There are only two asset classes really worth investing in for the “seven lean years” ahead, according to Jeremy Grantham (pictured), co-founder and strategist at famously bearish funds manager GMO.
Grantham argued that equities, importantly, only US high-quality and emerging market stocks made the cut, and timberland provided the best opportunities for outperformance in the turgid, low-growth years ahead.
Speaking in Sydney this week, Grantham pointed to GMO’s seven-year asset class return forecast, dated April 30, to show that the manager’s exposure to US high-quality stocks were expected to generate a 7.6 per cent return, emerging markets 8.4 per cent and timberland 7.5 per cent.
The forecasts include GMO’s expectation of its own outperformance against indices. For US high quality, this was calculated to be 1.8 per cent above the asset class index return, and 3.7 per cent for emerging market equities. For timberland, which includes an Australian plantation, GMO expects to outperform the broader market by 1.5 per cent.
Grantham said US high-quality stocks were currently “as cheap as they’ve ever been” and that emerging market equities should absorb much of an investor’s risk budget. In addition to favourable return expectations, an exposure to timberland should also be sought to provide diversification, or “to be different”.
The GMO forecast pertains to the “seven lean years” Grantham said global markets were now confronting, defined by the intractable problems “we all know about”, such as developed world deleveraging, trade imbalances and moral hazard (information asymmetry where one party in a transaction has more information than another).
This environment would follow the big “recovery” rally of 2009, which Grantham viewed as “the most speculative rally in decades,” or more accurately, since the Depression-era bear market rally of 1932.
GMO focuses on identifying and avoiding asset bubbles, and using mean-reversion as a core investment thesis, which can be detrimental to its business. In 2007, as the US housing market bubble continued to balloon, its funds under management fell 40 per cent as investors became dissatisfied with its decision not to buy risk. Since then, however, GMO has attracted more flows “from different investors” and now manages $105 billion.
Grantham said the career and business risks felt by executives at large funds management businesses and public companies in particular prevented them from selling out of assets during bubbles.
“When there’s something really aberrant, it really matters how you treat it. We find a clear reluctance to do that in the institutional business. People can see these things coming, but they don’t do anything about it because it’s risky. There’s a lot of career risk and business risk.
Chuck Prince, the Citi chief executive who oversaw the bank’s calamitous binge on toxic mortgage securities, expressed this risk as the pressure to “keep dancing” while risk appetite was still strong.
“Professionals look around and see what others are doing and this generates momentum,” Grantham said.
He identified two current asset bubbles “the UK housing market, and Australian property market, in which the median house price was far above the historical trend of 3.5-times average household income” and one forming in the Chinese property market.