and e t f s that you
Speaker 1: can you can get daily liquidity on these things, and
Speaker 1: you can. It's just that the prices underneath them aren't
Speaker 1: going to reflect that, and so as everybody starts going
Speaker 1: for the door, it might result in some some some
Speaker 1: results that hadn't quite anticipated. You can either get price
Speaker 1: or liquidity, but not necessarily both at the same thing.
Speaker 1: Ex So, so that that's kind of interesting. Um. One
Speaker 1: of the things that GMO has talked about is benchmark
Speaker 1: for ree investing. Clearly, any of the high yield or
Speaker 1: or lower quality um A liquid stuff is not going
Speaker 1: to have a real benchmark. But if we're talking equities,
Speaker 1: what is the significance of the phrase benchmark free invest there? Well,
Speaker 1: benchmark free investing kind of really came out in the
Speaker 1: run up in the bubble. And you know, our flagship
Speaker 1: strategy that has been around since nineteen with Princeton and
Speaker 1: Phillips Exeter was our our balanced strategy, and so you know,
Speaker 1: sixty five equity thirty five bonds. And so we we
Speaker 1: had two groups of clients, one of whom was firing
Speaker 1: us in. Another group was saying, hey, you know, Jeremy
Speaker 1: and Ben, you know, why do you have so much
Speaker 1: US equities? It's the most expensive and it's ever it's
Speaker 1: ever been, is this? And so then the reason was
Speaker 1: what we have tracking air. We have a benchmark that
Speaker 1: we're supposed to beat, and we have tracking air constraints
Speaker 1: that that run into it. And so they took that feedback,
Speaker 1: went back to the lab and they came up with
Speaker 1: what they called the where to high portfolio. And they
Speaker 1: actually remember that phrase very distinctly in the late nineties
Speaker 1: and and and it was a very interesting portfolio, and
Speaker 1: they actually uh unveiled it at our fall conference in
Speaker 1: n and in GMO grew up investing in a lot
Speaker 1: of investing for a lot of endowments and foundations. So
Speaker 1: the concept of five reel was, you know, kind of
Speaker 1: been part of who we are for a long time.
Speaker 1: And so they said, if the best way to make
Speaker 1: five reel, five reel five percent over inflation is to
Speaker 1: own a portfolio that is basically seventy bonds, a little
Speaker 1: bit of reads, and a little bit of emerging equities.
Speaker 1: And I wasn't at GMO at the time, but I
Speaker 1: could imagine kind of the crickets in the audience for sure,
Speaker 1: after they unveiled this in the middle of the dot
Speaker 1: com bubble. So this is the previous year the SMP
Speaker 1: was up thirty and as that was up forty something
Speaker 1: percent that year. For what I'm doing it off the
Speaker 1: top of my head. So and you're telling people, no, no, no,
Speaker 1: US equity mostly bonds. Here we are at the time,
Speaker 1: twenty years into a bondabule market, and people were already
Speaker 1: saying it was old, and it was long in the
Speaker 1: tooth and a little bit of e M and a
Speaker 1: little bit of reats. It was a portfolio that was
Speaker 1: so far out of central casting for any institution that
Speaker 1: it went over basically basically like led Zeppelin. Nobody could
Speaker 1: take that portfolio back to their investment committee and say
Speaker 1: this is the best way to compound wealth going forward.
Speaker 1: And so it wasn't until two thousand one, when the
Speaker 1: market started to fall apart. You're in the middle of
Speaker 1: the bear market, that we got somebody to say, hey,
Speaker 1: just maybe this thing isn't as half baked as as
Speaker 1: it as it originally seemed. And you know, benchmarks are
Speaker 1: necessary for measurement for institutions for individuals. But what is
Speaker 1: very difficult for us about benchmark oriented investing is that
Speaker 1: it forces you to own more of the things that
Speaker 1: you don't like and less of the things that you
Speaker 1: really do like. And if your goal is to compound, well,
Speaker 1: that's a pretty big inhibitor sure to that. Because the
Speaker 1: ability to get out of the way of the oncoming
Speaker 1: freight train, the ability to load up on an asset
Speaker 1: when it's really cheap, that's really how you compound well
Speaker 1: through time. And so that benchmark free investing, which was
Speaker 1: originally the where to hide portfolio, you know, really has
Speaker 1: been part of our DNA since. Wasn't until oh one
Speaker 1: that somebody gave you had the gumption to give us
Speaker 1: some money to invest that way? And how has that
Speaker 1: portfolio done since? And and how much assets has it attracted? Um,
Speaker 1: it's it's done very well versus stocks and bonds or
Speaker 1: any combination of over that very long period that it's compounded. Um,
Speaker 1: I don't know off the top of my head, but
Speaker 1: much higher than stocks over that time period, which half
Speaker 1: of volatility, it's got a sharp ratio of over one.
Speaker 1: Well sure from two thousand to two thousand and pull
Speaker 1: the two thousand and twelve at US equities are effectively
Speaker 1: flat with a ton of volatility in between, and bonds
Speaker 1: just kept getting bedroom and better and better over that time.
Speaker 1: So now looking at real plus five from here with
Speaker 1: what a number of high profile bond people, be it
Speaker 1: Bill Gross or Jeff Gunlocked have pretty much declared the
Speaker 1: bond bull market over what what's your outlook on bonds?
Speaker 1: From here? Does GMO see the bond market and that
Speaker 1: bond bull run that dates back to fit Chaff Paul
Speaker 1: Bocer is that still have any life left to it
Speaker 1: or is gross and unlock correct. The best years of
Speaker 1: the bond bull market are behind us. Over the intermediate
Speaker 1: to long term. I think it's hard to see how
Speaker 1: bonds could deliver anything associated with the longer term returns
Speaker 1: that we've seen in this bull market. Obviously, the yield
Speaker 1: is what the yield is. You've had duration that the
Speaker 1: benefits of duration and falling yields over that time period.
Speaker 1: So you know, our best guess is going forwards that
Speaker 1: bonds are going to be very disappointing, certainly relative to
Speaker 1: the last last thirty years years. We uh, we do
Speaker 1: like tips. We think that tips offer an interesting inflation
Speaker 1: hedge relative phenomenal bonds um. So you know, as we
Speaker 1: think about benchmark free we have very little in the
Speaker 1: way of non alduration. Most of our duration at this
Speaker 1: point is in real duration through through tips. In a
Speaker 1: benchmark oriented portfolio, it's about it's about half and half,
Speaker 1: but half tips half nominals. So tips for for um
Speaker 1: where we are today is going to be a measure
Speaker 1: of inflation um that gets adjusted. I think it's twice
Speaker 1: a year based on CPI data is something along those lines.
Speaker 1: So does this imply you're expecting higher inflation going forward?
Speaker 1: I think that's the worry. The thing that will cripple
Speaker 1: anyone's portfolio is arise in the discount rate, So that
Speaker 1: would impact every any anything with duration. Both stocks and
Speaker 1: bonds actually impact stocks the most because they have the
Speaker 1: higher the higher duration. But I think that's the concern,
Speaker 1: and if you weigh the risks one versus the other,
Speaker 1: I think over the longer term, the concern is that
Speaker 1: inflation is a higher risk than um than deflation at
Speaker 1: this point. So what does that tell us about forward
Speaker 1: expectations for US equities? I'm not quite sure what that
Speaker 1: specifically tells you about the how the interest rates impact
Speaker 1: the expected return for U S equities. I think as
Speaker 1: we look at US equities, they're just expensive on every
Speaker 1: metric that we can come up with, even the kindest
Speaker 1: and gentlest metrics. So um, you know. I think what
Speaker 1: has happened to us as well as all investors is
Speaker 1: basically the FED has bullied us into owning more risk
Speaker 1: assets than we would than we would normally given how
Speaker 1: poor cash yields and bond yields have been. So I've
Speaker 1: heard that phrase before. The FED has bullied us into
Speaker 1: riskier assets, but that was through quantitative easing, where they're
Speaker 1: buying up a lot of paper and through essentially zero
Speaker 1: interest rate. Now that QUEI is pretty much over and there,
Speaker 1: whatever is on their balance sheet is apparently being allowed
Speaker 1: to run off naturally there. It's not that they're selling anything,
Speaker 1: but things hit maturity and they don't seem to go
Speaker 1: out and replace it. So the conditions that led to
Speaker 1: the bullying into risk assets are now going away. The
Speaker 1: expectation is three more increases this year, but even if
Speaker 1: it's one or two, we had a few increases last year.
Speaker 1: It seems that everybody on the feed is lined up
Speaker 1: with ongoing normalization of interest rates. Does that mean risk
Speaker 1: assets become that much less attractive for a considerable period
Speaker 1: of time. Well, it's hard to envision quantitative tightening being
Speaker 1: bullish for us. I'm not quite sure what it really means,
Speaker 1: because the market can take on different narratives in the
Speaker 1: inner rown. If the economy economic growth is stronger, um,
Speaker 1: you know, the market can kind of twist it's you know,
Speaker 1: we can just twist the justification almost any way that
Speaker 1: we want. What I think is interesting is if we
Speaker 1: do get you know, the continued hike in rates over
Speaker 1: the next several years, I think the fascinating question is
Speaker 1: to be what is what point were those rates tip
Speaker 1: the economy over into recession? That's an interesting question. If
Speaker 1: you know, if it's you know, two and a quarter
Speaker 1: on FED funds, that's a pretty good indication that secular stagnation.
Speaker 1: You know, things are very different this time. If it's
Speaker 1: at three and a half on FED funds or three
Speaker 1: or three and a half on FED funds, that's a
Speaker 1: pretty good indication that secular stagnation, that things aren't different
Speaker 1: this time. That secular stagnation might not be the argument
Speaker 1: that's winning, that's winning the day. There's a lot of
Speaker 1: variables in there, and the way I'm hearing you contextualize
Speaker 1: this is the FED rate, whatever it happens to be
Speaker 1: when the economy is then tipped into recession, is going
Speaker 1: to be informative as to the broader macro cycle, as
Speaker 1: to whether or not, hey, was that new normal behind us?
Speaker 1: Are we still want a stag a slow growth I
Speaker 1: don't want to say stagflation, but a low wage, low
Speaker 1: growth period of time. Or is it possible that what
Speaker 1: ticks us into tips us into recession has nothing whatsoever
Speaker 1: to do with the FED. I think it'll be a
Speaker 1: pretty good indication of you know, it's not. It won't
Speaker 1: be dis positive, but it'll be a pretty good signal
Speaker 1: or pretty good sign post as where what regime we're in.
Speaker 1: You know, when we think about our forecast, our traditional
Speaker 1: forecasts assume normal mean reversion, normal mean reversion to cash rates,
Speaker 1: term premium on top of that, and then equity was
Speaker 1: premium on top of that. You know, Ben Anchor has
Speaker 1: written several quarter letters about this alternative universe that that
Speaker 1: we've coined hell, which is basically zero real in for
Speaker 1: cash rates, and then you get, uh, your bond premium
Speaker 1: on that, and your equity was premium on top of that.
Speaker 1: But if you're getting zero reel for cash instead of
Speaker 1: one and a quarter reel, which is our normal traditional assumption,
Speaker 1: you expect to return for bonds and stocks falls falls
Speaker 1: similar lower. And it has in the short run, it
Speaker 1: actually has the impact of you're you're assuming less meaner version,
Speaker 1: so you're actually your forecast actually improve equities two to
Speaker 1: three points, bonds about a point. We call it hell,
Speaker 1: because over the long term, if you're not getting five
Speaker 1: and a half or six reel out equities, if you're
Speaker 1: getting four or four and a half reel out of
Speaker 1: equities and you're getting two real out of bonds, not three,
Speaker 1: it really blows up everybody's asset allocation. Your ability to
Speaker 1: generate five reel in that environment is really has really hampered.
Speaker 1: And so the hard part with predicting what environment you're
Speaker 1: in hell versus purgatory is, you know, we don't have
Speaker 1: you know, we have people working on a model that
Speaker 1: will predict what what Powell is going to do or
Speaker 1: powal successor is going to do. We really don't have
Speaker 1: somebody working on that because that's that's a useless piece
Speaker 1: of activity. You can't forecast that. And so but we
Speaker 1: do have to weigh those probabilities, and we're thinking about
Speaker 1: expected returns for our portfolios. And you know, we are
Speaker 1: kind of card carrying members of Meaner Version. We are
Speaker 1: the kind of the founding members of the Meaner Version Society.
Speaker 1: And for us to recognize that there's a chance that
Speaker 1: things are different this time uh is very different, is
Speaker 1: certainly very different for us. That is that is uncharted
Speaker 1: territory certainly as far as asset allocation is concerned. So
Speaker 1: so you keep talking about five real. I'm used to
Speaker 1: the institutional side focused on five because if you're an
Speaker 1: endowment or foundation, you have to supposed five percent to
Speaker 1: maintain your tax exempt status. What is the significance of
Speaker 1: five reel? What? Why has that number become such a focus? Um?
Speaker 1: I mean that's just historically the spending rate for most
Speaker 1: for most institutions. Real. Yeah, so so you know, so
Speaker 1: that's the coming from from the actual behavior of clients
Speaker 1: as opposed to some abstract theoretical correct. So if you
Speaker 1: you know, if you are are an educational institution, your
Speaker 1: your endowment oftentimes is contributing you know, five percent of
Speaker 1: that endowment into the into the budget for the school.
Speaker 1: You think about it in real terms because you want
Speaker 1: to maintain the purchasing power of that environment over time.
Speaker 1: And and we're sitting here in Boston where stones throw
Speaker 1: from too fairly famous institutions, both of which have enormous
Speaker 1: um endowments. When when you guys are reading about changing
Speaker 1: of the guard at the Harvard and down or or
Speaker 1: some personnel change in M I T. What is the
Speaker 1: thought process like to do. And I know I'm kind
Speaker 1: of um pulling this up out of left field, but
Speaker 1: you you you mentioned educational institutions because I've been following
Speaker 1: that saga now for it seems like going back to
Speaker 1: Larry Summer's fifteen years ago? Is it longer? Is it
Speaker 1: twenty years ago? And I'm always astonished, Wait, aren't they
Speaker 1: supposed to be really smart at Harvard? Why? Why is this?
Speaker 1: Why did they kick out people who were doing so well?
Speaker 1: That original endowment team was just crushing it, And it
Speaker 1: seems like there's a different flavor each year, and nobody
Speaker 1: really seems to last. Obviously, I don't expect you to
Speaker 1: tell us what's going on in the inside, but do
Speaker 1: things like that cross your your um viewpoint? Do you
Speaker 1: look at that and say, what what's going on here?
Speaker 1: I think we read about it just because they're important
Speaker 1: parts of our industry. But you know, our our focus
Speaker 1: is not on kind of what the internal politics or
Speaker 1: what Harvard is doing. Our focus is more on, hey,
Speaker 1: how do we generate returns for for our clients? So
Speaker 1: it's interesting to read, but it's not really It's not
Speaker 1: really Germaine at the end of the day. So let
Speaker 1: me ask not about something that you read, but something
Speaker 1: that you wrote. Last summer, you co authored a paper
Speaker 1: with James Montier Um and I love both the title
Speaker 1: and some of the quotes from it. The title was
Speaker 1: the SMP five hundred just Say No, and within that
Speaker 1: you have this delightful quote. Please do not mistake us
Speaker 1: from members of that species known as parma bears. We
Speaker 1: don't always hate us equities. As a matter of principle,
Speaker 1: we are just governed by the precepts of valuation. So
Speaker 1: let's leap off. Use that as a leaping off point
Speaker 1: and discuss valuation. How do you guys measure valuation of equities?
Speaker 1: And it's obvious, but I have to ask the question,
Speaker 1: why do you believe valuation is so important? Yeah? So, um,
Speaker 1: you know, we think that valuation is going to determine
Speaker 1: the vast bulk of your outcomes. That no asset, no
Speaker 1: assets puror dained to make you money unless it's priced
Speaker 1: to do so. So our investment process, if you wanted
Speaker 1: to sum it up into eleven words, is figure out
Speaker 1: what you think something's worth and where you where you
Speaker 1: can be wrong. And so valuation for us is the
Speaker 1: thing that we have the highest degree of confidence in
Speaker 1: and you know, trying to predict the rhymes and rhythms
Speaker 1: of you know, the S and P. It's a twenty
Speaker 1: three trillion dollar market. It's it's complex, it's reflexive, it's
Speaker 1: got stochastic as a QUANTZ call, you know, random elements
Speaker 1: toss in that. Trying to predict that in the short
Speaker 1: run is simply impossible to do consistently. But we know,
Speaker 1: and we can test this back to the Chester A
Speaker 1: AR three administration, that valuation really is going to do um,
Speaker 1: your starting valuation, the price you pay for an asset
Speaker 1: is really going to really determine the vast bulk of
Speaker 1: your outcomes. It's not a guarantee, but uh, there's it's
Speaker 1: a good statistical debt exactly exactly. Every now and then,
Speaker 1: Jeremy says something that within the framework of evaluation of
Speaker 1: a value investor um brings in a little bit of
Speaker 1: behavioral finance. I'm always curious how clients respond to that.
Speaker 1: So the most recent seven year forecast was pretty um,
Speaker 1: I don't wanta say bearish, but it was pretty subdued.
Speaker 1: Is that a fair fair assess I think you're being kind,
Speaker 1: But at the same time, he very publicly said, I
Speaker 1: don't think we're up to the melt up stage yet,
Speaker 1: meaning the bullmarket still has ways to go, and that
Speaker 1: last stage things can really get out of hand. How
Speaker 1: do you reconcile our seven year forecast is negative, but
Speaker 1: there's some crazy stuff coming before that. Yeah, I think,
Speaker 1: you know, certainly, as we talk to clients, the clients
Speaker 1: are pretty We're pretty clear with them. You know the
Speaker 1: process they bought it was based on our long term
Speaker 1: evaluation forecast. That's the process that is going to be
Speaker 1: the primary input in terms of putting together their portfolio.
Speaker 1: I think Jeremy wove a very interesting mosaic with respect
Speaker 1: to hey, the pieces might be in place for this
Speaker 1: thing to really blow off and melt up, um he put.
Speaker 1: I think he put a probability of probability on it,
Speaker 1: so he wasn't saying it was it was a sure
Speaker 1: thing by any stretch. And I think it wasn't interesting.
Speaker 1: It isn't interesting speculation. But our job is to not speculate,
Speaker 1: obviously with clients money. It is to follow the process
Speaker 1: that we've been doing for almost thirty years within asset allocation.
Speaker 1: We do, from time to time have shorter term views
Speaker 1: on the markets, but they are few and far between between.
Speaker 1: It's a high bar to implement those views. We we
Speaker 1: got more defensive in oh eight because we were more
Speaker 1: scared about what was going on. That was a shorter
Speaker 1: term view. But but Jeremy's kind of one and two
Speaker 1: chance that things melting up. You know, we get less
Speaker 1: questions about it now after you know, the market fell
Speaker 1: even than we did at the end of January. When
Speaker 1: the market was market was taking off. But I think
Speaker 1: and just following the tax reform, everything seemed to just
Speaker 1: explode upwards. Um. Did anyone say, hey, is this the
Speaker 1: melt up? Where? Where? Where are we with this? Uh?
Speaker 1: It felt it certainly felt like in January things were
Speaker 1: trending in that direction. Um, I think there is room
Speaker 1: for that narrative to come back into the market, But
Speaker 1: I think February really was a shake up for some investors. Well,
Speaker 1: now that's a really valid and interesting point. We've had
Speaker 1: during this run, much more significant pullbacks than what we
Speaker 1: saw in February. And this is a little squishy and
Speaker 1: qualitative of me, not quantitative, but it felt that that
Speaker 1: eleven draw down had a far greater resonance amongst many
Speaker 1: more people than the previous There were a couple of
Speaker 1: nineteen pullbacks. February really seemed to scare the Bejesus out
Speaker 1: of a lot of people. What So the question is why, why?
Speaker 1: What made this pullback so significant? I think it was
Speaker 1: if you when you just had such an extended period
Speaker 1: where nothing had happened to the markets, and so when
Speaker 1: you know, when that gets jostled in a pretty violent way,
Speaker 1: and I think that just reawoken the fact to investors like, oh, hey,
Speaker 1: this thing is not a one way train that that
Speaker 1: that bad things can stop go down to Is that
Speaker 1: what you said? And also, you know you didn't get
Speaker 1: as much help from bonds in this particular run either,
Speaker 1: so so you know, investors portfolios were a bit more exposed.
Speaker 1: Now the markets kind of come back, not all the
Speaker 1: way bonds bond yields of state have stayed high. But
Speaker 1: I think it was a nice reminder that, hey, you know,
Speaker 1: bad things can happen out there. So when you look
Speaker 1: at valuation, how do you construct a measure valuation? Surely
Speaker 1: it's more than just price to earnings ratio. Yeah, so
Speaker 1: our our for our seven year forecast, the framework is
Speaker 1: pretty simple. You have valuation and you have growth and
Speaker 1: income on the on the valuation side, you have pees
Speaker 1: and you have margins or I think it's probably more
Speaker 1: technically we have proxies for return on capital. So uh
Speaker 1: so we know that what really mean reverts for equities
Speaker 1: is returns on capital, and so we'll look at that.
Speaker 1: We'll cut that several different ways in building our forecast,
Speaker 1: and we'll combine that with a pe to get a
Speaker 1: sense of the valuation. Will also combine that with growth.
Speaker 1: You get that as an equity investor, you get income
Speaker 1: as an equity investor, and that provides a fairly simple
Speaker 1: framework for thinking of out what you think something is worth.
Speaker 1: And then you ask the risk management question of where
Speaker 1: you might be where you might be wrong. So you
Speaker 1: are you looking at at evaluation across all assets or
Speaker 1: is it strictly equity? How do you evaluate bonds? How
Speaker 1: do you evaluate other non equity assets a non bond asset,
Speaker 1: So we look we value a whole host. I think
Speaker 1: there's forty or fifty different equity markets will do a
Speaker 1: similar exercise with respect to bonds. The issue with, however,
Speaker 1: with bonds, is that the evidence for mean reversion is
Speaker 1: not to be kind of nearly as strong as it
Speaker 1: is within equities, you have the central bankers who can
Speaker 1: kind of muck around with the front end of the
Speaker 1: curve or at the long end of the curve, depending
Speaker 1: upon the particular market. So the case for mean reversion
Speaker 1: within bonds is less strong, and so that leads us
Speaker 1: to you know, having a mean reverting model, having a
Speaker 1: model that doesn't mean revert, having a um kind of
Speaker 1: adopting a Leebwitz type framework with constant duration in real terms.
Speaker 1: So you you it's a little bit more of a
Speaker 1: mosaic with respect to bonds. Currencies, we also, you know,
Speaker 1: we value as well. It's it's primarily purchasing power parity.
Speaker 1: We make some adjustments for it, so it just becomes
Speaker 1: relative to other major exactly finance centers. So it's US, Japan, Europe,
Speaker 1: or are you looking at a broader range of currencies?
Speaker 1: Um it, you know, it's all the developed currencies and
Speaker 1: twenty five or thirty different emerging currencies. Maybe probably different
Speaker 1: emerging currencies and e M currencies can give help contribute
Speaker 1: to a read of is the dollar fairly valued? Is
Speaker 1: it weak? Is it's strong? Yeah? I think you know,
Speaker 1: the interesting thing about emerging currencies is that they you know,
Speaker 1: they can be valued in and of themselves. You have
Speaker 1: the meaner version of the currency, which you get get
Speaker 1: as part of it. As being an equity owner, you
Speaker 1: get the real you don't get the real rate aspect
Speaker 1: of things. Um. But for for us as we think
Speaker 1: about emerging historically, the times where emerging has really got
Speaker 1: into a lot of trouble has been when the currencies
Speaker 1: have been overvalued. So kind of heading into the Asian
Speaker 1: crisis thirteen or fourteen, we thought that the e M
Speaker 1: currencies were very expensive. So so that almost becomes in
Speaker 1: addition to an expected return to it almost becomes a
Speaker 1: risk management tool as well. And so EM currencies have ripped,
Speaker 1: They've had a you know, a great run over the
Speaker 1: past you know, probably two years now, but they're at
Speaker 1: the point where they're basically fairly valued there. You know,
Speaker 1: it's you know, it's not you know, they're certainly not
Speaker 1: expensive enough to to really cause you to to least
Speaker 1: lose sleep at night, and they certainly have room to run.
Speaker 1: When you're dealing with purchasing power parity with EM, you
Speaker 1: always have to take with a grain of salt because
Speaker 1: the data is not so great. But you know, when
Speaker 1: you're really looking at currencies, you're looking at extremes that
Speaker 1: that's when that really matters. Do commodities come under the
Speaker 1: same process or they really so dollar dependent that you
Speaker 1: don't look at it the same way. Well, they're they're
Speaker 1: different for for for different reasons. Commodities. We do look
Speaker 1: at oil, iron ore, A copper iron ore, oil and
Speaker 1: natural gas, UM copper iron ore. So there's your industrial side, UM,
Speaker 1: natural gas and what was the last one? And oh
Speaker 1: and oil so that's you're heating and your transportation. Yeah,
Speaker 1: the problem that the um the confidence in those forecasts
Speaker 1: is less understanding the supply and demand diamics in those
Speaker 1: market is very difficult. We had we did have strong
Speaker 1: views on copper and iron ore in two thousand and
Speaker 1: eleven and two thousand and twelve. We had a fairly
Speaker 1: exhaustive view of the supply side and we just felt
Speaker 1: like demand couldn't be strong enough to match the prices
Speaker 1: and the supply coming on. So but but the competence
Speaker 1: in those forecasts generally tends to be lower. And I
Speaker 1: didn't hear you mentioned precious metals or golds and which
Speaker 1: has its own set of issues. Yeah, well, you know,
Speaker 1: I I Jim Grant wants how he valued gold, and
Speaker 1: he basically said it was the value manager's indulgence. So
Speaker 1: he said he even he could not put put a
Speaker 1: price on it. You know, for years, Jeremy said, our
Speaker 1: own gold when it yields the same thing as a
Speaker 1: T bill. And so, uh, there in oh eight, it
Speaker 1: actually yielded close. It actually yielded more than more than
Speaker 1: a T bill for a period of time. And so
Speaker 1: we did own some gold in our mean reversion hedge
Speaker 1: fund for a period and then we actually made a
Speaker 1: good bit of money on it, and and we tried
Speaker 1: to value it and we just couldn't, and we got scared,
Speaker 1: and we just took our profits and ran. Totally understandable
Speaker 1: that that's a lot of value investors view on on gold.
Speaker 1: So so as some of the founding members of the
Speaker 1: mean Reversion Club, let's let's talk about those corporate profits
Speaker 1: that that you referenced. Why haven't we seen corporate profits
Speaker 1: mean revert? They seem not just at record levels, but
Speaker 1: significantly elevated overpass cycles. Can we credit or blame the
Speaker 1: fit for this or is something else going on? Yeah,
Speaker 1: that's a I mean, that's a really hard question. It's
Speaker 1: a question that we puzzled over for you know, literally
Speaker 1: years and years actually before the financial crisis, when profit
Speaker 1: margins were high, we spent a lot of time thinking
Speaker 1: about why those profit margins are Jeremy has put together
Speaker 1: again a pretty interesting mosaic as to why profit margins
Speaker 1: are high. That you have uh decreasing competition with an
Speaker 1: industry that leads to higher profits. You have greater after
Speaker 1: citizens United, you have greater corporate influence in Washington, making
Speaker 1: it harder for new companies to come in UM, and
Speaker 1: so that there's I think there's qualitative reasons that we
Speaker 1: can come up with as to why profit margins are higher.
Speaker 1: We've tried to quantify those, and we've been less successful
Speaker 1: in uh in in being able to put data to that. UM.
Speaker 1: I think it's something that we struggle to answer. We
Speaker 1: do as we think about our valuation models, we do
Speaker 1: build in higher profitability assumptions for the US. But I
Speaker 1: also think it comes back to an observation you know
Speaker 1: that we made years ago, actually Jeremy Jeremy years ago,
Speaker 1: that the real medium wage in the United States hasn't
Speaker 1: moved in forty five years, and so the meaning real
Speaker 1: after inflation wages have been flat for half a century,
Speaker 1: half a century since the early sixties, and so um
Speaker 1: and I think so all of the you know, the
Speaker 1: benefits have approved that have have crued to capital rather
Speaker 1: than labor, and that's allowed profit margins to be to
Speaker 1: be higher. Uh and I think that does present some
Speaker 1: pretty difficult issues for the for the economy in the
Speaker 1: long run. So I completely agree with that assessment, but
Speaker 1: I want to push back on a little bit because
Speaker 1: I've heard some interesting counter arguments elsewhere um and they
Speaker 1: go something like this, on a formation side, for a company,
Speaker 1: it's never been cheaper easier to get a laptop and
Speaker 1: an Internet connection and suddenly you're in business. As even
Speaker 1: during the dot COM's you needed ten or twenty million
Speaker 1: dollars to build the back end infrastructure that literally a
Speaker 1: laptop provides today and a handful of of off the
Speaker 1: shelf web products. And that a lot of the new companies,
Speaker 1: UM be they Google or Facebook or um some of
Speaker 1: the other firms that are more digital than physical. You
Speaker 1: don't need giant factories, you don't need tremendous amounts of
Speaker 1: capital you don't need huge pools of labor. You could
Speaker 1: be incredibly efficient, incredibly effective, and so of course Google
Speaker 1: should have a higher p ratio than Ford. Um. Uh,
Speaker 1: the same with Facebook. Shouldn't Facebook be worth more than
Speaker 1: U S Steel? Shouldn't we value shouldn't the return on
Speaker 1: investment be much higher for that? Maybe Amazon is a
Speaker 1: little different because they have so much physical facilities, and
Speaker 1: Apple is its own sort of unique creature. Are we
Speaker 1: seeing more and more of the if not Google, but
Speaker 1: digital or low cost, low capital, low personnel companies, and
Speaker 1: therefore they should be more profitable and and our entire
Speaker 1: title to a higher pe or is that just an
Speaker 1: excuse for an overvalued Marita, Well, I think what you're
Speaker 1: saying is true. Uh. The the issue that we have
Speaker 1: with that is it is true for the technology sector.
Speaker 1: It is not true for the system as a whole.
Speaker 1: And so as we value profits for the system as
Speaker 1: a whole. Uh, that is what is elevated. Tech is
Speaker 1: a part of it. But it's also true outside outside
Speaker 1: of tech as well. So aren't so. I I'm using
Speaker 1: my firm as an example, and I assume GMO has
Speaker 1: the same experience. The things you can do with again,
Speaker 1: a laptop and some software. Um, it doesn't requires as
Speaker 1: much manpower as necessary. If we were to go back
Speaker 1: in time and I was gonna say, hey, you're going
Speaker 1: to manage seventy billion dollars, communicate with clients all over
Speaker 1: the world, and run a dozen different strategies across various
Speaker 1: hedge funds, mutual funds, s m A s down the list,
Speaker 1: you'd say, oh, well, that's a three thousand person entity,
Speaker 1: and today it's it's a tiny fraction of it. So
Speaker 1: even out of outside of the Google's and the technico
Speaker 1: technology companies, aren't we all that much more effective and
Speaker 1: efficient thanks to technology? Or again is that just excuse
Speaker 1: making um, you know, it's just as you were, you know,
Speaker 1: giving that hypothetical. I just started thinking about how many
Speaker 1: more people that we have in compliance, and how complex
Speaker 1: our business has become, and the demands of clients are greater,
Speaker 1: and how you deal with the data. You know that
Speaker 1: those issues. You know, so much data has been created
Speaker 1: in the last two years, Like how do you deal
Speaker 1: with that data? So you need people for that. So
Speaker 1: I think I think our world in general is becoming
Speaker 1: more complex and that is requiring additional resources in order
Speaker 1: to in order to combat that. You know, I think
Speaker 1: we have to work harder on the investment side. I
Speaker 1: think you need more people. You think you need more
Speaker 1: smarter people in order in order to do that as well.
Speaker 1: You can run multiple portfolios and you can do it
Speaker 1: more easily, but that doesn't mean you do it as well.
Speaker 1: So one of the things you mentioned was when you're
Speaker 1: putting together a forecast, the risk management side is how
Speaker 1: and where might this be off and how can we
Speaker 1: anticipate in adjust for that. So when you look at
Speaker 1: this changing dynamic in in earnings UH and corporate profits,
Speaker 1: how would you think you might be off? How might
Speaker 1: it be different this time? Usually the most expensive full
Speaker 1: words you can say, but there's no doubt the world
Speaker 1: is changing and technology and business is changing. What might
Speaker 1: that mean to future profit models? You know, the world
Speaker 1: has always changed, and so you know, if you think
Speaker 1: about a hundred years ago, how the economy has evolved
Speaker 1: over that over that time period, it's really been unbelievable.
Speaker 1: And I think we would say that the normal required
Speaker 1: return to stocks has fallen through time because there's less
Speaker 1: volatility and economy, they're less volatility inflation. You have things
Speaker 1: like the sec You can debate whether the FEDS actually
Speaker 1: helpful or hurtful, but there's more institutional controls in the economy,
Speaker 1: and so that we do think that the required return
Speaker 1: to stocks has come down because they are inherently less
Speaker 1: risky than they were. Honest friction as well to even
Speaker 1: execute something or or just go buy something is cheaper,
Speaker 1: fessed or easier exactly, So so it justifies a higher multiple.
Speaker 1: Now that the real question is are what how much?
Speaker 1: How much higher? And so if you think at multiple
Speaker 1: as a normal return for stocks, well then your long
Speaker 1: term expectations are pretty small. Your earnings yield is for
Speaker 1: there's some slippage in there between the earnings zeald and
Speaker 1: what you receive. I don't know that many investors really
Speaker 1: think stocks are there to determine. You know, there there
Speaker 1: generate three reel so so you know, for us what
Speaker 1: was always there's the risk parity. Folks out there, we've
Speaker 1: always had a greater confidence in the equity risk premium.
Speaker 1: We would rather have more of our portfolios associated with
Speaker 1: the equity risk premium because equities are inconvenient assets, so
Speaker 1: they go down at the time that you just you
Speaker 1: don't want them to as a recession as people lose
Speaker 1: jobs that as that hits, and so there should be
Speaker 1: a required way to return there. And so you can debate,
Speaker 1: you know, whether that is six or five or four.
Speaker 1: But when you look at the market today and you
Speaker 1: know whether you value it based on historical assumptions or
Speaker 1: if you kind of valuated in new normal assumptions, you know,
Speaker 1: the US market just is so expensive no matter which
Speaker 1: way we slice it that it's just hard to justify
Speaker 1: these multiples. So what part of the world from an
Speaker 1: equity perspective is not expensive? We look at Japan, we
Speaker 1: look at Europe, we look at e M. What do
Speaker 1: you think are the most attractive regions where the valuation
Speaker 1: is not as stretch as it is here. Yeah, e
Speaker 1: M is really the only game in town, and specifically
Speaker 1: e M value. So the value side of EM is
Speaker 1: the exact opposite of the ten cent and the baidu
Speaker 1: and the Ali baba. It is uh you know, it
Speaker 1: is Taiwani semiconductors, it's Russian energy stocks, it's Brazilian utilities,
Speaker 1: Turkish financials, it's a fairly Korean kiballs, it's a fairly
Speaker 1: motley motley group of stocks. But those value stocks are
Speaker 1: priced to deliver a significantly higher return round that versus
Speaker 1: the rest of of the market. And we think about this,
Speaker 1: and we call this the margin of superiority. That how
Speaker 1: how cheap is the cheapest asset class versus the next
Speaker 1: cheap at cheap stasset class. And and normally you have
Speaker 1: two or three things that are within spitting distance of
Speaker 1: each other. But today e M value is is so
Speaker 1: by so far the most dominant in terms of its
Speaker 1: forecast that we've actually altered our portfolio construction to take
Speaker 1: a bigger bet on it because there are so few
Speaker 1: other opportunities out there, really that that's quite fascinating. So
Speaker 1: I don't disagree that the US is pricy, but when
Speaker 1: we look around the rest, when I look around the
Speaker 1: rest of the world, Japan doesn't look that horrific, especially
Speaker 1: if you can hedge the currency. And Europe isn't the
Speaker 1: craziest it's been. It's it's had a nice move off
Speaker 1: the lows. How do you see what's in between the
Speaker 1: US and and e M. Yeah, if of value, so
Speaker 1: kind of taking what you just send, just broaden it
Speaker 1: to EFA value is the next is really the next
Speaker 1: cheapest asset class outside of e M. It is uh,
Speaker 1: certainly relative to the U s ifa is. I think
Speaker 1: it's in the top death stile of attractiveness off versus
Speaker 1: the Europe Australia far East on a value basis right
Speaker 1: sorry on on just just S and P versus M,
Speaker 1: S C I EFA UM. And then you get some
Speaker 1: premium for owning value on top of it. So so
Speaker 1: we still have of the portfolio and EFA value. Now
Speaker 1: it's not cheap and absolute terms, um, you know, we
Speaker 1: think it's it's worthy of having some space in an
Speaker 1: equity portfolio. Uh, it's hard to get you know, stand
Speaker 1: on the table, pound, you know, pound your fist, bullish
Speaker 1: on it. But we think that certainly relative to the US,
Speaker 1: you can get very bullish on it. Absolute terms, it's
Speaker 1: a little bit harder to get get excited about it.
Speaker 1: But we think it's still worth a portion of your
Speaker 1: portfolio in benchmark free so priority it's M at the top,
Speaker 1: IF in the middle and and SMP far below far below. UM.
Speaker 1: So when we come back to this extended valuation, what
Speaker 1: do we blame more credit that that price? Are we
Speaker 1: are we over emphasizing the role of the Fed, is
Speaker 1: it other factors? Well, it's always fun to bash the FED,
Speaker 1: at least at least in these in these halls. Um,
Speaker 1: you know, I give them full credit for their transparency,
Speaker 1: you know, BARRANKI went in the Washington Post and wrote
Speaker 1: wrote an op ed saying, Hey, we're trying to gin
Speaker 1: up the prices of these things. So but by the way,
Speaker 1: anybody who didn't read that and go out and buy
Speaker 1: equities really should not be managing. It's like when the
Speaker 1: FED chief says we want equity prices higher, you have
Speaker 1: to pay attention to that. I did. What was that
Speaker 1: like the morning after that came out in these halls?
Speaker 1: Were people aghast and astonished that a FED chief actually said, Hey,
Speaker 1: strap yourself in, We're taking this higher. It's it was extraordinary.
Speaker 1: And you know, I think we have an inherent skepticism
Speaker 1: for central bankers and their ability to influence the economy
Speaker 1: and markets. But I think, you know, we did not
Speaker 1: grasp that as quickly as some others did. You know,
Speaker 1: it took us a while for us to really internalize
Speaker 1: that and think about it within our framework. And that
Speaker 1: really was the genesis for kind of creating these hell forecasts.
Speaker 1: Which take into account the fact that financial repression can
Speaker 1: go on long enough that can really start to impact,
Speaker 1: you know, impact the cash flows and then the fair value,
Speaker 1: the fair value for equities. But it's you know it,
Speaker 1: the FED seems to continue to play a dangerous game.
Speaker 1: Who knows what Powell will do. Maybe he's more hawkish,
Speaker 1: maybe he's got more of a business background versus the
Speaker 1: academics that have preceded him. Um, but it seems like,
Speaker 1: you know, the meaner version of profit margins, stocks trading
Speaker 1: at higher multiples and normal kind of started. The green
Speaker 1: span continued with Bernanke yelling, you know, so if interest
Speaker 1: rates keep going higher, if if they normalize, if the
Speaker 1: FED successfully gets us too, I don't know, pick you
Speaker 1: poison three and three quarters, four and a half, whatever
Speaker 1: they consider normal, what should that do to valuation? I mean,
Speaker 1: stocks should be vulnerable under that scenario. We've certainly read
Speaker 1: and heard so much from the cell side over the past,
Speaker 1: you know, five seven, nine years. Lower rates require higher multiples,
Speaker 1: So it will be interesting to see how they walk
Speaker 1: that back. They're always pretty good at giving a pretty
Speaker 1: elegant explanation as to why it's different, But it certainly
Speaker 1: seems like that would be a pretty key underpinning as
Speaker 1: to why you should justify paying you know, multiples similar
Speaker 1: to these. Um, I think that, you know, as we
Speaker 1: were talking about before, the real concern is what happens
Speaker 1: with inflation, and that is the one thing that could
Speaker 1: really croak um, you know, all portfolios. And I think
Speaker 1: that's just that's the that's just the longer term wory.
Speaker 1: So I'm gonna I'm gonna focus on the concept of
Speaker 1: financial repression for a moment. Over this period of financial repression,
Speaker 1: one valuation has been median priced to sales, and this
Speaker 1: has been not just elevated, but record highs for five
Speaker 1: or six years. What do you make of that as
Speaker 1: a value investor? Yeah, price to sales is an interesting
Speaker 1: one because there's not a we can't think about theoretical
Speaker 1: reasons why price to sales should mean revert. We think, really, yeah,
Speaker 1: it has historically. It's actually been nicely mean reverting historically.
Speaker 1: But you don't you don't assume that's a requirement. No,
Speaker 1: it's it's it's it's it's your return on capital that
Speaker 1: should that should mean revert through time. So we're not
Speaker 1: quite sure what to make of it um. We used
Speaker 1: to run our models exclusively on price to sales because
Speaker 1: it was nicely comparable across regions. In across time, you
Speaker 1: don't have all the different gap accounting rules, and a
Speaker 1: lot of things change on some of the other metrics.
Speaker 1: And if we were to continue just following a price
Speaker 1: to sales methodology, I think our forecast or minus eight
Speaker 1: or minus nine real for the SMP five. So we've
Speaker 1: diversified that into other what we think a reasonable proxies,
Speaker 1: and that has um. You know, those are expensive, but
Speaker 1: just not nearly as expensive as as price to sales.
Speaker 1: So what do you end up as the forecast if
Speaker 1: you're using other valuation metrics as we kind of hot
Speaker 1: off the press, the forecast for US large assuming normal
Speaker 1: mean version is minus four point nine real a year
Speaker 1: for seven years. So I mean that that's definitely not
Speaker 1: built into anybody's asset allocation models. If we you know,
Speaker 1: we talked about that hellth scenario earlier, that that forecast
Speaker 1: is minus two real, so it's better, but it's still
Speaker 1: a far cry from five or six. So if you
Speaker 1: end up with a big taking inflation, you could end
Speaker 1: up with flat markets over seven years and essentially zero return.
Speaker 1: That that's that's a not a forecast, but a significant probability.
Speaker 1: I think if you had a significant take in inflation,
Speaker 1: it would really do a number on PE. So Jeremy
Speaker 1: and Ben have this is something they call this comfort model,
Speaker 1: which is an explanatory model for current p s and
Speaker 1: it looks at the volatility of inflation, the volatility of GDP,
Speaker 1: and the level of profit margins. And so if you
Speaker 1: do get higher inflation, I think that has an impact
Speaker 1: on profit margins, or at least Buffett thought in the
Speaker 1: seventies from inflation had a big impact on profit margins
Speaker 1: UM that that model would be perturbed and you would
Speaker 1: get a much lower a much lower multiple. And we
Speaker 1: saw in the seventies certainly that inflation really was scary
Speaker 1: for equity and bond investors. But I think inflation definitely
Speaker 1: your your multiple comes down. So let's talk a little
Speaker 1: bit about UM investing in general. This is a topic
Speaker 1: that everybody is interested in UM. One of the things
Speaker 1: that you this office that GMO has to be on
Speaker 1: guard against is that what some people have called the
Speaker 1: danger of success. Obviously, the farm has been tremendously successful
Speaker 1: UM over a multi decade period. How does this affect
Speaker 1: the psychology here? How does it affect your outlook? Does
Speaker 1: it make you more cautious because you're protecting gains or
Speaker 1: is can the farm still be a risk taker and
Speaker 1: an innovator despite all the success? Well, I feel like
Speaker 1: the market does a wonderful job of humbling you because
Speaker 1: you're very, very quickly. And you know, Jeremy has an
Speaker 1: expression that you always cry over spilt milk, and so
Speaker 1: I think part of our process is to ask questions
Speaker 1: as to you know, what we did, why we did
Speaker 1: what we did, what we didn't do, and why we
Speaker 1: did that and whether that's right. So I think that
Speaker 1: process of self introspection is very important. I think having
Speaker 1: James Montier around, who's you know, an expert in behavioral
Speaker 1: aspects is U is very helpful. Um and you know,
Speaker 1: the game is hard, and so you know, figuring out
Speaker 1: whether you're in a bubble or not. You know, we
Speaker 1: have technical quantitative definitions, but it's much more nuanced than that.
Speaker 1: So there was a lot of success calling both the
Speaker 1: dot com bubble and the housing bubble. Do you run
Speaker 1: a risk of, hey, we've we've really built a reputation
Speaker 1: as spotting these bubbles. Do you start to see bubbles everywhere?
Speaker 1: Is that a genuine concern? Um? I think I think
Speaker 1: that's an you know, there's a concern for any investor
Speaker 1: as to their process and what they're doing and whether
Speaker 1: things are different this time. And certainly if you believe,
Speaker 1: I mean we're version, things being different this time is
Speaker 1: really the critical the critical question. So we spend an
Speaker 1: inordinate amount of time in what we would refer to
Speaker 1: as risk management as you know, where these forecasts can
Speaker 1: be wrong and how are things different this time? And
Speaker 1: it's you know there it's nuanced. Unfortunately, there's not you know,
Speaker 1: we can't quantify you know, all of these things there.
Speaker 1: It tends to be more art than science, although we
Speaker 1: do want to reduce things to numbers. Um. But I
Speaker 1: also think having you know, people who have been around
Speaker 1: the block, like Jeremy and Ben is very helpful because
Speaker 1: you know, they've seen multiple cycles. So a lot of
Speaker 1: people like to make the claim they're contrarians. GMO has
Speaker 1: very much been a contrarian over the years. Uh, And
Speaker 1: that sometimes means being a little early. I don't want
Speaker 1: to use the word wrong, but it sometimes means, hey,
Speaker 1: this market is stretched. How does it affect interacting with clients?
Speaker 1: How does effect forecast You start to recognize we're always early,
Speaker 1: We're gonna be a little early now, and we just
Speaker 1: have to write it out until um time proves us
Speaker 1: right or not. We certainly don't frequently refer to ourselves
Speaker 1: as contraring. What we refer to ourselves are value value investors.
Speaker 1: And it feels like people are tripping them over themselves
Speaker 1: to call themselves contraring these days. So, you know, kind
Speaker 1: of natural responses. You need to be a trend follower
Speaker 1: in order to be in order to be contraring. It
Speaker 1: feels like, um, you know, I think you know, we
Speaker 1: try and design a process that we recognize that we
Speaker 1: tend to be early. We build some things into the
Speaker 1: process to try and help ameliorate that, but it is
Speaker 1: what we do. It is kind of the curse of
Speaker 1: a value investor. There's nothing worse than thinking something is
Speaker 1: cheap and not owning it and having it go up.
Speaker 1: And so so you know, we try and be as
Speaker 1: transparent as we can with clients as to what we're
Speaker 1: doing and why we're doing it, so that they can
Speaker 1: kind of get to the finish line so that they
Speaker 1: can get to the finish line with US. When seven
Speaker 1: year real returns are expected to be negative for US
Speaker 1: large gap stocks and negative for US equities across the board,
Speaker 1: how do you discuss that with clients? Are they comfortable
Speaker 1: with the expectation? Don't look to the US equity side
Speaker 1: of things for any real returns going forward. I think
Speaker 1: our mandre with clients has been owned as little U
Speaker 1: S equities as your committee or your career will allow.
Speaker 1: Uh that that that you know, they've just beaten the
Speaker 1: rest of the world by a hundred points, They've beaten
Speaker 1: you know, they've beaten em by a hundred and fifty points.
Speaker 1: And you can look historically and see these cycles where
Speaker 1: US performs and then IFA outperforms, And we've just been
Speaker 1: through the period where we've had the greatest outperformance of
Speaker 1: the U stocks relative to the rest world in history.
Speaker 1: That well, that we've seen since the seventies where you
Speaker 1: kind of have legitimate, legitimate data. And so we've got
Speaker 1: a lot of questions from clients in sixteen the beginning
Speaker 1: of sixteen saying, hey, this diversification sounds like, you know,
Speaker 1: sounds good in principle, but I generally before more more
Speaker 1: money to less like, what are we doing here? We're
Speaker 1: really not seeing the benefits of that. Now, there's less
Speaker 1: questions about that over the preceding two years, as IF
Speaker 1: and EM have done have done much better. But um,
Speaker 1: you know, as we think about you know, benchmark free
Speaker 1: for instance. You know, we we owned a quality stocks
Speaker 1: in the US outright and then actually recently this year,
Speaker 1: we converted that to a long short. So we go
Speaker 1: long quality and we short the market against it. The
Speaker 1: only longs that we have are you know, IF value
Speaker 1: and e M Value at this point in the cycle.
Speaker 1: So let's talk a little bit about hedge funds since
Speaker 1: you mentioned long short. After doing pretty well in the
Speaker 1: nineties and the early two thousand's, hedge fund performance has
Speaker 1: been fairly mediocre at least back to the financial crisis
Speaker 1: and certainly since the recovery. What do you make of that?
Speaker 1: Is that cyclical? Are we ever going to see mean
Speaker 1: reversion and head fund hedge fund performance or has the
Speaker 1: game changed? It was one thing when there was two
Speaker 1: hundred hedge funds and now there's twelve thousand. You'll never
Speaker 1: see those sort of numbers again across the whole industry. Yeah,
Speaker 1: I think the game has changed, you know. I remember
Speaker 1: looking at some data from morning Star that you know,
Speaker 1: there was about a thousand hedge funds in two thousand
Speaker 1: or something like that, and it rose to seven or
Speaker 1: eight thousand. I don't know how many there are are today.
Speaker 1: It's over eleventh, is it over eleven thousand? And about
Speaker 1: of them disappear each year reform without the high water mark,
Speaker 1: so they kind of rebooting. Apparently clients come along with them. Yeah,
Speaker 1: that's a dirty, dirty little secret of the hedge hedge
Speaker 1: fund industry. Well, you know, I think the game has
Speaker 1: changed for hedge funds. Although, you know, just like most things,
Speaker 1: like the pendulum swings too far the other way where
Speaker 1: people are kind of throwing the baby out with the bathwater.
Speaker 1: One of the things that we like about the profile
Speaker 1: of some hedge fund returns is that you are taking risk,
Speaker 1: but you're doing with a shorter duration. So merger Arb
Speaker 1: is kind of the poster child for this. So you're
Speaker 1: trying to capture an equity risk premium. You're doing it,
Speaker 1: you know, our merger Ore portfolio, there's twenty to thirty deals.
Speaker 1: The average average duration of the deal is ninety days.
Speaker 1: If you do get that duration increase that we talked
Speaker 1: about earlier. You know, merger R may get hit, but
Speaker 1: it's going to hit a lot less than than something else.
Speaker 1: So we think that diversifying hedge funds, particularly at this
Speaker 1: point of the cycle, are are reasonable activities to be
Speaker 1: thinking about for your portfolio. There's another question as to
Speaker 1: how much you should pay for them. I think the
Speaker 1: two and twenty model is under significant pressure, and certainly
Speaker 1: the fund of fund industry seems to have have gone,
Speaker 1: you know, the way of the dinosaur. Yeah. Yeah, that
Speaker 1: that that becomes harder to justify. And I want to
Speaker 1: say that one and a half and fifteen seems to
Speaker 1: be the new two and twenty, But that's just no
Speaker 1: anecdotal um along the along the same lines as hedge funds. Uh,
Speaker 1: perhaps being a little cyclical. What do you make of
Speaker 1: the value under performance the past few years and doesn't
Speaker 1: remind you of any other periods? Yeah, values under performance
Speaker 1: has been brutal, particularly for US who tend to tilt
Speaker 1: more towards value type strategies. Uh. It's magnitude is not
Speaker 1: as bad as it was in the dot com bubble,
Speaker 1: but the duration has been has been longer. So so
Speaker 1: we think that there's opportunities for certainly for value outside
Speaker 1: the US that we think is much cheaper than growth.
Speaker 1: We do think value is cheaper than growth in the US. However,
Speaker 1: we still think quality is more attractive, more attractive in
Speaker 1: the US. UM, it's been a long cycle, you know,
Speaker 1: whether the rise of interest rates and inflation of value
Speaker 1: stocks they have kind of intrinsically a short duration, whether
Speaker 1: they do better in that type of environment, We're not sure,
Speaker 1: you know. I think that's that's tough to tell. I
Speaker 1: think that story makes sense, but we'd rather focus on
Speaker 1: the valuation, which which looks attractive, particularly in e M.
Speaker 1: And then finally, the question that you guys are perfect
Speaker 1: to ask. UM. Everybody has been looking at the rise
Speaker 1: of indexing, being black Rock or Vanguard, what have you,
Speaker 1: And a number of people have ascribed indexing UM as
Speaker 1: a distorting factor and it's making price discovery more challenging
Speaker 1: and perhaps even contributing to this extended valuation issue. What
Speaker 1: what are your views on indexing and do you put
Speaker 1: any continents in any of this indexing or making things pricier.
Speaker 1: I think as as the world comes more and more
Speaker 1: into the you know, does more and more indexing, Uh,
Speaker 1: the ability to find cheap stocks out there increases. So
Speaker 1: I think for active management, the more the world indexes,
Speaker 1: the better it becomes. There's nothing better than a cheap
Speaker 1: stock that stays cheap, because that you get the gift
Speaker 1: that keeps on giving, You keep getting that earning zeal,
Speaker 1: you keep generating the dividend yield um. You know, Bernstein
Speaker 1: has some great research on the you know, the asset
Speaker 1: management industry. But but they I read a report they had,
Speaker 1: at least according to the SMP, there's over a million
Speaker 1: indexes now, which just seems like that's not that's that's
Speaker 1: not possible. Um, you know, I know Bloomberg ran a
Speaker 1: story last summer saying that they're more indexes than there
Speaker 1: are stocks. Well, in a couple of years ago, there
Speaker 1: were more mutual funds and stocks. Now there are more
Speaker 1: indexes than stocks. I recall I recall seeing that that
Speaker 1: same thing. So what does it mean? Does it? Does it?
Speaker 1: Is it contributing to the evaluation conundrum? I mean, certainly
Speaker 1: that more people are investing indexes. That generates momentum, and
Speaker 1: I think that generates price inefficiencies. So, you know, for
Speaker 1: you know, for us who are largely quantitative in our
Speaker 1: equity investing, I think it presents some opportunity. Now we
Speaker 1: do need to work harder than we did ten years ago.
Speaker 1: You know, quant tools, smart beta, you know those things
Speaker 1: have been largely commoditized. So so I think you know
Speaker 1: our f it's in quantitative. We've done a lot of
Speaker 1: work over the past several years with our models trying
Speaker 1: to uncover intrinsic value. We know we're less about AI
Speaker 1: and and and more about trying to discover the intrinsic values.
Speaker 1: So I think we have to work harder in that
Speaker 1: realm than we did historically. But I think that there's
Speaker 1: there's certainly more scope for ALPHAH than there was a
Speaker 1: couple of years ago. Thank you, Matt. This has been
Speaker 1: absolutely fascinating. We have been speaking with Matt Kadner. He
Speaker 1: is a member of GMO's asset Allocation team and a
Speaker 1: value investor par Excellence. If you enjoy this conversation, be
Speaker 1: sure and stick around for the podcast extras. Will we
Speaker 1: keep the tape rolling and continue discussing all things asset allocation, valuation, hedge,
Speaker 1: fund etcetera. Be sure and check out my daily column.
Speaker 1: You can find that on Bloomberg View dot com. You
Speaker 1: could follow me on Twitter at rid Halts. We love
Speaker 1: your comments, feedback and suggestions right to us at m
Speaker 1: IB podcast at Bloomberg dot net. I'm Barry Reholts. You're
Speaker 1: listening to Masters in Business on Bloomberg Radio. Welcome to
Speaker 1: the podcast. Thank you Matt so much for doing this.
Speaker 1: Tell us the most important thing that we don't know
Speaker 1: about you. Um, I mean, frankly, I don't know that
Speaker 1: there's I don't know if I have anything. I don't know,
Speaker 1: well what don't Okay, so let me rephrase it. Tell
Speaker 1: us the most important thing that friends and family who
Speaker 1: know you might not be aware of. Um. I'm probably
Speaker 1: more competitive than people realize. You know that there's a
Speaker 1: veneer of of trying to be calm and cool, but
Speaker 1: inside I, um, you know, I run pretty pretty hot.
Speaker 1: You want to win. That's what it's all about. I
Speaker 1: can't say I disagree. Um. Tell us about your your
Speaker 1: early mentors who helped guide your career. Yeah, you know,
Speaker 1: I you know, like you. I kind of put the
Speaker 1: legal stuff to this aside because it was such a
Speaker 1: painful episode in my life. But you know, when I
Speaker 1: think about Putnam. You know, I had such valuable business mentors,
Speaker 1: So you know, Kevin Sullivan and Alex Nelson originally Rob
Speaker 1: job you know, in consultant relations, they were you know,
Speaker 1: such they were so formative, John Brown, who ran the
Speaker 1: institutional group, it was such a good group of people
Speaker 1: that there was a ton of things that we learned
Speaker 1: from that I learned from them. And then you know,
Speaker 1: more recently, you know, it's really been Jeremy and Ben.
Speaker 1: You know, I found that the way we approached acid
Speaker 1: allocation in the world was so different than what I
Speaker 1: had learned in the c f A or kind of
Speaker 1: normal institutional investing. That that that that has just such
Speaker 1: such a profound influence on the way I think about returns.
Speaker 1: And you know, if I would have known about the
Speaker 1: seven year forecast in or mean version, I mean, I
Speaker 1: think it could have would have been very interesting to
Speaker 1: say the least. Um who else influenced your approach to
Speaker 1: invest in UM? I mean that there are other kind
Speaker 1: of the the traditional value value folks out there. I
Speaker 1: think Ed Chancellor is also influenced. So Ed was a
Speaker 1: former colleague, although he still is engaged with the firm.
Speaker 1: He's a financial historian, and he has a deep understanding
Speaker 1: of bubbles, and I think his historical approach is so
Speaker 1: helpful because there's so much rhetoric as to why it's
Speaker 1: different this time or elegant explanations as to why it's different,
Speaker 1: and his you know, understanding of history cuts across a
Speaker 1: lot of that in ways that Yeah, I just find
Speaker 1: so much more credible than you know, a sell side
Speaker 1: generic self side report makes a lot of sense. Um.
Speaker 1: Everybody's favorite question, what are some of your favorite books,
Speaker 1: be they finance, nonfinance, fiction nonfiction, what do you enjoy
Speaker 1: reading and what books would you recommend other people should read. Yeah,
Speaker 1: on the finance side, you know, Anti Illman illmanin wrote
Speaker 1: a fantastic book called Expected Returns, where it's going to
Speaker 1: basically a finance textbook, and he goes through all of
Speaker 1: the asset classes and the risk premiums and he does
Speaker 1: a wonderful job of laying those out. And I think
Speaker 1: that's a very good book. I did read, you know,
Speaker 1: years ago, at David Rosenberg's recommendation, a Diary of the
Speaker 1: Great Depression. It's about this lawyer Benjamin Roth in Youngstown, Ohio,
Speaker 1: and it was his diary, you know, contemporaneous diary of
Speaker 1: what the depression was like. And it was fascinating in
Speaker 1: that what he had to do to survive, you know,
Speaker 1: in terms of a businessman, you know, bartering. I was
Speaker 1: amazed how he was worried about inflation over that time period.
Speaker 1: And it also struck me how much he looked at stocks,
Speaker 1: these blue chip stocks, and and how cheap he said
Speaker 1: they were, but he said he had no money to
Speaker 1: invest in them, and and how much money he could
Speaker 1: have made if he did put some capital to work.
Speaker 1: And I'm struck by today where you know, the concern
Speaker 1: for illiquidity is so removed, the private equity, direct lending.
Speaker 1: You know, everybody's trying to lock up their money for
Speaker 1: ten years. You know, nine years ago we saw how
Speaker 1: important liquidity was, and today that seems to be a
Speaker 1: very much a backseat consideration. And I think about Benjamin
Speaker 1: Roth in that book. Huh, that's that's quite fascinating. What
Speaker 1: what excites you right now? It's a complicated environment. What
Speaker 1: do you find very interesting or exciting today? Um, I
Speaker 1: think building a portfolio today is really hard. That you know,
Speaker 1: in O eight, at least on our numbers, it was
Speaker 1: pretty clear what to do. You should take as little
Speaker 1: risk as your career should allow. I think today it's
Speaker 1: much more difficult, it's much more complicated. And the the
Speaker 1: other aspect of it is the our business is evolving
Speaker 1: so rapidly. Where twenty or thirty years ago, you know,
Speaker 1: Jeremy and Dick Mayo and Ivanadolue they can focus on
Speaker 1: they could focus on defined benefit pensions and that's all
Speaker 1: they needed to worry about. I mean, obviously today you
Speaker 1: know you can't do that. You know, define contribution. We
Speaker 1: know that their issues there the r A space, high
Speaker 1: net worth family office. How taxes impact that. I think
Speaker 1: that trying to solve the problems for clients is much
Speaker 1: more layered and intricate than it was even ten years ago.
Speaker 1: Quite quite interesting. Um, what are you looking forward to
Speaker 1: as upcoming changes in the asset management business? What do
Speaker 1: you think is going to either shift or surprise us
Speaker 1: going forward? So being part of a team that's done
Speaker 1: asset allocation for coming on thirty years, one of the
Speaker 1: things that I'm oppressed by the number of people who
Speaker 1: believe that they can do asset allocation today, and I
Speaker 1: wonder how many of those people were around in oh
Speaker 1: seven and oh eight, how many people were around in nine,
Speaker 1: in two thousand towards you get to the when you
Speaker 1: get towards the end of the cycle, everybody seems to
Speaker 1: be able to do this asset allocation thing quite easily.
Speaker 1: And so you know, I am looking forward to the
Speaker 1: turn of the cycle and that kind of the shaking
Speaker 1: of the industry where where people, you know, people with
Speaker 1: skill will be differentiated from people who who really don't
Speaker 1: have skill. I'm trying, I'm trying to remember the book.
Speaker 1: It might have been Adam Smith's Money Game, where he's
Speaker 1: talking to a manager who's in his forties and he
Speaker 1: hires these young twentysomethings to run the portfolios because he said,
Speaker 1: I couldn't touch any of this stuff. It's all terrible junk.
Speaker 1: But they're making money of it and from it, which
Speaker 1: is great for the farm. And as soon as the
Speaker 1: cycle turns, we'll we'll get rid. I don't remember if
Speaker 1: it was if it was Money, Money Game or um.
Speaker 1: It might have been Market Wizards, but it stood out as, yeah,
Speaker 1: I can't touch any of that, but they don't. They've
Speaker 1: never lived through the cycle, so they don't know. It
Speaker 1: will be very interesting to see what happens when things
Speaker 1: go through the next substantial downtown and because they're always
Speaker 1: very different, and so so you know, the cause from
Speaker 1: this one is going to be different. How we come
Speaker 1: through it's gonna be different. What's going to be cheap
Speaker 1: is going to be different. UM. And I think it's
Speaker 1: just you know, as you talk to clients, you talk
Speaker 1: to folks out there, you know, I think there's more
Speaker 1: a sense of like, oh, we do the asset allocation.
Speaker 1: You know, we'll listen to what you guys have to say.
Speaker 1: But but but we've got this, thank you, right. It's
Speaker 1: always amazing whenever I see UM, anybody writing something along
Speaker 1: the lines of everybody who's working on a trading desk today, UM,
Speaker 1: who started since filling the blank has not seen a
Speaker 1: rising rate. Environment is not seen, Inflation is not seen.
Speaker 1: So if any of these things come back, everybody half
Speaker 1: of or more of the death step there would be
Speaker 1: experiencing things for the first time that that will be
Speaker 1: very interesting and there's always new lessons to be learned.
Speaker 1: And I'm sure some of the people will now navigate
Speaker 1: it it, you know, just fine. But UM does feel
Speaker 1: like it is late cycle in terms of the number
Speaker 1: of people who claim that they can do it. Well,
Speaker 1: tell us about a time you failed and what you
Speaker 1: learned from the experience. Yeah, you know, when I when
Speaker 1: I was a lawyer, I was I was desperately trying
Speaker 1: to get out and I first in private practice and
Speaker 1: then you know, at LPL, and I can't tell you
Speaker 1: how many times I got to like the final round
Speaker 1: or the final person and I just didn't get the job.
Speaker 1: And it was so frustrating and disheartening because I knew
Speaker 1: I wasn't doing what I enjoyed or what I wanted
Speaker 1: to do with with my life, and so, uh, you know,
Speaker 1: it was just that perseverance of like, listen, you know,
Speaker 1: there's a there's got to be a better way to
Speaker 1: do this, and so kind of keeping to push and
Speaker 1: and to kind of deal with that failure, but but
Speaker 1: keep you know, adapting and evolving to get to a
Speaker 1: point where, you know, I was excited about coming to
Speaker 1: work every day. And I think that process was a
Speaker 1: long and difficult one, and much more difficult than I
Speaker 1: would have hoped. But I think it also gave me
Speaker 1: a greater pre creation for how incredible it is to
Speaker 1: be excited on a Monday morning to come into work.
Speaker 1: That's that's quite a uh happy answer. That that's a
Speaker 1: fulfilling answer. Um, tell us what you do for fun
Speaker 1: outside of the office, What what gets you side? Yeah,
Speaker 1: I mean obviously the family. You know, we have three kids,
Speaker 1: thirteen year old boy, girl, twins and then um a
Speaker 1: nine year old daughter. Wonderful wife, wonderful family. That's a
Speaker 1: lot of fun. So we're going skiing in Vermont this weekend.
Speaker 1: Got lots of snow here in Boston up in the mountains,
Speaker 1: so skiing in the winter and then golf golf in
Speaker 1: the summer. What sort of advice would you give to
Speaker 1: a millennial or a recent college graduate who was interested
Speaker 1: in a career in either finance or asset allocation. I
Speaker 1: it's it's it's reading. You know, it's reading and buffets
Speaker 1: compounding knowledge through time, and you just need to be
Speaker 1: a voracious reader. I would also say that certainly, you know,
Speaker 1: when I was in college, my understanding of, you know,
Speaker 1: being a portfolio managers is quite glamorous. I mean, it
Speaker 1: is a humbling, soul crushing it is a in many
Speaker 1: many times when you're not doing well, it is a
Speaker 1: miserable existence and so you really need to love it
Speaker 1: in order to kind of persevere and stay in the game.
Speaker 1: And if you don't really love it, I would encourage
Speaker 1: you to find something that you really did, because I
Speaker 1: think it's impossible to be successful, certainly in this industry
Speaker 1: unless you you really love it and you can give
Speaker 1: it a hundred and ten. It can be that painful
Speaker 1: over over certain periods of the cycle. You just you
Speaker 1: just it's hard to get out of bed. That that
Speaker 1: that those are the times where it's actually hard to
Speaker 1: get out of bed. Thank you, Matt. This has been
Speaker 1: absolutely fascinating. We have been speaking with Matt Kadner of GMO.
Speaker 1: If you enjoy this conversation, be showing look up an
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Speaker 1: to us at m IB podcast at Bloomberg dot net.
Speaker 1: I would be remiss if I did not thank the
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