Ben Inker on Value and Asset Allocation (Podcast)

and nuanced conversation about all things value related. I was especially intrigued about his take on why we are measuring intangibles from companies and whether that's intellectual property or various other assets they hold that make them less capital intensive and therefore potentially more valuable. Was intriguing. They they've done some fascinating research that really is very interesting. He explains how and why value has underperformed what he thinks is

going to happen going forward. We go over a handful of different sectors of the economy of the world and and talk about specific stocks. If you are at all interested in either value or asset allocation or anything along those those um lines, you'll find this to be an absolutely fascinating conversation. So, with no further ado, my sit down with GMOs. Ben Inker VI is Masters in Business with Barry Ridholtz on Boomberg Radio. My special guest this

week is Ben Inker. He is GMO's head of asset allocation. During the dot com implosion, the GMO aggressive long short strategy, which was long undervalued stocks and short overvalued stocks, achieved an eighty percent cumulative net return for clients. The firm is led by Jeremy Grantham, currently manages about sixty billion dollars. Then Incher, Welcome to Bloomberg. Well, thanks very much for having me. Very so, your current role is head of

GMO's asset allocation team. How did you arrive at that position? Tell us a little bit about your career path. Well, I have been at GMO for the entirety of my professional career. I joined GMO in I was hired as a research analysts working for Jeremy Grantham. Um And since Jeremy was the person who was kind of most focused on top down acid allocation stuff at GMO, well, I did a lot of different kinds of research over the first you know, eight or ten years of my career.

I was the person who had done the most work on AFID allocation as our business in Athidelic Asian grew. I was, you know, his assistant portfolio manager, and then the portfolio manager, and then over time the head of the team. That's the short form. Interesting, So you started early nineties, which was quite an interesting decade to cut your teeth on. How did your early experiences during that

era shape your views of the market? Yeah, so, I mean I came at a time when kind of the forces of let's say, mean reversion had shown themselves to be powerful. We've seen in the eighties, you know, when both bonds and stocks got to ludicrously cheap levels that they recovered. We had just experienced a pretty extraordinary bubble and the bursting of it in Japan uh in the

late eighties and into the early nineties. So one of the things I got early on was this um kind of strong understanding and belief that markets can do crazy things, but over time they do eventually come back, whether that's because they have gotten absurdly cheap or absurdly expensive. You know. I then got to participate in the next great bubble, which was quite painful for us as investors. But then you got to experience just how crazy, uh, the world

could get. So it was a a fascinating kind of crucible to h to grow up in as an investor. So you say that was painful, But in the ends, ultimately the firm and Grantham's calls ended up being right. It was a big money maker to the downside. Does that offset the pain? What do we take away from when markets go crazy? But ultimately you know, as always that sort of excess ends and tears. Yeah, I think you know it is. It is truly the case, um

that Uh. You know, the the market in the short term may be a voting machine, but in the long term is a weighing machine. Um. And at the end of the day, at least four assets that where valuation is relevant. Uh. And it is astonishing that we live in a world where there are more assets where valuation is is not a relevant thing anymore. But for the vast majority of financial assets out there where valuation is relevant, um,

valuation will eventually out. Um. You know, at the end of the day, everything is worth the present value of the future cash flows. Um. And what we have seen time and time again is the market will forget that. Uh. And as the market forgets that, it will do some sort of objectively silly things. Uh. But in the end, UM, those cash flows or the lack of them, is a profound discipline to the market, which will pull things back. UM. Now, the time frame that they're going to pull them back

over is uncertain UM. And one of the things you know we we lived in in the late nineties events is that while in the end the collapse of that bubble was positive for us, it was positive for our clients because we did manage to make the money for

it and helped GMO grow as a business. The reality is there were a number of other money managers that saw what we saw and did some of the things we did, and for whatever reason couldn't hold off either the firm, the firms themselves folded, or the people who were doing the what I call right thing um were eventually told by their bosses, we can't stand this pain anymore. Either you change what you are doing, or we are going to change the person in charge of uh of

your area. UM. So yeah, if you have a long enough time horizon, you can rely on the market eventually becoming sane again. But I don't think anybody should pull themselves into thinking taking those bets is easy or is guaranteed to work out well for the people who do them. So that raises the question here we are It's markets have had a fantastic recovery from choose your time frame, the lows in OH nine, the breakout in the crash, and recovery in Where are we in the market cycle?

There's obviously a lot of valuation questions, a ton of fraud, but also a ton of of fiscal stimulus and very very high monetary stimulus. Where are we in the cycle? It's it is a more difficult question than I'd love for it to be. I think the evidence of the fraud is everywhere around us. Um. We are seeing stuff. Every bit is crazy and in some ways even more inexplicable than some of the stuff we saw in the

Internet bubble. Um. But if one thinks back to the Internet bubble, right, we had all time high valuations for the S and P five coexisting with real interest rates of four right the inflation index bonds in the US the tips yielded over four UM. So the alternative to investing inequities that had never traded at such high valuations UM was low risk assets that offered really good perspective

returns today, that is absolutely not the case. We know low risk assets, whether it has been engineered by central banks or whether it is a more natural um outgrowth of the economy, low risk assets are offering extraordinarily low returns UM. And what I wish I knew the answer to was whether those incredibly low rates are sustainable h or not. UM. If they're sustainable, then the difference between now and two thousand is that the general level of

risky assets from a valuation perspective probably makes sense. UM. The extraordinary gap between kind of the secular growth names versus value names still doesn't make sense. Even if you believe that you know the S and P S valuation or h M s c I world valuation is sustainable, that gap doesn't make sense UM. But it may be that the overall market on average makes sense if if inflation is truly permanently gone as a meaningful risk in

the developed world. UM. I don't know the answer to that, but I will say one of the things I have been surprised by, on average over the last twenty years is that even in those times where you would have expected inflation to be UM accelerating, it's been pretty tame um. So I don't know whether the market has to fall from here. I do think even if the market level makes sense, we've got a speculative bubble going on, and

that speculative bubble will have to break. But whether the breaking of that speculative bubble is associated with, you know, the market falling by as it did in two thousands, or whether it's going to be driven by a strong outperformance by value stocks which are simply not priced to deliver the low return and that are sustainable, if low risk assets are going to permanently lose your money after inflation.

I just don't have the perfect answer. So you write very thoughtful quarterly or so letters that that I enjoy, And I don't recall if this was December's quarter or October quarter, but a couple of quarters ago you had explained as some of the tech stocks keep rallying, as some of the valuations continue to stretch, no one could really guess where this ends. But the most likely ends will be when the FED starts to tighten and raise rates. First of I am I oversimplifying that or is that

more or less right? And do you still hold that sort of belief? You know it is not. It won't surprise you at all to hear that. The most common question I am getting from the clients these days is what's the catalyst? What's going to be the trigger for the turn here? Um? So one thing we have absolutely done is gone back and looked at the profound turning points and markets and tried to see, Okay, well, what was the catalyst in two thousand? What was the catalysts

in Japan? What was the catalyst in the US? Sometimes there is a catalyst, but a surprising amount of the time, even in retrospect, there doesn't seem to be one. Right. The catalyst for the cracking of the Internet bubble in two thousand, I don't know. I mean, I was certainly there, I was staring at the market, um, But even twenty years later, I can't tell you exactly what it was. Let me flow the theory at you on that, because I was also there and watching the I l X

and the Bloomberg terminal all the time. And I have a very vivid recollection of the first or second week of March two thousand and remember we had that giant y two K concern and there was a ton of of hardware purchased in anticipation of that, and you very quickly. I don't remember if it was Dell that had a terrible quarter pre announced or Intel. It might it might have been Dell, like the first week of March. I think there was their window to announce that their previous

guidance was gonna be wrong. So it could have been like March eighth, two thousand. It's funny how all these things have been happening around March oh eight and and uh uh was the oh nine was the bottom and oh eight was to March two thousand was the top, and then again the bottom in But is that the sort of thing that is a credible precipitent or is it really just the reveal and the collapse would happen otherwise,

you know, I don't know. Certainly. The basic thing the market was getting wrong in two thousand, um was this belief in incredibly strong continued growth in corporate profits. Um. If you look at what people were saying. Sure, there was the Dow six thousand argument that was basically saying

there should be no equity risk treamum. But if you look at what analysts were saying and how analysts were assuming decent returns going forward was you know, expected earnings growth had never really been higher, so they were expecting something like annualized earnings growth. Now they always overpredict earnings growth, but that was some of the highest levels ever. Um. You know, the the reality of what was going on.

The funny thing is, in March we had this extraordinary day and I'm sure you remember it as vividly as I do, where the market in the morning collapsed like twelve or four uh, and then in the afternoon made this extraordinary recovery to wind up down I don't know one or two um. And it was this kind of intra day volatility that hadn't been seen well more or less ever, um. And that was maybe kind of a

shot across the bow. If if you look at what happened um across two thousand, you know, the first group to really crack was the pure internet startups uh. And then a little bit later in my memory this was really late spring, early summer, was the hardware names uh, you know, including Dell. UH. Software guys held out farther until the fall um UM. But then they cracked UM.

And maybe it was as simple as disappointing earning UM, but it wasn't obvious at the time that it was disappointing earnings numbers, And I certainly don't remember a change in the you know, the general tenor of market commentary UM as being around this sudden realization that that earnings weren't going to be there. Quite interesting. So let's talk a little bit about the forecasts that you guys make

on a regular basis, the seven year forecasts. What are the primary inputs into that seven year forecast that let you conclude US stocks are likely to deliver negative real returns over the next seven years. The basic underlying idea behind the forecast UH that goes back to when we started publishing them in the mid nineties, is that the market, it spends very little time looking normal UM, but UM

over time goes through normal reasonably often. So in principle, what we're really saying is, look, we don't know exactly what the future is going to hold, but let's assume that it's some uncertain point in the future we'll call

it seven years from now. Everything looks normal, So the p of the market looks normal, profitability looks normal UM, and the return we're going to get between now and then is going to be driven by whatever earnings growth will occur, whatever income we're going to get from that asset, and then either a gain or a loss associated with

these reverting to normal and profitability reverting to normal. Now, one thing that has changed about the forecast um is we do now have two different scenarios that we are

explicitly using. One of them is kind of the traditional one that we started choosing in, which is that fair value is the long term normal, so the stock market should be trading around sixteen times normalized earnings, bond yields will be somewhere between two percent and three percent above inflation, uh, kind of the old aisle assumption of where equilibrium is. More recent years, we've built in another scenario, which we

also consider to be a reasonable one. It's predicated on the idea that interest rates have permanently from those levels. We used to call that scenario hell um. We now call it partial mean reversion. We stopped calling it hell maybe because we were offending some people, but mostly because we were confusing them because our forecasts in hell are generally better than our forecasts otherwise, because the allowable valuation in a world where interest rates have permanently fallen is higher.

So for any given level of the market, if equilibrium valuation is higher, the return will be higher UM. Now Today, particularly for the US, even in that low interest rate environment, today's valuations were stocked in the US really look too high. In the rest of the world, that's less true. Uh. And if interest rates are truly permanently low, you know, the emerging market in general are probably trading at a

very reasonable valuations. But in the US, even if we make that adjustment, we come to the conclusion that the that the market is overvalued um. And that's I would say the last couple of years we have generally said that is more true for large gaps than small caps UM. But among the extraordinary things that happened, despite an environment that was unquestionably worse for smaller cap companies, the Russell

two thousands outperformed. And so at this point we think even even the small caps in the US are are likely to be a significant haven. And then our performance really came in the last few months of the year, didn't it. Yeah, And in the trigger in terms of the catalyst of performance, the obvious catalyst on that performance was the vaccine news and that vaccine news was unquestionably wonderful news for humanity and wonderful news on a perspective

basis for the global economy. Um. But wow, it was an awfully big move in these stocks, particularly given that they weren't all that cheap to begin with. So it was a move that directionally made sense, but from our perspective, the scale of the move was just inexplicably large. So you mentioned emerging markets which have been cheap for quite a while. What are your what's on developed x US? Is the rest of the developed world as pricey as US equities? Uh? No, The valuations are lower in the

rest of the world. Now, some of that is driven by the fact that UM I T is a smaller piece of the rest of the world. UM industrial set and information technology firms do probably deserve to trade at higher valuations than kind of more traditional love But even when you adjust for that, UM, we do see a big gap between what a company would trade at in the US and what that company would trade at if

it were somewhere else in the world. UM. So we see the non US developed markets looking cheaper than the US. UM we don't see them looking by any means dirt cheap. The place that I think is most intriguing today in the developed world UH is actually Japan UM, where the

valuations are reasonably low UM. And it is a place where it is easy to imagine that profitability can improve in a sustainable way UM because if you look at you know, the return on capital in Japan, it's been lower than that of the rest of the world for the last forty years. And in principle, there is nothing that stopped these companies from doing some of the same things that companies in the rest of the world have done UM and being able to really improve that UH.

And so you know, the simple math is if you have two stock markets trading at the same pe and one of them has significant scope for earnings growth real to the other, well that that one is cheaper UM. So within the rest of the developed world, UM, we are intrigued by Japan today because of the potential for kind of significant earnings and profitability growth over the next five or ten years UM. But for really cheap markets um. UH we think you can find more in the emerging

world than in the developed world today. Let me stay with Japan for a few moments. Historically, not big stock by backs, at least not compared to the US, And there's always a little bit of currency risk of dollar versus yen. How do you incorporate the currency risk into your thesis? I mean, there's always currency risk whenever you're

buying an asset that's denominated in another currency. We find is in the longer run, UH, that risk tends to dissipate because let's imagine you buy Japanese stocks and the yen really fall, so you're taking this this loss in the nearer term. The good news once that has happened is Japanese companies are now going to be really competitive relative to their global peers because of what's happened to the end um. So what we what we tend to find is as your time horizon lengthens, uh, the extra

risk associated with the currency tends to fall away. Because countries that experience a fall in their currency normally experience better than average earning scrowth, and companies that experience a rise in their currency experience subpar earning scrow. So it kind of comes out in the wash. And that's more strongly true in the developed world than it is in the emerging world, because the emerging world sometimes you know, a following currency can turn into a currency crisis, which

is more problematic for for the companies. But in the developed world, I don't get that worried about UM the currencies. Most of the time. I do get nervous if I'm buying into a country where the currency is at a given point in time substantially overvalued. UM. That doesn't seem

to be true of Japan today. UM. You know the risk in Japan, I would say the primary risk is if they don't get that religion, if they don't start paying more money out to shareholders, if they don't do some rationalization of their capital structures, they're not going to

improve UM and the returns will be black. UM. But we are seeing the evidence that both at the at the macro level, the government is trying to push these companies to change, and we're seeing on the ground that more and more company management is receptive to hearing about this and receptive to making moves in the right direction. Interesting. You mentioned emerging markets, and we tend to speak of them like they're monolithic block, but they're really very very

specific countries with different risks and different potential upside. What do you see in the emerging market space that is especially interesting or something that you're less interested in. Yeah, you're You're absolutely right. Emerging markets is not this monolithic saying. From my perspective, that's really part of its charm. Um. These countries all have very significant risks associated with them, but in a lot of cases those risks are very idiosyncratic.

You know, Turkey has problems, Russia has problems, China has problems. They do not have the same problems by any stretch of the imagination. Uh. And so the kind of thing that could prove to be a real challenge for Turkey might actually be something that works out pretty well for Russia or Korea or Brazil. So what we find is when people think about the risks in emerging they tend to focus on, oh my god, what if this really

bad thing happens in this country. And the good news is you can invest across you know, thirty odd different countries and the same thing is unlikely to blow through all of them. But it is still the case that the come countries that wind up really cheap. Um, there's almost always a pretty good reason for that. Uh. And so the diversification of being able to invest in a wide array of them is incredibly important. So for example, today Russia is very cheap um and that's not just

because of the energy stocks. In fact um, you know, our Emerging markets team really likes Russia today, but there their favorite stocks are not really in the energy space. The markets cheap. The markets cheap partially because you know, on um Russia is a bit of a you know, pariah state at this point, given some of their their misbehavior, and people don't really like investing there. The levels of corporate governance from the standpoint of tection of outside shareholders stinks,

and their economy isn't in great shape. Okay, those are all pretty good reasons for the stocks to be cheap, but at the same time they're also avenues for which some improvement could lead to quite good returns. So what I'm hearing you describe is sort of a corruption discount, which raises the question, does that unusually high level of corruption within the Russian economy and government does that need

to improve to see Russian stocks do better? Something probably needs to improve, Uh, for Russian stocks to do better, an improvement in the kind of the level of corruption and the and the level of corporate governance will help UH. And while it's not a guarantee by any means, it

is fascinating that kind of UH. In recent quarters, I have been getting UM uh kings, whether it is email or voicemails UM from UH, from from consulting companies representing some of the big Russian state owned enterprises who are UM canvassing UH current and former shareholders to understand what kind of governance improvements they would like to see. UM. It's not that, you know, gas Prom has suddenly become

a paragon of corporate governance, but it is fascinating. UM. They do care enough to at least want to know what either people who have hold them or have held them in the past would like to see them do. UM. And and again you know, one of the things that Argent Davetcha, who has been our head of emerging markets going back into the early nineties, the extraordinary returns that you can get periodically in emerging do not tend to come when things are good and become great. They come

when things were absolutely horrible and become nearly bad. UM. The scope for better corporate governance UM in a place like Russia. Man, they don't have to jump over that high a hoop for things to get better. UM, and given the very substantial discounts that investors are currently demanding for these assets, uh, a little bit of improvement would

go along, right. Quite quite interesting. So you guys are known as not only contrarians, but value investing, and we see value go through regular periods of under an overperformance. It's it's been pretty cyclical. But you described this past decade as quote truly a hellish time. What's going on with value investing? Yeah, well that is that is a question that we have spent an extraordinary amount of time

trying to analog. One of the things we really like to do, UH, when looking at any asset, whether it's been doing well or poorly, is not just look at what its returns have been, but try to understand where those returns have come from. UH. And value at this point famously has underperformed as a stock selection technique since about two thousand seven. So we've got a thirteen year

period of value underperforming. UM was particularly spectacular year for that it was the worst single year for value relative to growth in history UM. But even before that, value had been under performing. Now the question is why I would say the common the common received wisdom is, well, the reason why value has underperformed is because they have

proved to be value traps. The growth stocks have grown in a way that is, uh, you know, qualitatively different than what had happened before, and these guys have just fundamentally been a disaster. If we look under the surface at where the returns have come from, we find that's actually not true. Value stocks have certainly undergrown the market. Now, they undergrew the market in the period in which value

one um as well. If we look from two thousand six, which was a period when the value outperformed the market by about two and a half points a year in the US, value stocks still undergrew the market by about five points a year. So how can you win if you're undergrowing by five points a year. Well, there's a couple of ways. Um. One of them is more income. One of the reasons why value stocks don't grow as much as because those companies pay out more of their

earnings to shareholders. UM, So you get more income out of value. But the other important piece of the return to value in the long run comes from the fact that value isn't a static strategy. You're not just buying a group of stocks and holding them for the next decade.

You are buying a group of stocks because they look cheap today, and you are refreshing that group of stocks over time, and that rebalancing, that refreshing of that portfolio has been very additive to returns to value you over time. That's even been true in this more recent period. So the rebalancing effect always accrues in favor of value and helps make up for the fact that the value stocks undergrow.

If we look at the underperformance of value, and since two thousand seven, the value half of the market has underperformed the overall market by about a point and a half a year. As we break that down, the relative valuation piece of that return um, which is to say, the amount of the return that came from the fact that value stocks traded at a different discount to the market at the end of the year than they did at the beginning of the year, has been has cost

you two points a year. So more than of the underperformance of value has come from the fact that value has been getting cheaper. And the thing about that is a source of return is it's not a sustainable one, right. You can't have a group of stocks have its valuations go in the same direction forever, you get kind of absurd things eventually, UM. And we do think that because that valuation discount has gotten to the point where it's

some of the widest we have ever seen. UM, we have a hard time believing it's going to spend the next five or ten years getting still wider. And if it were to just stay where it is and the other sources of return for value stayed where they are, value would win. So we think under the surface, and this is the same kind of analysis we did that had us confident in value in two thousands, under the surface, the value effect is still there, UM, but it's hidden

by this changing valuation UM. So we think if we could get stable valuation gap between value and growth, value would win. We also think that the gap between value and growth has gotten extraordinarily wide. UM. It is trading at kind of seventy wider UM then it has on average over the last forty years, Which is to say, if value was going to move to the same relative valuation versus growth stock that it's traded on average over the last forty years, value stock deserved to beat growth

by seventy percentage points. But we don't need to assume that that's going to happen in order for value to win going forward. We just need this pattern to stop. And frankly, one of the things that gives us confidence that this pattern is going to stop is just how crazy some of the market action has been in recent months. M. Jeremy Grantham, our firm's founder, has written about that and

and uh and and talked about it in interviews. This is what we believe to be a full fledged speculative bubble um, and those events have a tendency to end themselves in a space of months, usually more than years. So let's stick with that idea. I have some other value questions for you, but I want to stick with the bubble issue. Back in Alan Greenspan made his famous irrational Exuberance speech, and lots of people were discussing how bubbly and frothy the market had become and how valuations

had gotten so extended. But the market powered higher another four years, So arguably nine wasn't the ninth inning. It was, you know, the fifth or sixth inning. Are you suggesting we're closer to the ninth inning here? And that this is a full throated bubble everywhere or is it more pockets of froth and this could still go for years and not not weeks or months. Well, I'd say the scale of what has been going on in recent months is really quite qualitatively different from what we saw in

ninety six or seven. It does have kind of much stronger parallels to what we saw in nine or early two Thousand's right, Yes, we saw I think Netscape went public, uh, and there was some fascination with that, um, But we didn't have a huge swath of internet companies going public. We didn't see you know, huge amounts of capital having moved into that space or uh kind of being fascinated um by h companies that traditional measures didn't didn't look

all that appeeling. That took quite a while to happen. But I'd say about you know, this market is Look, we are eleven years into a bowl market here. Uh. It's not the case that um that that what's going on now is something new from the standpoint of rising valuations.

What I'd say is new and different and something that we weren't seeing and hill certainly in the US, UM is we moved kind of away from the fascination with the giant Oligopolis and Monopolis to more fascination with companies where the proponents of them are telling us, look, what you're missing is you are trying to value this company on traditional security analysis, and traditional security analysis doesn't matter anymore.

Um And that's to me, that's a different statement than the the accurate statement and people were making about say Amazon a few years ago, which was, yeah, Amazon doesn't look like it's very profitable, but of course it must be profitable. Look at the way it is growing, and look at the way it is it is funding that growth when out having to raise capital. That must mean under the surface they are actually quite a profitable company and the accounting is just not keeping up with that.

That is true, and that helps explain how some of these companies have done extraordinary things. But if we talk about you know, a tesla, if we talk about a door dam, if we talk about you know, a quantum scape where the company management was saying, look in we think we might be making a billion dollars and it was priced at you know, at the peak in December something like eighty times those twenty eight company forecast earnings.

Um Man, That's that's not the same thing as saying the accounting is wrong is saying we're in a new world where evaluation doesn't matter. UM, and I make the argument that that kind of mentality UM leads to a level of well, let's stupidity in the pricing of assets that will prove to be unsustainable in a finite period of time. Quite interesting. Last question on the value thesis.

You know, when we look at historical ways to measure value, price to book is something that's that's really come under attack over the past couple of years. What do you think the best way to define value and try and capture the value premium actually is. Yeah, So it is one of the fascinating things about these episodes. UM. There's almost invariably a significant amount of truth to the complaints that people have with whatever asset it is that has

been performing poorly. Price the book is a profoundly flawed measure at this point. UM. Its laws come from two basic issues, UM, that are much more prevalent now than they were thirty or forty years ago. The first is the changing way that corporations are doing their investment. UM. You know, forty years ago, if most corporate investment was in the form of building a new factory, UM, you know,

putting up a new building something like that. That kind of investment is recognized as investment under GAP accounting and

under the foreign version the I s B accounting. UM. The investments that corporations are more likely to make today in intangible assets through R and D and similar kind of UH spending are not properly treated by the accounting standards, so they don't show up as assets on corporate balance sheets unless a corporation has bought another company whose assets were predominantly about intangible and then it shows up as goodwill.

So we've got this issue that for lots of companies, a lot of the investments that they make aren't properly capitalized, don't show up on the balance sheet at all. And then we've compounded that with the rise of stock buy backs. And in the case of a stock buy back, if a company buys back it's stock at a price to book greater than one UH, it's book value has a tendency to implode. So one thing that is increasingly prevalent today is you have um perfectly solvent companies with negative

book values. So today I think, for example, McDonald's has negative book value. That does not mean that McDonald's is in any danger of going bankrupt anytime soon. It means that the price the book has really become flawed. UM. So if you're buying UM companies on the basis of price to book, you've got a problem. UM. You've got a particular problem with the growthier company because those are the ones who have been doing the most investment that

has not been properly capitalized. So you're going to systematically underestimate the value of all of them UM, and you're also going to get screwed up valuations for anybody who has has been buying that stock. UM. We think if you're going to be a sensible value investor, you have to adjust for that UM. Now, if you're buying your stocks when at a time, the right way to do it is to build a discount count the cash flow model about what the future is going to look like.

If you're going to be a more traditional a what people tend to think of as a quantitative investor, what we think you have to do is you have to go back through time and reclassify those expenditures which should have been understood as investment and start putting them on the balance sheet. UM. So what we've done is we've gone back over the last fifty years UM, and we have rebuilt the income statement and balance sheet for every company in our database so that we're at least starting

from the economically meaningful valuation. UH. Now, from then we have gone on to build a discounted cash flow model to try to understand the future of these companies. UM. But the key as act and the frustrating thing about talking about value today. I truly believe value as a style really out of favor, that it deserves to outperform.

I also believe that you know, the be priced the book and even PE based style indices are a really poor way of getting at that, and they have way too many effective data errors showing up as either very cheap companies or very expensive companies. UM. So I love value today, I'm I'm scared in somewhat skeptical of that is represented in the value indusees quite fascinating. So we've been discussing intangibles and I want to spend a little

more time focusing on that. So we've seen the rise of asset light companies, lots of intangible assets, R and D, patents, processes, etcetera. And these tend to not only generate high profit margins, but we've seen multiples rising over time. How can an investor take advantage of this gap between the way we account for those assets and how they perform in the market. Well, that's always one of the kind of challenges of of of security analysis. UM. Even if this stuff was accounted

for properly. UM, there is a difference between the patent that accome money has been given that turns out to be worth next to nothing uh and those rare patents UM that embody intellectual property that is going to be absolutely fantastically valuable. So it's not, you know, generically possible

to get this right all the time. UM. But I do think it's really helpful UM to try to get as close as you can to the economic truth here to answer the question of, well, is this a company that is trading at you know whatever what what like Amazon looks to be a few years ago four hundred times earnings UM? Or is it the case that those earnings numbers are really wrong um, and and the valuation is more reasonable UM. I think you can get closer

to that, UM. But I think it's also the case that that you you hit upon kind of the key distinction between the fairly rare company that turns out to be extraordinary, uh, and most of the rest of the corporate system, which is, there are some companies that have shown an ability to have a return on capital much higher than the average company and to maintain that for an extended period of time. Let's talk about some of

those companies. When we look at the SMP five hundred, the six largest companies now make up about of that index, and they're all big cap tech companies. Can you maintain a sort of bearish view on the market without being embarish on those companies that at least so far have have proven to be absolutely extraordinary, Well, they have proven

to be absolutely extraordinary. One of the things that it is important to keep in mind, um is um you can maintain your status as an extraordinary company without maintaining extraordinarily high levels of growth. So I'll come up with kind of a very simple case. Let's take Google or

Alphabet a truly extraordinary company. Uh. You know, their monopoly on search, although I'm sure they would argue they do not have a monopoly on search, but their extraordinary power in in search has led them to be able um to make uh, wonderful amounts of money and very high returns on capital on advertising um. And they have seen extraordinary growth over the last ten or fifteen years now. But at the end of the day, you called them

a technology company, and they sort of are. But another way of thinking about them is they are a company that is funded by advertising revenues. And if we go back fifteen years ago when they were a tiny piece of global advertising revenue, the fact that advertising revenue doesn't grow that fast, it grows approximately in line with GDP

wasn't a big deal. If you are fifty basis points of the market and you believe you can get to be you know, of the market, Well, that is a twentyfold increase um, and whether that market has grown materially or not is irrelevant, because you've grown twentyfold either plus a little bit because the market's grown or mine. It's

a little bit because the markets shrunk. Now, Uh, Google and Facebook are pretty material parts of global advertising spend um, and their ability to outgrow advertising gets harder and harder. Right that It is certainly not the case if you have gone from ten percent of that market, well, if you've gone from half a percent of that market to ten percent of the market, you're not going to be

able to grow your share twentyfold. Again, the best you can do is of that market, and as your share grows, it becomes more and more of the case that the stuff you don't have is advertising that is spent differently for a very good reason. Um So, I'd say with all of these companies, they're as their scale grows as a percent of the economic activity that they are capitalizing on, their ability to achieve extraordinary growth uh deteriorates. Um So Google will not grow over the next ten years the

way it grew over the last ten years. The other piece that they are now fighting against is they are such big, dominant companies, um that what they do has a real impact on the global economy, and some of those impacts are not necessarily so positive. So they have a regulatory risk um that I don't know exactly how much of that is going to materialize in limitations of their business model, limitations of their profitability. But man, you've

got to keep it in mind. Um. Yes, these companies have done extraordinarily well, but if we look over the last three years or four years or so. You know, Apple has done great, Um, but Apple four years ago was trading at thirteen times earnings and it's now trading in approximately thirty nine times earnings. So three of that return comes from a tripling of pe. Now, that's not exactly right because economically their p s are a little

bit different from the stated numbers. UM. But in general, what I'd say about the tech giants is they're not going to grow the way they've grown historically. UM. They might be facing some idiosyncratic risks that had hit them and don't hit you know, technology firms as a whole. Um. And the bad news is, in general their valuations are a lot higher than they were just a few years ago. UM. That is not the recipe for wonderful returns out of them. But on the other hand, I don't think those are

the stupidest valued companies out there. Right of the largest companies in the US, you know, Apple, Microsoft, they look ends is to us. But maybe they're twice fair value. Maybe they're one and a half times fair value. That's expensive, but that's not stupid. Stocks like Netflix or Zoom are Are they in that category? Also? Um? Some of them have gotten two levels that we consider to be very

dangerously expensive. Not all of them, but we can find a significant cohort of companies that look to be trading five times fair value, ten times fair value, twenty times fair value or more. Um. Normally you don't see very many of those companies, and today we see quite a wide array of them. Um. So we do think that there are more crazily valued companies today then we've seen, certainly in the US since uh, the Internet bubble. Quite interesting.

I'm going to shift gears here and I want to address your founder, Jeremy Grantham, who has been outspoken about climate change. How does GMO approach the idea of either E S G investing or or low carbon investing. Yeah, it's uh, it's kind of a fascinating challenge for us because on the one hand, we absolutely agree with Jeremy that, uh, climate is this overwhelming challenge for mankind uh, and that as a society we don't seem to generally understand how

big these impacts will be. So you know, from an E S D perspective, the environmental stuff absolutely matters, and it is going to matter profoundly as time goes forward. But at the same time, as valuations driven investors, UH, we believe there's kind of an appropriate price for everything UM.

And even though you know oil companies are likely to face tough times ahead UH and may well be in the case in a situation where they're not even going to be able to produce all of their current reserves UM, there is a price at which they are a decent

investment anyway. UM. So what we have tried to do in our models is make adjustments where we know how to quantify UM for those environmental UH metrics that strike us as being problematic for the future of a company from kind of a risk or future earnings perspective, and also understanding particularly on the governance side of things, where

poor governance UM means worse outcomes for shareholders. UM. Where I think we are ramping up our activity is going beyond that into uh more corporate engagement, which is tough, particularly on the on the quantitative side UM. Quantitative managers are used to not really interfacing with company management UM. And we vote our proxies, and we try to vote our proxies in a sustainable way UM. But the question is how can we get these companies to do better

UM And that's a significant effort in the firm. We hired a group into the firm UH, a former independent investment firm called the Usonian who they they are fundamental UH stock pickers in Japan and one of the things that they have specialized in is a form of friendly

engagement with management. UM. You know, corporate activism in Japan can have this very bad taste in the mouths for corporate management, where certain foreigners have come in and you know, tried to strong arm management into really changing their ways.

What they have found is that if you can find a constructive way to talk to management about things they can do two improve um the way the outside eide world understand what they're actually doing uh and relatively small things they can do to improve their actual uh you know, impact on the environment, they can be pretty receptive to it. UM. So we're trying to learn from their example UH and do that more broadly. But it's it is still a

work in progress. Quite interesting. I know I only have you for a limited amount of time, so let's jump to our favorite questions that we ask all of our guests, starting with what are you streaming these days? Tell us your favorite Netflix or Amazon Prime shows that you might be watching. Uh. Well, my my wife and I have been really enjoying UH loop in on on Netflix. It's not that original, I think it's now one of the top the top shows at the momentum, but kind of

wonderful uh uh, kind of escapist um entertainment. We've also been watching spy Craft um, which is about the kind of the technologies that uh spies have used over the years to get their information. Um. And one thing I have definitely uh watched of late that admittedly this wasn't on Netflix, but this has been a difficult uh period right. I mean, certainly as a value manager, it's no fun when your stocks are not participating in uh in the bull market, but just in general life has not been

as much fun as we've been stuck at home. Um. And And one show that I particularly appreciated during the fall is just a nice way to feel a little bit better for half an hour was Ted Lasso on on on Apple TV. It was delightful. Yeah, and and just filled with in general pleasant people, uh, you know, just people you kind of want to have a beer with. I'm with you on that I have I have a hard time with They're a handful of shows that I know people really like, and I've tried them out and

none of the characters are redeemable. Why why do I want to spend an hour with the people I wouldn't want to spend five minutes in an elevator with. So the next question, I assume I know what the answer is going to be, but I'm gonna ask it anyway. Who are your mentors who helped to shape your career? Well, certainly Jeremy Grantham UH is first and foremost among them. I've had the privilege of getting to learn from him

for close to thirty years. UM. But I would say I've I've been extraordinarily blessed on the on the mentor side of things, because before I got UH to g m O UM, I had some utterly extraordinary teachers who really UH taught me lessons on investing UM that absolutely resonate to today. UM. Kind of my thesis adviser when I was an undergraduate UH was David Swinson, Manager Revealed Endowments.

And I've had the further blessing of being able to be on the investment committee there UH for the last decade or so, and so both learned from him early on and have learned from him more recently. UM. But for kind of my traditional investing in finance underpinnings UM. The two other finance professors that I was fortunate enough

to have we're James Tobin uh and Ob Chiller. So I have been extraordinarily blessed uh in terms of being able to learn from absolutely brilliant and uh and groundbreaking investment thinkers uh all throughout my career Tobin, Schiller, Swanson Grantham. Yeah, you could do worse than that. UM. Let's go to everybody's favorite question. Tell us what you're reading these days? What are some of your favorite books and what are

you enjoying currently? Yeah. In terms of my uh my, my kind of long term favorite books, I would say the book that I come back and reread every few years and enjoy it every single time. UM is a Short History of Nearly Everything by Bill Bright UM. And I have loved much of what what Bill has has written over the years. UM. But what I particularly love about that book is it's an exploration of how we

came to know the things we know about the world. UH. And I find that um and absolutely uh fascinating topic and never gets old for me. UM. In terms of what I am reading today, I am rather embarrassingly uh sort of between between books um. Uh. Most recently I was going through UM A a fun book. It's one of those uh kind of classics where you don't understand how they managed to pack as much in UM as they did. But p h Gombris a little story of the world UM and again UH, wonderful kind of primer

on how the world has got to be? Uh. Where we are? You mentioned the Brison book. I literally this weekend just finished reading his book at home, and like all his works, at every page is just a delight. I don't know how else to describe it. And our last two questions, what sort of advice would you give to a recent college grad who was interested in going

into investing as a career. I guess the first thing I would say is, if you're interested in going into investing as a career, make sure you actually love the act of investing, in the act of doing research. UM. Getting into it because you're hoping to make a lot of money or because there seems to be some glamour in it, UM is allows the reason to do anything. UM. For one thing, you never know what the future will hold, UM.

But I will say the the people who, um I think I've had the most satisfying careers and I watched UM are the people who are doing the stuff they really enjoy. And that is I think more important than anything. Uh. Investing can be a ton of fun because you're continually trying to solve problems. On the other hand, it's also in industry where you are going to be wrong a lot um. And if you can't handle that emotionally, if those times when you are wrong cause you to start

doubting your self worth, um, you're going to burn out. UH. So you've got to love investing as craft. UM. You've also got to have the right kind of emotional mindset um, or you'd be better off doing something with kind of less uh manic depressive highs. Interesting and our our final question, what do you know about the world of value investing today that you wish you knew thirty years or so

ago when you first got started. The thing I wish I had known how to do, and it is something that I continually have to remind myself to do is whenever you are talking to someone who thinks you are dead wrong about investing. Make sure to listen very carefully to what they have to say, UM, because as there's

probably some truth to what they are saying. And even if you believe in your heart of heart a kind of value investing as a philosophical um underpinning is the right way to do it, that doesn't mean UM, people aren't raising perfectly valid challenges UH to the way you and others are expressing. That quite fascinating. Thanks Ben for being so generous with your time. We have been speaking with Ben Inker. He is the head of asset Allocation

at GMO. If you enjoy this conversation, well, be sure and check out any of our nearly four hundred prior discussions. You can find that at iTunes, Spotify, wherever you feed your podcast fix. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg Net. Give us a review on Apple iTunes. You can sign up for our daily morning reads. You'll find those at Rid Halts dot com. Check out my weekly column that's at Bloomberg dot com slash Opinion. Follow me on Twitter

at Rit Halts. I would be remiss if I did not thank the crack staff that helps us put these conversations together each week. Tim Harrow is my audio engineer. Michael Boyle is my producer. A Tick of val Bron is our project manager. Michael Batnick is our head of research. I'm Barry rid Halts. You've been listening to Master's Business on Bloomberg Radio.