Matthew Kadnar Talks About His Transition From Law to Finance

He comes out of a law firm background, and in fact he was in house council for LPL, which is a giant UH brokerage firm, and ended up at at one of the pre eminent shops value shops in the world. Fascinating guy. Matthew enough that I think you can rely on his analysis, but sort of right brain squishy enough that he can weave an interesting narrative discussion about how GMO sets about setting up their entire outlook and their asset allocation and portfolio management. It really is quite a

fascinating conversation. He's tremendously insightful and this is just one of those conversations that I don't think you're gonna hear anywhere else. So, with no further ado, my sit down straight from GMO's offices in Boston, GMOs, Matt Katner. I am sitting in a conference room at GMO's office here in Boston, overlooking Boston Harbor, and it is a spect accular view. And I am sitting with Matt Kadner, who is a member of GMO's Asset Allocation Team, where he

focuses on research and portfolio management. He's been with GMO for almost fifteen years. You joined in two thousand four. Before that, he was an investment specialist and consultant relations manager at Putnam Investments. And even more fascinating, he served as in house council for LPL Financial Services. We'll spend some time talking about that. That's a really interesting transition from legal to law to finance. You went to school here in Boston College, and you hail from uh the Midwest.

You have a j d from St. Louis University, and you are a c F a charter holder. Normally, at this point, I say, Matt Kadener, welcome to Bloomberg. But instead, I'm gonna say thank you for having me here at GMO. It's a pleasure. So let's start with that initial fascinating background. You're in house counsel for LPL Financial Services, you have a j D. You you spent years as an associated Melican porter, so so you have you've done pretty much the full legal gig. What made you decide, hey, let's

let's shift to finance. It was pretty simple, Barrier. I was just miserable, Okay, the uh you know, I did litigation for my legal career. So while I always enjoyed advocating for my clients, the adversarial process was pretty miserable. And here in Boston, you know, a lot of the litigation was pretty brass brass knuckled, and so I just, uh, you know, I would take the train into work every day and I would look, you know, watch the tea coming back out, and just could not wait to be

on that tea coming back. And so my my father in law, he wasn't my father in law at the time, but he he has a lot of wisdom, and so he said he knew I was miserable, and he said, son, if if you enjoy what you're doing, you'll never work a day in your life. And so he actually gave me the book What Colors Your Parachute and uh, and that did a nice job of matching up what I enjoyed doing, which with what I thought I was good at, and that was finance and and and sales and communicating

with people. And so I was lucky enough to kind of get an opportunity at Putnam where a couple of guys Alex Nelson and Kevin Sullivan took took a chance, and so I joined them in the fall of two thousand and I discovered that you could actually enjoy working. That that's fascinating. If memory serves, I believe the data point is something like, of all law school grads seven years later are no longer practicing attorneys. I'm surprised it's

that low. Oh really. And and by the way, I'm part of that fift I moved on from law years ago, and and I couldn't be more thrilled to have, like you made the transition of finance. Yeah. I think the hardest part was getting my mom to understand that there was a better way to make a living. I had the same issue with my wife. She's like what what do you mean? I married a lawyer. You're gonna become a traitor. What are you talking about? This a stable income is going away and you can replace it with

something speculative and risky. That doesn't sound like a smart move. So you're at You're at lp L. How do you do the transition? You go from LPL to Putnam? Um? What was your first gig? What were you doing that? So? I was in the d C investment only group, so so basically working with institutional clients that had Putnam investments on their DC platform. I did that for a couple of years and then transitioned over into the consultant relations channel,

where I was covering the West coast dB consultants. And the travel is starting to wear a little bit. My wife was pregnant with twins, and I got an opportunity to come work at GMO and oh four and GMO, you know, had made its way through the bubble, acquitted itself very well, very well, very well, you're you're understanding it.

Not Not only did GMO pretty much called the bubble in real time, but they were one of the few who turned around and said, hey, this is about as bad as it gets things look cheap, feel free to

start adding equity to your portfolios. Yeah, and they they the performance out of the bubble actually, you know, Jeremy will talk about you know, generally we don't do well in bowl markets, but the performance you know, into the bubble, through it and out of it was really spectacular where there was a lot of cheap, low quality assets, international small cap emerging that just did spectacularly. Cheap low quality

as opposed to cheap high quality. Correct, high quality doesn't get it quite as cheap as the low quality does. Is that the thinking, um, well, you know there's a price for there's a price for everything, and and high quality got pretty expensive kind of into two thousand and as the value value tends to be lower in quality, and so you know, the value in US and outside the US, particularly international small value, particularly e M just

got really left behind. And so as the market got it got its legs and rallied, that stuff was so cheap and just was you know, just just took off. Let me let me come back to what you just said, because it's kind of a fascinating observation. Value tends to be low quality. How are you defining quality in my mind.

I know there are technical definitions and other definitions is it and some of involves um the amount of debt, the variable crazy things that sometimes happens that may not show up on a balance sheet, but constant turnover in the executive suite? How do you define value under those circumstances?

So um, so here value is is basically the cheap half of the market, whereas quality is quantitatively low debt, high r o E and stable r o E and so value because it tends to be in the more cyclical sectors, it has more financials, tends to be on average lower quality and growthfitions. Correct that that makes a lot of sense. So you transition from laws of finance, you start at GMO and O four what's your day to day? Like? What do you what do you focus on? Well?

Back then, actually I was. I joined as a client relationship manager, and so because GMO was growing, they needed more folks to deal with clients, and so I spent a lot of time in those early days trying to better understand asset allocation because I felt it was my edge as a relationship manager that I could go in and talk to a client about our seven year forecast about how we think about the total portfolio, and I guess I spent so much time up talking to the

asset allocation folks. After several months, they said, hey, you know, you seem like you have a lot of interest in the stuff. Why don't you join the ASCID allocation team. We need somebody out there as a perportolio portfolio strategist talking to clients. He seemed like a nice guy. Why don't you Why don't you take the gig? Is that is that a flu it sort of Um? Is that typical of GMO where people move within departments? So was

that a little bit of an unusual shift? I think that was that was a typical for somebody to go from the relationship side to the investment side. That's actually happened a couple of times since then. GMO tends to be a pretty flat place, so that does produce a fair amount of fluidity between roles. UM. But I think that was just an opportunity to kind of do something that I discovered that I really loved, that I thought

was interesting. I thought would give me an edge, But I probably took it to the next level of trying to really understand it. So so you go from effectively client facing to portfolio managing. How did you educate yourself on what works for portfolios what doesn't? Because there's a fairly broad and rich literature about everything related to asset allocation and portfolio management, although some of it contradicting itself, how did you teach yourself what what was the right

way to do this? You know, I found that the way GMO approaches the world is different than a lot of other firms, a lot of other academic literature. So I basically asked my boss Ben Anker a million questions, and I spent a lot of time with Jeremy and other members of the team listening, asking questions, trying to you know, trying to understand how we approached the world, why we did what we did, all in an effort to be able to educate clients what we what what

we did. But I would say most of that education was internal as well as you know, there's you know a handful of other kind of friends of the firm out there that you know, we read. Andrew Smithers in the UK wrote a lot of very good pieces that seemed to rhyme with what we were doing. So it was an education with a limited outside but mostly trying to take the wealth of information that my colleagues had and digested in a way that that I could use.

And when you were originally client facing, GMO is or almost a hundred percent institutional? Is that is that correct? It was almost not quite a hundred percent. We we we had a small relationship with Evergreen at the time on the retail side, and today, uh, we have a relationship with Wells Fargo that that grew into Wacoba, which grew into Wells Fargo. So the Wells Fargo absolutely return fund is still a big piece of our business. But

you're you're, you're traditionally known as an institutional shop. The vast majority is that of and if memory serves you, guys are up to about seventy billion dollars correcting those those numbers. So let you mentioned the seven year forecast. Let's let's talk about that a little bit, because um, Jeremy Grantham has been doing these seven year forecasts for as long as I've been in the industry and which is about when I started, and he has over that

own period of time been fairly consistent. Nobody is a right, but he's been a whole lot more right than wrong over that that period of time. Why seven years? What's the significance of seven years um? And how did that come about? So the forecast originally when they started where that they were a ten year forecast, and so what we had heard from clients was, hey, we get that year long term, but ten years just just too long.

And so in actually Ben Inker, the current my boss that had acid allocation, he had done this study where he had found twenty eight bubbles going back to the South Sea Bubble and the remember century, and so at some point he just did the math to see how long it took for those bubbles to rise and fall. And so it turns out that the average of those was actually six and a half years, and so we

converted to a seven year forecast. I automatically assumed it was biblical and seven seven fat years got a nice ryme to it, for sure. So so that's interesting. So

that raises that raises a fascinating question. Back in February oh nine, right before the market bottomed, Uh, Jeremy comes out with a seven year or I should say GMO comes out with a seven year forecast, and that forecast for US large stocks was close to nine percent a year going forward, which, if you remember back to February oh nine, was kind of hard to imagine a lot of people were hiding under their desks the thought of, Hey, you're gonna get eight point nine percent a year for

the next seven years. Um, no one really believed it. It turned out. As bullish as that was at the bottom, it was fairly cautious. Over the next seven years, we saw over twelve percent returns. So the questions that come up from there is, um, are you as bullish today as you were back then? What's the outlook going forward? And why do you think the market did as exceeded your bullish expect stations from pretty much the nature of the financial crisis. Yeah. That well, that last one is

a that's a that's a that's a tough one. So I'm going to start with the easier question first, um, and then come back. But you know, I think our our view today is certainly cautious. That you've been in this environment where you've had extraordinary equity returns, where you've gotten kind of twenty years worth returns in at ten nine or ten year ten year period, and so we think that that we believe in mean reversion, there's going to be there's going to be a give back to that.

So I think we are cautious in our outlook in that there's just not much return left in markets because everything with duration, stocks and bonds have done incredibly well. I would contrast this with two thousand seven, where valuations were also poor, but you had a wonderful three standard

deviation housing bubble staring you in the face. You had this market narrative of the Great Moderation, that central bankers had figured out the rhymes and the rhythms of the capitalist cycle, and that recessions were a thing of the past. You had just unbelievable stupidity in the credit markets, people levying things fifteen times to make two basis points over lib or. And so we were very defensive, you know.

I think Jeremy's term was that there was a bubble and risk assets, and we were very defensive, and we were very scared in in many ways. The valuation, certainly US equity is actually worse today, but we are not as defensive as we were in two thousand and seven. We don't have an obvious bubble kind of staring us in the face. You have some steins of stupidity in the credit markets, but as not as nearly as pervasive

as it was. Give us an example. I mean, everybody seems to go to the subprime auto market, but that seems to be not the foundation for the rest of the economy the way the subprime housing exactly. Yeah, I mean, you know, the return with a vengeance of Cuve light lending. You know, I would have bet a lot of money and lost that. You know, Cuve light Lending would have been you know exactly, Yeah, you and me both, I'm shocked.

That is that a substantial amount of capital at risk and that um, I mean, it's a reasonable amount of capital. And I think, you know, one of the things that is a source of worry is the rise of mutual funds and e t f s in high yield and the levered loan market, with that market used to be

dominated by insurance companies. Now it's dominated by mutual funds and ETFs, which have obviously the daily liquidity and you know, Stein and and some others have had you know, the quote that their liquid claims on it liquid investments, and so I think that's a potential source of worry liquid claims on illiquid investments. That's never a good thing, is it. Uh, It's it's okay until it's not, and then it tends

to end tends to end pretty badly. Well. The last time we saw a bit of a run on some of the high yield products was two or three years ago when one of the funds effectively blew up. Is that the concern going forward there'll be some either some fund unable to to meet its obligations and that sets off the next cascade. What what do you guys think is the bigger concern looking out? Um, I think it's

difficult to figure out, like what that concern is. I think that the general concern is there's been a huge reach for yield, and people are of the belief that these mutual funds and e t f s that you can you can get daily liquidity on these things, and you can. It's just that the prices underneath them aren't going to reflect that, and so as everybody starts going for the door, it might result in some some some

results that hadn't quite anticipated. You can either get price or liquidity, but not necessarily both at the same thing. Ex So, so that that's kind of interesting. Um. One of the things that GMO has talked about is benchmark for ree investing. Clearly, any of the high yield or or lower quality um A liquid stuff is not going to have a real benchmark. But if we're talking equities,

what is the significance of the phrase benchmark free invest there? Well, benchmark free investing kind of really came out in the run up in the bubble. And you know, our flagship strategy that has been around since nineteen with Princeton and Phillips Exeter was our our balanced strategy, and so you know, sixty five equity thirty five bonds. And so we we had two groups of clients, one of whom was firing

us in. Another group was saying, hey, you know, Jeremy and Ben, you know, why do you have so much US equities? It's the most expensive and it's ever it's ever been, is this? And so then the reason was what we have tracking air. We have a benchmark that we're supposed to beat, and we have tracking air constraints that that run into it. And so they took that feedback, went back to the lab and they came up with

what they called the where to high portfolio. And they actually remember that phrase very distinctly in the late nineties and and and it was a very interesting portfolio, and they actually uh unveiled it at our fall conference in n and in GMO grew up investing in a lot of investing for a lot of endowments and foundations. So the concept of five reel was, you know, kind of been part of who we are for a long time.

And so they said, if the best way to make five reel, five reel five percent over inflation is to own a portfolio that is basically seventy bonds, a little bit of reads, and a little bit of emerging equities. And I wasn't at GMO at the time, but I could imagine kind of the crickets in the audience for sure, after they unveiled this in the middle of the dot com bubble. So this is the previous year the SMP was up thirty and as that was up forty something

percent that year. For what I'm doing it off the top of my head. So and you're telling people, no, no, no, US equity mostly bonds. Here we are at the time, twenty years into a bondabule market, and people were already saying it was old, and it was long in the tooth and a little bit of e M and a little bit of reats. It was a portfolio that was so far out of central casting for any institution that

it went over basically basically like led Zeppelin. Nobody could take that portfolio back to their investment committee and say this is the best way to compound wealth going forward. And so it wasn't until two thousand one, when the market started to fall apart. You're in the middle of the bear market, that we got somebody to say, hey, just maybe this thing isn't as half baked as as it as it originally seemed. And you know, benchmarks are

necessary for measurement for institutions for individuals. But what is very difficult for us about benchmark oriented investing is that it forces you to own more of the things that you don't like and less of the things that you really do like. And if your goal is to compound, well, that's a pretty big inhibitor sure to that. Because the ability to get out of the way of the oncoming freight train, the ability to load up on an asset when it's really cheap, that's really how you compound well

through time. And so that benchmark free investing, which was originally the where to hide portfolio, you know, really has been part of our DNA since. Wasn't until oh one that somebody gave you had the gumption to give us some money to invest that way? And how has that portfolio done since? And and how much assets has it attracted? Um, it's it's done very well versus stocks and bonds or

any combination of over that very long period that it's compounded. Um, I don't know off the top of my head, but much higher than stocks over that time period, which half of volatility, it's got a sharp ratio of over one. Well sure from two thousand to two thousand and pull the two thousand and twelve at US equities are effectively flat with a ton of volatility in between, and bonds just kept getting bedroom and better and better over that time.

So now looking at real plus five from here with what a number of high profile bond people, be it Bill Gross or Jeff Gunlocked have pretty much declared the bond bull market over what what's your outlook on bonds? From here? Does GMO see the bond market and that bond bull run that dates back to fit Chaff Paul Bocer is that still have any life left to it or is gross and unlock correct. The best years of the bond bull market are behind us. Over the intermediate

to long term. I think it's hard to see how bonds could deliver anything associated with the longer term returns that we've seen in this bull market. Obviously, the yield is what the yield is. You've had duration that the benefits of duration and falling yields over that time period. So you know, our best guess is going forwards that bonds are going to be very disappointing, certainly relative to the last last thirty years years. We uh, we do

like tips. We think that tips offer an interesting inflation hedge relative phenomenal bonds um. So you know, as we think about benchmark free we have very little in the way of non alduration. Most of our duration at this point is in real duration through through tips. In a benchmark oriented portfolio, it's about it's about half and half, but half tips half nominals. So tips for for um where we are today is going to be a measure

of inflation um that gets adjusted. I think it's twice a year based on CPI data is something along those lines. So does this imply you're expecting higher inflation going forward? I think that's the worry. The thing that will cripple anyone's portfolio is arise in the discount rate, So that would impact every any anything with duration. Both stocks and bonds actually impact stocks the most because they have the

higher the higher duration. But I think that's the concern, and if you weigh the risks one versus the other, I think over the longer term, the concern is that inflation is a higher risk than um than deflation at this point. So what does that tell us about forward expectations for US equities? I'm not quite sure what that specifically tells you about the how the interest rates impact

the expected return for U S equities. I think as we look at US equities, they're just expensive on every metric that we can come up with, even the kindest and gentlest metrics. So um, you know. I think what has happened to us as well as all investors is basically the FED has bullied us into owning more risk assets than we would than we would normally given how poor cash yields and bond yields have been. So I've

heard that phrase before. The FED has bullied us into riskier assets, but that was through quantitative easing, where they're buying up a lot of paper and through essentially zero interest rate. Now that QUEI is pretty much over and there, whatever is on their balance sheet is apparently being allowed to run off naturally there. It's not that they're selling anything, but things hit maturity and they don't seem to go out and replace it. So the conditions that led to

the bullying into risk assets are now going away. The expectation is three more increases this year, but even if it's one or two, we had a few increases last year. It seems that everybody on the feed is lined up with ongoing normalization of interest rates. Does that mean risk assets become that much less attractive for a considerable period of time. Well, it's hard to envision quantitative tightening being

bullish for us. I'm not quite sure what it really means, because the market can take on different narratives in the inner rown. If the economy economic growth is stronger, um, you know, the market can kind of twist it's you know, we can just twist the justification almost any way that we want. What I think is interesting is if we do get you know, the continued hike in rates over the next several years, I think the fascinating question is to be what is what point were those rates tip

the economy over into recession? That's an interesting question. If you know, if it's you know, two and a quarter on FED funds, that's a pretty good indication that secular stagnation. You know, things are very different this time. If it's at three and a half on FED funds or three or three and a half on FED funds, that's a pretty good indication that secular stagnation, that things aren't different this time. That secular stagnation might not be the argument

that's winning, that's winning the day. There's a lot of variables in there, and the way I'm hearing you contextualize this is the FED rate, whatever it happens to be when the economy is then tipped into recession, is going to be informative as to the broader macro cycle, as to whether or not, hey, was that new normal behind us? Are we still want a stag a slow growth I don't want to say stagflation, but a low wage, low

growth period of time. Or is it possible that what ticks us into tips us into recession has nothing whatsoever to do with the FED. I think it'll be a pretty good indication of you know, it's not. It won't be dis positive, but it'll be a pretty good signal or pretty good sign post as where what regime we're in. You know, when we think about our forecast, our traditional forecasts assume normal mean reversion, normal mean reversion to cash rates, term premium on top of that, and then equity was

premium on top of that. You know, Ben Anchor has written several quarter letters about this alternative universe that that we've coined hell, which is basically zero real in for cash rates, and then you get, uh, your bond premium on that, and your equity was premium on top of that. But if you're getting zero reel for cash instead of one and a quarter reel, which is our normal traditional assumption, you expect to return for bonds and stocks falls falls

similar lower. And it has in the short run, it actually has the impact of you're you're assuming less meaner version, so you're actually your forecast actually improve equities two to three points, bonds about a point. We call it hell, because over the long term, if you're not getting five and a half or six reel out equities, if you're getting four or four and a half reel out of equities and you're getting two real out of bonds, not three,

it really blows up everybody's asset allocation. Your ability to generate five reel in that environment is really has really hampered. And so the hard part with predicting what environment you're in hell versus purgatory is, you know, we don't have you know, we have people working on a model that will predict what what Powell is going to do or powal successor is going to do. We really don't have somebody working on that because that's that's a useless piece

of activity. You can't forecast that. And so but we do have to weigh those probabilities, and we're thinking about expected returns for our portfolios. And you know, we are kind of card carrying members of Meaner Version. We are the kind of the founding members of the Meaner Version Society. And for us to recognize that there's a chance that things are different this time uh is very different, is certainly very different for us. That is that is uncharted

territory certainly as far as asset allocation is concerned. So so you keep talking about five real. I'm used to the institutional side focused on five because if you're an endowment or foundation, you have to supposed five percent to maintain your tax exempt status. What is the significance of five reel? What? Why has that number become such a focus? Um? I mean that's just historically the spending rate for most

for most institutions. Real. Yeah, so so you know, so that's the coming from from the actual behavior of clients as opposed to some abstract theoretical correct. So if you you know, if you are are an educational institution, your your endowment oftentimes is contributing you know, five percent of that endowment into the into the budget for the school. You think about it in real terms because you want to maintain the purchasing power of that environment over time.

And and we're sitting here in Boston where stones throw from too fairly famous institutions, both of which have enormous um endowments. When when you guys are reading about changing of the guard at the Harvard and down or or some personnel change in M I T. What is the thought process like to do. And I know I'm kind of um pulling this up out of left field, but you you you mentioned educational institutions because I've been following that saga now for it seems like going back to

Larry Summer's fifteen years ago? Is it longer? Is it twenty years ago? And I'm always astonished, Wait, aren't they supposed to be really smart at Harvard? Why? Why is this? Why did they kick out people who were doing so well? That original endowment team was just crushing it, And it seems like there's a different flavor each year, and nobody really seems to last. Obviously, I don't expect you to tell us what's going on in the inside, but do

things like that cross your your um viewpoint? Do you look at that and say, what what's going on here? I think we read about it just because they're important parts of our industry. But you know, our our focus is not on kind of what the internal politics or what Harvard is doing. Our focus is more on, hey, how do we generate returns for for our clients? So it's interesting to read, but it's not really It's not

really Germaine at the end of the day. So let me ask not about something that you read, but something that you wrote. Last summer, you co authored a paper with James Montier Um and I love both the title and some of the quotes from it. The title was the SMP five hundred just Say No, and within that you have this delightful quote. Please do not mistake us from members of that species known as parma bears. We don't always hate us equities. As a matter of principle,

we are just governed by the precepts of valuation. So let's leap off. Use that as a leaping off point and discuss valuation. How do you guys measure valuation of equities? And it's obvious, but I have to ask the question, why do you believe valuation is so important? Yeah? So, um, you know, we think that valuation is going to determine the vast bulk of your outcomes. That no asset, no assets puror dained to make you money unless it's priced

to do so. So our investment process, if you wanted to sum it up into eleven words, is figure out what you think something's worth and where you where you can be wrong. And so valuation for us is the thing that we have the highest degree of confidence in and you know, trying to predict the rhymes and rhythms of you know, the S and P. It's a twenty three trillion dollar market. It's it's complex, it's reflexive, it's got stochastic as a QUANTZ call, you know, random elements

toss in that. Trying to predict that in the short run is simply impossible to do consistently. But we know, and we can test this back to the Chester A AR three administration, that valuation really is going to do um, your starting valuation, the price you pay for an asset is really going to really determine the vast bulk of your outcomes. It's not a guarantee, but uh, there's it's

a good statistical debt exactly exactly. Every now and then, Jeremy says something that within the framework of evaluation of a value investor um brings in a little bit of behavioral finance. I'm always curious how clients respond to that. So the most recent seven year forecast was pretty um, I don't wanta say bearish, but it was pretty subdued.

Is that a fair fair assess I think you're being kind, But at the same time, he very publicly said, I don't think we're up to the melt up stage yet, meaning the bullmarket still has ways to go, and that last stage things can really get out of hand. How do you reconcile our seven year forecast is negative, but there's some crazy stuff coming before that. Yeah, I think, you know, certainly, as we talk to clients, the clients

are pretty We're pretty clear with them. You know the process they bought it was based on our long term evaluation forecast. That's the process that is going to be the primary input in terms of putting together their portfolio. I think Jeremy wove a very interesting mosaic with respect to hey, the pieces might be in place for this thing to really blow off and melt up, um he put. I think he put a probability of probability on it, so he wasn't saying it was it was a sure

thing by any stretch. And I think it wasn't interesting. It isn't interesting speculation. But our job is to not speculate, obviously with clients money. It is to follow the process that we've been doing for almost thirty years within asset allocation. We do, from time to time have shorter term views on the markets, but they are few and far between between. It's a high bar to implement those views. We we got more defensive in oh eight because we were more

scared about what was going on. That was a shorter term view. But but Jeremy's kind of one and two chance that things melting up. You know, we get less questions about it now after you know, the market fell even than we did at the end of January. When the market was market was taking off. But I think and just following the tax reform, everything seemed to just explode upwards. Um. Did anyone say, hey, is this the melt up? Where? Where? Where are we with this? Uh?

It felt it certainly felt like in January things were trending in that direction. Um, I think there is room for that narrative to come back into the market, But I think February really was a shake up for some investors. Well, now that's a really valid and interesting point. We've had during this run, much more significant pullbacks than what we

saw in February. And this is a little squishy and qualitative of me, not quantitative, but it felt that that eleven draw down had a far greater resonance amongst many more people than the previous There were a couple of nineteen pullbacks. February really seemed to scare the Bejesus out of a lot of people. What So the question is why, why?

What made this pullback so significant? I think it was if you when you just had such an extended period where nothing had happened to the markets, and so when you know, when that gets jostled in a pretty violent way, and I think that just reawoken the fact to investors like, oh, hey, this thing is not a one way train that that that bad things can stop go down to Is that

what you said? And also, you know you didn't get as much help from bonds in this particular run either, so so you know, investors portfolios were a bit more exposed. Now the markets kind of come back, not all the way bonds bond yields of state have stayed high. But I think it was a nice reminder that, hey, you know, bad things can happen out there. So when you look at valuation, how do you construct a measure valuation? Surely

it's more than just price to earnings ratio. Yeah, so our our for our seven year forecast, the framework is pretty simple. You have valuation and you have growth and income on the on the valuation side, you have pees and you have margins or I think it's probably more technically we have proxies for return on capital. So uh so we know that what really mean reverts for equities is returns on capital, and so we'll look at that.

We'll cut that several different ways in building our forecast, and we'll combine that with a pe to get a sense of the valuation. Will also combine that with growth. You get that as an equity investor, you get income as an equity investor, and that provides a fairly simple framework for thinking of out what you think something is worth. And then you ask the risk management question of where you might be where you might be wrong. So you are you looking at at evaluation across all assets or

is it strictly equity? How do you evaluate bonds? How do you evaluate other non equity assets a non bond asset, So we look we value a whole host. I think there's forty or fifty different equity markets will do a

similar exercise with respect to bonds. The issue with, however, with bonds, is that the evidence for mean reversion is not to be kind of nearly as strong as it is within equities, you have the central bankers who can kind of muck around with the front end of the curve or at the long end of the curve, depending

upon the particular market. So the case for mean reversion within bonds is less strong, and so that leads us to you know, having a mean reverting model, having a model that doesn't mean revert, having a um kind of adopting a Leebwitz type framework with constant duration in real terms. So you you it's a little bit more of a mosaic with respect to bonds. Currencies, we also, you know, we value as well. It's it's primarily purchasing power parity.

We make some adjustments for it, so it just becomes relative to other major exactly finance centers. So it's US, Japan, Europe, or are you looking at a broader range of currencies? Um it, you know, it's all the developed currencies and twenty five or thirty different emerging currencies. Maybe probably different emerging currencies and e M currencies can give help contribute to a read of is the dollar fairly valued? Is

it weak? Is it's strong? Yeah? I think you know, the interesting thing about emerging currencies is that they you know, they can be valued in and of themselves. You have the meaner version of the currency, which you get get as part of it. As being an equity owner, you get the real you don't get the real rate aspect of things. Um. But for for us as we think about emerging historically, the times where emerging has really got into a lot of trouble has been when the currencies

have been overvalued. So kind of heading into the Asian crisis thirteen or fourteen, we thought that the e M currencies were very expensive. So so that almost becomes in addition to an expected return to it almost becomes a risk management tool as well. And so EM currencies have ripped, They've had a you know, a great run over the past you know, probably two years now, but they're at

the point where they're basically fairly valued there. You know, it's you know, it's not you know, they're certainly not expensive enough to to really cause you to to least lose sleep at night, and they certainly have room to run. When you're dealing with purchasing power parity with EM, you always have to take with a grain of salt because the data is not so great. But you know, when you're really looking at currencies, you're looking at extremes that

that's when that really matters. Do commodities come under the same process or they really so dollar dependent that you don't look at it the same way. Well, they're they're different for for for different reasons. Commodities. We do look at oil, iron ore, A copper iron ore, oil and natural gas, UM copper iron ore. So there's your industrial side, UM, natural gas and what was the last one? And oh

and oil so that's you're heating and your transportation. Yeah, the problem that the um the confidence in those forecasts is less understanding the supply and demand diamics in those market is very difficult. We had we did have strong views on copper and iron ore in two thousand and eleven and two thousand and twelve. We had a fairly exhaustive view of the supply side and we just felt like demand couldn't be strong enough to match the prices and the supply coming on. So but but the competence

in those forecasts generally tends to be lower. And I didn't hear you mentioned precious metals or golds and which has its own set of issues. Yeah, well, you know, I I Jim Grant wants how he valued gold, and he basically said it was the value manager's indulgence. So he said he even he could not put put a price on it. You know, for years, Jeremy said, our own gold when it yields the same thing as a T bill. And so, uh, there in oh eight, it

actually yielded close. It actually yielded more than more than a T bill for a period of time. And so we did own some gold in our mean reversion hedge fund for a period and then we actually made a good bit of money on it, and and we tried to value it and we just couldn't, and we got scared, and we just took our profits and ran. Totally understandable that that's a lot of value investors view on on gold.

So so as some of the founding members of the mean Reversion Club, let's let's talk about those corporate profits that that you referenced. Why haven't we seen corporate profits mean revert? They seem not just at record levels, but significantly elevated overpass cycles. Can we credit or blame the fit for this or is something else going on? Yeah,

that's a I mean, that's a really hard question. It's a question that we puzzled over for you know, literally years and years actually before the financial crisis, when profit margins were high, we spent a lot of time thinking about why those profit margins are Jeremy has put together again a pretty interesting mosaic as to why profit margins are high. That you have uh decreasing competition with an

industry that leads to higher profits. You have greater after citizens United, you have greater corporate influence in Washington, making it harder for new companies to come in UM, and so that there's I think there's qualitative reasons that we can come up with as to why profit margins are higher. We've tried to quantify those, and we've been less successful in uh in in being able to put data to that. UM.

I think it's something that we struggle to answer. We do as we think about our valuation models, we do

build in higher profitability assumptions for the US. But I also think it comes back to an observation you know that we made years ago, actually Jeremy Jeremy years ago, that the real medium wage in the United States hasn't moved in forty five years, and so the meaning real after inflation wages have been flat for half a century, half a century since the early sixties, and so um and I think so all of the you know, the benefits have approved that have have crued to capital rather

than labor, and that's allowed profit margins to be to be higher. Uh and I think that does present some pretty difficult issues for the for the economy in the long run. So I completely agree with that assessment, but I want to push back on a little bit because I've heard some interesting counter arguments elsewhere um and they go something like this, on a formation side, for a company, it's never been cheaper easier to get a laptop and

an Internet connection and suddenly you're in business. As even during the dot COM's you needed ten or twenty million dollars to build the back end infrastructure that literally a laptop provides today and a handful of of off the shelf web products. And that a lot of the new companies, UM be they Google or Facebook or um some of the other firms that are more digital than physical. You don't need giant factories, you don't need tremendous amounts of

capital you don't need huge pools of labor. You could be incredibly efficient, incredibly effective, and so of course Google should have a higher p ratio than Ford. Um. Uh, the same with Facebook. Shouldn't Facebook be worth more than U S Steel? Shouldn't we value shouldn't the return on investment be much higher for that? Maybe Amazon is a little different because they have so much physical facilities, and

Apple is its own sort of unique creature. Are we seeing more and more of the if not Google, but digital or low cost, low capital, low personnel companies, and therefore they should be more profitable and and our entire title to a higher pe or is that just an excuse for an overvalued Marita, Well, I think what you're saying is true. Uh. The the issue that we have with that is it is true for the technology sector. It is not true for the system as a whole.

And so as we value profits for the system as a whole. Uh, that is what is elevated. Tech is a part of it. But it's also true outside outside of tech as well. So aren't so. I I'm using my firm as an example, and I assume GMO has the same experience. The things you can do with again, a laptop and some software. Um, it doesn't requires as

much manpower as necessary. If we were to go back in time and I was gonna say, hey, you're going to manage seventy billion dollars, communicate with clients all over the world, and run a dozen different strategies across various hedge funds, mutual funds, s m A s down the list, you'd say, oh, well, that's a three thousand person entity,

and today it's it's a tiny fraction of it. So even out of outside of the Google's and the technico technology companies, aren't we all that much more effective and efficient thanks to technology? Or again is that just excuse making um, you know, it's just as you were, you know, giving that hypothetical. I just started thinking about how many more people that we have in compliance, and how complex our business has become, and the demands of clients are greater,

and how you deal with the data. You know that those issues. You know, so much data has been created in the last two years, Like how do you deal with that data? So you need people for that. So I think I think our world in general is becoming more complex and that is requiring additional resources in order to in order to combat that. You know, I think we have to work harder on the investment side. I

think you need more people. You think you need more smarter people in order in order to do that as well. You can run multiple portfolios and you can do it more easily, but that doesn't mean you do it as well. So one of the things you mentioned was when you're putting together a forecast, the risk management side is how and where might this be off and how can we anticipate in adjust for that. So when you look at this changing dynamic in in earnings UH and corporate profits,

how would you think you might be off? How might it be different this time? Usually the most expensive full words you can say, but there's no doubt the world is changing and technology and business is changing. What might that mean to future profit models? You know, the world has always changed, and so you know, if you think about a hundred years ago, how the economy has evolved over that over that time period, it's really been unbelievable.

And I think we would say that the normal required return to stocks has fallen through time because there's less volatility and economy, they're less volatility inflation. You have things like the sec You can debate whether the FEDS actually helpful or hurtful, but there's more institutional controls in the economy, and so that we do think that the required return to stocks has come down because they are inherently less

risky than they were. Honest friction as well to even execute something or or just go buy something is cheaper, fessed or easier exactly, So so it justifies a higher multiple. Now that the real question is are what how much? How much higher? And so if you think at multiple as a normal return for stocks, well then your long term expectations are pretty small. Your earnings yield is for there's some slippage in there between the earnings zeald and

what you receive. I don't know that many investors really think stocks are there to determine. You know, there there generate three reel so so you know, for us what was always there's the risk parity. Folks out there, we've always had a greater confidence in the equity risk premium.

We would rather have more of our portfolios associated with the equity risk premium because equities are inconvenient assets, so they go down at the time that you just you don't want them to as a recession as people lose jobs that as that hits, and so there should be a required way to return there. And so you can debate, you know, whether that is six or five or four.

But when you look at the market today and you know whether you value it based on historical assumptions or if you kind of valuated in new normal assumptions, you know, the US market just is so expensive no matter which way we slice it that it's just hard to justify these multiples. So what part of the world from an equity perspective is not expensive? We look at Japan, we look at Europe, we look at e M. What do you think are the most attractive regions where the valuation

is not as stretch as it is here. Yeah, e M is really the only game in town, and specifically e M value. So the value side of EM is the exact opposite of the ten cent and the baidu and the Ali baba. It is uh you know, it is Taiwani semiconductors, it's Russian energy stocks, it's Brazilian utilities, Turkish financials, it's a fairly Korean kiballs, it's a fairly motley motley group of stocks. But those value stocks are priced to deliver a significantly higher return round that versus

the rest of of the market. And we think about this, and we call this the margin of superiority. That how how cheap is the cheapest asset class versus the next cheap at cheap stasset class. And and normally you have two or three things that are within spitting distance of each other. But today e M value is is so by so far the most dominant in terms of its forecast that we've actually altered our portfolio construction to take a bigger bet on it because there are so few

other opportunities out there, really that that's quite fascinating. So I don't disagree that the US is pricy, but when we look around the rest, when I look around the rest of the world, Japan doesn't look that horrific, especially if you can hedge the currency. And Europe isn't the craziest it's been. It's it's had a nice move off

the lows. How do you see what's in between the US and and e M. Yeah, if of value, so kind of taking what you just send, just broaden it to EFA value is the next is really the next cheapest asset class outside of e M. It is uh, certainly relative to the U s ifa is. I think it's in the top death stile of attractiveness off versus the Europe Australia far East on a value basis right sorry on on just just S and P versus M, S C I EFA UM. And then you get some

premium for owning value on top of it. So so we still have of the portfolio and EFA value. Now it's not cheap and absolute terms, um, you know, we think it's it's worthy of having some space in an equity portfolio. Uh, it's hard to get you know, stand on the table, pound, you know, pound your fist, bullish on it. But we think that certainly relative to the US, you can get very bullish on it. Absolute terms, it's a little bit harder to get get excited about it.

But we think it's still worth a portion of your portfolio in benchmark free so priority it's M at the top, IF in the middle and and SMP far below far below. UM. So when we come back to this extended valuation, what do we blame more credit that that price? Are we are we over emphasizing the role of the Fed, is it other factors? Well, it's always fun to bash the FED,

at least at least in these in these halls. Um, you know, I give them full credit for their transparency, you know, BARRANKI went in the Washington Post and wrote wrote an op ed saying, Hey, we're trying to gin up the prices of these things. So but by the way, anybody who didn't read that and go out and buy equities really should not be managing. It's like when the FED chief says we want equity prices higher, you have

to pay attention to that. I did. What was that like the morning after that came out in these halls? Were people aghast and astonished that a FED chief actually said, Hey, strap yourself in, We're taking this higher. It's it was extraordinary. And you know, I think we have an inherent skepticism for central bankers and their ability to influence the economy and markets. But I think, you know, we did not

grasp that as quickly as some others did. You know, it took us a while for us to really internalize that and think about it within our framework. And that really was the genesis for kind of creating these hell forecasts. Which take into account the fact that financial repression can go on long enough that can really start to impact, you know, impact the cash flows and then the fair value, the fair value for equities. But it's you know it, the FED seems to continue to play a dangerous game.

Who knows what Powell will do. Maybe he's more hawkish, maybe he's got more of a business background versus the academics that have preceded him. Um, but it seems like, you know, the meaner version of profit margins, stocks trading

at higher multiples and normal kind of started. The green span continued with Bernanke yelling, you know, so if interest rates keep going higher, if if they normalize, if the FED successfully gets us too, I don't know, pick you poison three and three quarters, four and a half, whatever they consider normal, what should that do to valuation? I mean, stocks should be vulnerable under that scenario. We've certainly read and heard so much from the cell side over the past,

you know, five seven, nine years. Lower rates require higher multiples, So it will be interesting to see how they walk that back. They're always pretty good at giving a pretty elegant explanation as to why it's different, But it certainly seems like that would be a pretty key underpinning as to why you should justify paying you know, multiples similar

to these. Um, I think that, you know, as we were talking about before, the real concern is what happens with inflation, and that is the one thing that could really croak um, you know, all portfolios. And I think that's just that's the that's just the longer term wory. So I'm gonna I'm gonna focus on the concept of

financial repression for a moment. Over this period of financial repression, one valuation has been median priced to sales, and this has been not just elevated, but record highs for five or six years. What do you make of that as a value investor? Yeah, price to sales is an interesting one because there's not a we can't think about theoretical reasons why price to sales should mean revert. We think, really, yeah, it has historically. It's actually been nicely mean reverting historically.

But you don't you don't assume that's a requirement. No, it's it's it's it's it's your return on capital that should that should mean revert through time. So we're not quite sure what to make of it um. We used to run our models exclusively on price to sales because it was nicely comparable across regions. In across time, you don't have all the different gap accounting rules, and a lot of things change on some of the other metrics.

And if we were to continue just following a price to sales methodology, I think our forecast or minus eight or minus nine real for the SMP five. So we've diversified that into other what we think a reasonable proxies, and that has um. You know, those are expensive, but just not nearly as expensive as as price to sales.

So what do you end up as the forecast if you're using other valuation metrics as we kind of hot off the press, the forecast for US large assuming normal mean version is minus four point nine real a year for seven years. So I mean that that's definitely not built into anybody's asset allocation models. If we you know, we talked about that hellth scenario earlier, that that forecast is minus two real, so it's better, but it's still

a far cry from five or six. So if you end up with a big taking inflation, you could end up with flat markets over seven years and essentially zero return. That that's that's a not a forecast, but a significant probability. I think if you had a significant take in inflation, it would really do a number on PE. So Jeremy and Ben have this is something they call this comfort model, which is an explanatory model for current p s and it looks at the volatility of inflation, the volatility of GDP,

and the level of profit margins. And so if you do get higher inflation, I think that has an impact on profit margins, or at least Buffett thought in the seventies from inflation had a big impact on profit margins UM that that model would be perturbed and you would get a much lower a much lower multiple. And we saw in the seventies certainly that inflation really was scary for equity and bond investors. But I think inflation definitely your your multiple comes down. So let's talk a little

bit about UM investing in general. This is a topic that everybody is interested in UM. One of the things that you this office that GMO has to be on guard against is that what some people have called the danger of success. Obviously, the farm has been tremendously successful UM over a multi decade period. How does this affect the psychology here? How does it affect your outlook? Does it make you more cautious because you're protecting gains or is can the farm still be a risk taker and

an innovator despite all the success? Well, I feel like the market does a wonderful job of humbling you because you're very, very quickly. And you know, Jeremy has an expression that you always cry over spilt milk, and so I think part of our process is to ask questions as to you know, what we did, why we did what we did, what we didn't do, and why we did that and whether that's right. So I think that

process of self introspection is very important. I think having James Montier around, who's you know, an expert in behavioral aspects is U is very helpful. Um and you know, the game is hard, and so you know, figuring out whether you're in a bubble or not. You know, we have technical quantitative definitions, but it's much more nuanced than that. So there was a lot of success calling both the dot com bubble and the housing bubble. Do you run a risk of, hey, we've we've really built a reputation

as spotting these bubbles. Do you start to see bubbles everywhere? Is that a genuine concern? Um? I think I think that's an you know, there's a concern for any investor as to their process and what they're doing and whether things are different this time. And certainly if you believe, I mean we're version, things being different this time is

really the critical the critical question. So we spend an inordinate amount of time in what we would refer to as risk management as you know, where these forecasts can be wrong and how are things different this time? And it's you know there it's nuanced. Unfortunately, there's not you know, we can't quantify you know, all of these things there. It tends to be more art than science, although we

do want to reduce things to numbers. Um. But I also think having you know, people who have been around the block, like Jeremy and Ben is very helpful because you know, they've seen multiple cycles. So a lot of people like to make the claim they're contrarians. GMO has very much been a contrarian over the years. Uh, And that sometimes means being a little early. I don't want to use the word wrong, but it sometimes means, hey, this market is stretched. How does it affect interacting with clients?

How does effect forecast You start to recognize we're always early, We're gonna be a little early now, and we just have to write it out until um time proves us right or not. We certainly don't frequently refer to ourselves as contraring. What we refer to ourselves are value value investors. And it feels like people are tripping them over themselves to call themselves contraring these days. So, you know, kind of natural responses. You need to be a trend follower

in order to be in order to be contraring. It feels like, um, you know, I think you know, we try and design a process that we recognize that we tend to be early. We build some things into the process to try and help ameliorate that, but it is what we do. It is kind of the curse of a value investor. There's nothing worse than thinking something is cheap and not owning it and having it go up.

And so so you know, we try and be as transparent as we can with clients as to what we're doing and why we're doing it, so that they can kind of get to the finish line so that they can get to the finish line with US. When seven year real returns are expected to be negative for US large gap stocks and negative for US equities across the board, how do you discuss that with clients? Are they comfortable with the expectation? Don't look to the US equity side

of things for any real returns going forward. I think our mandre with clients has been owned as little U S equities as your committee or your career will allow. Uh that that that you know, they've just beaten the rest of the world by a hundred points, They've beaten you know, they've beaten em by a hundred and fifty points.

And you can look historically and see these cycles where US performs and then IFA outperforms, And we've just been through the period where we've had the greatest outperformance of the U stocks relative to the rest world in history. That well, that we've seen since the seventies where you

kind of have legitimate, legitimate data. And so we've got a lot of questions from clients in sixteen the beginning of sixteen saying, hey, this diversification sounds like, you know, sounds good in principle, but I generally before more more money to less like, what are we doing here? We're really not seeing the benefits of that. Now, there's less questions about that over the preceding two years, as IF

and EM have done have done much better. But um, you know, as we think about you know, benchmark free for instance. You know, we we owned a quality stocks in the US outright and then actually recently this year, we converted that to a long short. So we go long quality and we short the market against it. The only longs that we have are you know, IF value and e M Value at this point in the cycle. So let's talk a little bit about hedge funds since

you mentioned long short. After doing pretty well in the nineties and the early two thousand's, hedge fund performance has been fairly mediocre at least back to the financial crisis and certainly since the recovery. What do you make of that? Is that cyclical? Are we ever going to see mean reversion and head fund hedge fund performance or has the game changed? It was one thing when there was two hundred hedge funds and now there's twelve thousand. You'll never

see those sort of numbers again across the whole industry. Yeah, I think the game has changed, you know. I remember looking at some data from morning Star that you know, there was about a thousand hedge funds in two thousand or something like that, and it rose to seven or eight thousand. I don't know how many there are are today. It's over eleventh, is it over eleven thousand? And about of them disappear each year reform without the high water mark,

so they kind of rebooting. Apparently clients come along with them. Yeah, that's a dirty, dirty little secret of the hedge hedge fund industry. Well, you know, I think the game has changed for hedge funds. Although, you know, just like most things, like the pendulum swings too far the other way where people are kind of throwing the baby out with the bathwater. One of the things that we like about the profile of some hedge fund returns is that you are taking risk,

but you're doing with a shorter duration. So merger Arb is kind of the poster child for this. So you're trying to capture an equity risk premium. You're doing it, you know, our merger Ore portfolio, there's twenty to thirty deals. The average average duration of the deal is ninety days. If you do get that duration increase that we talked about earlier. You know, merger R may get hit, but it's going to hit a lot less than than something else.

So we think that diversifying hedge funds, particularly at this point of the cycle, are are reasonable activities to be thinking about for your portfolio. There's another question as to how much you should pay for them. I think the two and twenty model is under significant pressure, and certainly the fund of fund industry seems to have have gone, you know, the way of the dinosaur. Yeah. Yeah, that

that that becomes harder to justify. And I want to say that one and a half and fifteen seems to be the new two and twenty, But that's just no anecdotal um along the along the same lines as hedge funds. Uh, perhaps being a little cyclical. What do you make of the value under performance the past few years and doesn't remind you of any other periods? Yeah, values under performance has been brutal, particularly for US who tend to tilt

more towards value type strategies. Uh. It's magnitude is not as bad as it was in the dot com bubble, but the duration has been has been longer. So so we think that there's opportunities for certainly for value outside the US that we think is much cheaper than growth. We do think value is cheaper than growth in the US. However, we still think quality is more attractive, more attractive in

the US. UM, it's been a long cycle, you know, whether the rise of interest rates and inflation of value stocks they have kind of intrinsically a short duration, whether they do better in that type of environment, We're not sure, you know. I think that's that's tough to tell. I think that story makes sense, but we'd rather focus on the valuation, which which looks attractive, particularly in e M. And then finally, the question that you guys are perfect

to ask. UM. Everybody has been looking at the rise of indexing, being black Rock or Vanguard, what have you, And a number of people have ascribed indexing UM as a distorting factor and it's making price discovery more challenging and perhaps even contributing to this extended valuation issue. What what are your views on indexing and do you put any continents in any of this indexing or making things pricier.

I think as as the world comes more and more into the you know, does more and more indexing, Uh, the ability to find cheap stocks out there increases. So I think for active management, the more the world indexes, the better it becomes. There's nothing better than a cheap stock that stays cheap, because that you get the gift that keeps on giving, You keep getting that earning zeal, you keep generating the dividend yield um. You know, Bernstein has some great research on the you know, the asset

management industry. But but they I read a report they had, at least according to the SMP, there's over a million indexes now, which just seems like that's not that's that's not possible. Um, you know, I know Bloomberg ran a story last summer saying that they're more indexes than there are stocks. Well, in a couple of years ago, there were more mutual funds and stocks. Now there are more indexes than stocks. I recall I recall seeing that that same thing. So what does it mean? Does it? Does it?

Is it contributing to the evaluation conundrum? I mean, certainly that more people are investing indexes. That generates momentum, and I think that generates price inefficiencies. So, you know, for you know, for us who are largely quantitative in our equity investing, I think it presents some opportunity. Now we do need to work harder than we did ten years ago. You know, quant tools, smart beta, you know those things have been largely commoditized. So so I think you know

our f it's in quantitative. We've done a lot of work over the past several years with our models trying to uncover intrinsic value. We know we're less about AI and and and more about trying to discover the intrinsic values. So I think we have to work harder in that realm than we did historically. But I think that there's there's certainly more scope for ALPHAH than there was a couple of years ago. Thank you, Matt. This has been

absolutely fascinating. We have been speaking with Matt Kadner. He is a member of GMO's asset Allocation team and a value investor par Excellence. If you enjoy this conversation, be sure and stick around for the podcast extras. Will we keep the tape rolling and continue discussing all things asset allocation, valuation, hedge, fund etcetera. Be sure and check out my daily column. You can find that on Bloomberg View dot com. You

could follow me on Twitter at rid Halts. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. I'm Barry Reholts. You're listening to Masters in Business on Bloomberg Radio. Welcome to the podcast. Thank you Matt so much for doing this. Tell us the most important thing that we don't know about you. Um, I mean, frankly, I don't know that there's I don't know if I have anything. I don't know,

well what don't Okay, so let me rephrase it. Tell us the most important thing that friends and family who know you might not be aware of. Um. I'm probably more competitive than people realize. You know that there's a veneer of of trying to be calm and cool, but inside I, um, you know, I run pretty pretty hot. You want to win. That's what it's all about. I can't say I disagree. Um. Tell us about your your early mentors who helped guide your career. Yeah, you know,

I you know, like you. I kind of put the legal stuff to this aside because it was such a painful episode in my life. But you know, when I think about Putnam. You know, I had such valuable business mentors, So you know, Kevin Sullivan and Alex Nelson originally Rob job you know, in consultant relations, they were you know, such they were so formative, John Brown, who ran the institutional group, it was such a good group of people that there was a ton of things that we learned

from that I learned from them. And then you know, more recently, you know, it's really been Jeremy and Ben. You know, I found that the way we approached acid allocation in the world was so different than what I had learned in the c f A or kind of normal institutional investing. That that that that has just such such a profound influence on the way I think about returns.

And you know, if I would have known about the seven year forecast in or mean version, I mean, I think it could have would have been very interesting to say the least. Um who else influenced your approach to invest in UM? I mean that there are other kind of the the traditional value value folks out there. I think Ed Chancellor is also influenced. So Ed was a former colleague, although he still is engaged with the firm.

He's a financial historian, and he has a deep understanding of bubbles, and I think his historical approach is so helpful because there's so much rhetoric as to why it's different this time or elegant explanations as to why it's different, and his you know, understanding of history cuts across a lot of that in ways that Yeah, I just find so much more credible than you know, a sell side

generic self side report makes a lot of sense. Um. Everybody's favorite question, what are some of your favorite books, be they finance, nonfinance, fiction nonfiction, what do you enjoy reading and what books would you recommend other people should read. Yeah, on the finance side, you know, Anti Illman illmanin wrote a fantastic book called Expected Returns, where it's going to basically a finance textbook, and he goes through all of the asset classes and the risk premiums and he does

a wonderful job of laying those out. And I think that's a very good book. I did read, you know, years ago, at David Rosenberg's recommendation, a Diary of the Great Depression. It's about this lawyer Benjamin Roth in Youngstown, Ohio, and it was his diary, you know, contemporaneous diary of what the depression was like. And it was fascinating in that what he had to do to survive, you know,

in terms of a businessman, you know, bartering. I was amazed how he was worried about inflation over that time period. And it also struck me how much he looked at stocks, these blue chip stocks, and and how cheap he said they were, but he said he had no money to invest in them, and and how much money he could have made if he did put some capital to work. And I'm struck by today where you know, the concern for illiquidity is so removed, the private equity, direct lending.

You know, everybody's trying to lock up their money for ten years. You know, nine years ago we saw how important liquidity was, and today that seems to be a very much a backseat consideration. And I think about Benjamin Roth in that book. Huh, that's that's quite fascinating. What what excites you right now? It's a complicated environment. What do you find very interesting or exciting today? Um, I

think building a portfolio today is really hard. That you know, in O eight, at least on our numbers, it was pretty clear what to do. You should take as little risk as your career should allow. I think today it's much more difficult, it's much more complicated. And the the other aspect of it is the our business is evolving so rapidly. Where twenty or thirty years ago, you know, Jeremy and Dick Mayo and Ivanadolue they can focus on they could focus on defined benefit pensions and that's all

they needed to worry about. I mean, obviously today you know you can't do that. You know, define contribution. We know that their issues there the r A space, high net worth family office. How taxes impact that. I think that trying to solve the problems for clients is much more layered and intricate than it was even ten years ago. Quite quite interesting. Um, what are you looking forward to

as upcoming changes in the asset management business? What do you think is going to either shift or surprise us

going forward? So being part of a team that's done asset allocation for coming on thirty years, one of the things that I'm oppressed by the number of people who believe that they can do asset allocation today, and I wonder how many of those people were around in oh seven and oh eight, how many people were around in nine, in two thousand towards you get to the when you get towards the end of the cycle, everybody seems to be able to do this asset allocation thing quite easily.

And so you know, I am looking forward to the turn of the cycle and that kind of the shaking of the industry where where people, you know, people with skill will be differentiated from people who who really don't have skill. I'm trying, I'm trying to remember the book. It might have been Adam Smith's Money Game, where he's talking to a manager who's in his forties and he hires these young twentysomethings to run the portfolios because he said,

I couldn't touch any of this stuff. It's all terrible junk. But they're making money of it and from it, which is great for the farm. And as soon as the cycle turns, we'll we'll get rid. I don't remember if it was if it was Money, Money Game or um. It might have been Market Wizards, but it stood out as, yeah, I can't touch any of that, but they don't. They've

never lived through the cycle, so they don't know. It will be very interesting to see what happens when things go through the next substantial downtown and because they're always very different, and so so you know, the cause from this one is going to be different. How we come through it's gonna be different. What's going to be cheap

is going to be different. UM. And I think it's just you know, as you talk to clients, you talk to folks out there, you know, I think there's more a sense of like, oh, we do the asset allocation. You know, we'll listen to what you guys have to say. But but but we've got this, thank you, right. It's always amazing whenever I see UM, anybody writing something along the lines of everybody who's working on a trading desk today, UM, who started since filling the blank has not seen a

rising rate. Environment is not seen, Inflation is not seen. So if any of these things come back, everybody half of or more of the death step there would be experiencing things for the first time that that will be very interesting and there's always new lessons to be learned. And I'm sure some of the people will now navigate it it, you know, just fine. But UM does feel like it is late cycle in terms of the number

of people who claim that they can do it. Well, tell us about a time you failed and what you learned from the experience. Yeah, you know, when I when I was a lawyer, I was I was desperately trying to get out and I first in private practice and then you know, at LPL, and I can't tell you how many times I got to like the final round or the final person and I just didn't get the job.

And it was so frustrating and disheartening because I knew I wasn't doing what I enjoyed or what I wanted to do with with my life, and so, uh, you know, it was just that perseverance of like, listen, you know, there's a there's got to be a better way to do this, and so kind of keeping to push and and to kind of deal with that failure, but but keep you know, adapting and evolving to get to a point where, you know, I was excited about coming to

work every day. And I think that process was a long and difficult one, and much more difficult than I would have hoped. But I think it also gave me a greater pre creation for how incredible it is to be excited on a Monday morning to come into work. That's that's quite a uh happy answer. That that's a fulfilling answer. Um, tell us what you do for fun outside of the office, What what gets you side? Yeah,

I mean obviously the family. You know, we have three kids, thirteen year old boy, girl, twins and then um a nine year old daughter. Wonderful wife, wonderful family. That's a lot of fun. So we're going skiing in Vermont this weekend. Got lots of snow here in Boston up in the mountains, so skiing in the winter and then golf golf in the summer. What sort of advice would you give to a millennial or a recent college graduate who was interested in a career in either finance or asset allocation. I

it's it's it's reading. You know, it's reading and buffets compounding knowledge through time, and you just need to be a voracious reader. I would also say that certainly, you know, when I was in college, my understanding of, you know, being a portfolio managers is quite glamorous. I mean, it is a humbling, soul crushing it is a in many many times when you're not doing well, it is a miserable existence and so you really need to love it in order to kind of persevere and stay in the game.

And if you don't really love it, I would encourage you to find something that you really did, because I think it's impossible to be successful, certainly in this industry unless you you really love it and you can give it a hundred and ten. It can be that painful over over certain periods of the cycle. You just you just it's hard to get out of bed. That that that those are the times where it's actually hard to get out of bed. Thank you, Matt. This has been

absolutely fascinating. We have been speaking with Matt Kadner of GMO. If you enjoy this conversation, be showing look up an Inch or Down an Inch on Apple iTunes. Well you can see any of the other two hundred such conversations we've had. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. I would be remiss if I did not thank the staff who helps put together this weekly show. Uh. Michael Batnick is my head of research. Taylor Riggs is our

book or slash producer. Medina Parwana is our audio engineers slash producer par excellent. You've been listening to Masters in Business on Bloomberg Radio