This is Master's in Business with Barry rid Holds on Bloomberg Radio.
This week on the podcast, I have an extra special guest. I love finding these people who are just absolute rock stars within their space that most of the investing public probably is not familiar with, haven't heard about them. Maybe they're a little below the radar or institutionally facing, and so the average investor is unaware of them. You certainly are familiar with GMO. Jeremy Grantham shop with Mayo and Ottolou his partners. That shot was founded in nineteen seventy seven.
The person who heads their focus and quality strategies this gentleman named Tom Hancock. He also helps run some of their mutual funds and helped put together their first ETF and he as really quite an astonishing track record. The Quality Fund mutual fund that GMO runs, that symbol gq et X, it's just crushed it over the past decade, thirteen point six percent a year, way over both its index and its benchmark. It's in the top one percent of its peers Morning Star, five star, gold rated, just
really really interesting. And Tom has helped with the introduction of GMO's first retail product the Quality ETF stock symbol QLTY. GMO has been institutionals since they launched in nineteen seventy seven. This is the first time they're putting out a product for retail, and Tom explains what goes into quality stock selection, why they went to the ETF. You wouldn't be surprised to learn the tax consequences of owning a mutual fund
is a part of it. Really fascinating guy, tremendous track record, unusual background comes from computer science and software and pivoted into quantitative investing. I found this conversation to be really fascinating if you're at all interested in focused portfolios, the concept of quality as a sub sector, undervalue, and just how you build a portfolio, and a track record that's tough to be. I think you'll find this conversation as fascinating as I did. With no further ado my discussion
with GMOs. Tom Hancock, Thanks, Perry, it's great to be here. So you have a really interesting and unusual background. Let's start there. Computer science bachelors from RPI in eighty five, PhD in computer science from Harvard in ninety two. What was the career plan?
Yeah, well it wasn't doing investing quality stocks in the early days, that's for sure. I actually come from a very academic family. My father was a university professor. My mother worked as an editor. Her father had been a university professor. You have doctors in the family. I actually don't know that anyone in my family actually had a job at a private, for profit, traditional company. Ever, I'm the first, so I'm kind of the black sheep, So
that's where I started from. In fact, the fact that I actually went into computer science rather the more liberal arts discipline, was a little bit non traditional, let's say. And I think that was kind of an early wise decision that I give myself credit for. Is back in high school, I was really interested in history and stuff, but I didn't really want to be a historian, So it's like, what do I actually like to do as opposed to think was interesting? And that's where at the
time your computer programming was becoming a thing. I really loved it. That led me down that track, and really, while I had a software engineering job, I was always sort of pointing toward a research career. And then at some point after my PhD school studies, we could get into that if you like, but I kind of decided to switch, and finance was kind of what was available for me at that point.
Yeah, let's lead up to that transition. Software engineer at IBM, then you get your PhD. Then research at SEMENS, which seems to be more of a technological position than a finance position. What was your focus within tech?
I worked the area in which I studied in graduate school, and then worked at SEMENS, which, as you say, it's a research lab, think like Bell Labs, IBM, Watson, that kind of think tank environment. I worked on machine learning, which is a sub field of of course, artificial intelligence. So the nineties, Yeah, that was a nineties So artificial intelligence is a it's an area that's been around for a long time. I think the term was coined in
the nineteen fifties. But I was doing it, at least, I should say, working on a small part of it back in the nineties in graduate school is at a fairly theoretical way. A Semens who was with more applications in mind.
So, so how does the transition to finance take place? It seems like maybe you're going to tack into researcher academia. How did you find your way to both finance and GMO.
Yeah, so there's two parts of that. One is just sort of why not the academic track, and then by the finance part. So the why not the academic track was in academia, I was doing very theoretical stuff that was very maybe intellectually interesting, but understood by increasingly few people in the world. So I just sort of wanted to be something that was a little more relevant, and I thought maybe the research lab would provide that, and
for various reasons, it still didn't feel like that. So it was I was basically looking for something that was relevant. You know, I want to be loved like everyone white, So I want to do something that I can talk to people about and they don't want to be loved.
Do you want to go into finance? That's one or the other.
Well, so, at least the other with finance, which wasn't certainly an opportunistic element to that, Like what kind of industry he hires people that values fancy academic degrees that don't have necessary a lot of developed specific skills and finance, I said, management consulting is any of the other thing, at least at that time, was the other career trajectory. Just my personality more of an math oriented introvert. Finance
was the natural fit for GMO particularly. I got really lucky when I was in graduate school, so I was at Harvard. Harvard has a smaller computer science department. We do a lot down the river at MIT, and I went to a research group there. I was headed by Ron Revest, who's perhaps known to some as you are behind RSA cryptography, but he also worked in machine learning in this area. And he ran this research group of scruffy grad students and postdocs that I would go to.
But there was this one guy who came from downtown who wore a suit, and no one quite knew who he was. I asked, so, who's that guy? You think he's a banker, And he was a very smart guy. My mental image was that he worked in the back of a bank approving mortgage applications. He was really frushtra and this was his intellectual outlook. It turns out that was not what he was. He was a guy named Chris Darnell who was the start of the quantitative research
effort at GMO. He was Jeremy Grantham's right hand man in the early eighties, but he was just he also came for an academic family. He had broad interests. He came to this group. I'm not even quite sure how he found it, honestly, but in any case, when I was sort of casting around at places to look, that connection was rekindled and that was my entree into GMO.
Really really interesting. And you joined GMO in nineteen ninety five, you've been there ever since. That's kind of unusual these days in finance to stay with one firm, for Gee, it's almost thirty years. What makes GMO so special? What's kept you there for three decades?
It's been a great place to work, obviously, I've thought so. I think GMO felt very familiar to me when I joined as a smaller firm I think maybe sixty people at the time. It's very much of a intellectual debate, academic kind of vibe. It felt very comfortable to me, and the firm's grown. I've kind of grown with it. I think one of the things that kept me engaged is I've actually done different things, so kind of as we're alluding to, and as you'd think, my background is
very much on the quantitative side. Now I do fundamental side research portfolio management.
So you joined GMO, there's sixty people. Thirty years, they've grown tremendously. How big is GMO today versus when you joined, and what was that process like to experience all that growth?
Yeah, I think it's about five hundred people today. The book are in Boston, which is where I sit, but we have investment offices in San Francisco, in London, in Singapore and Sydney, Australia, so it's a global firm of the One of the things, these are things. When I started at GMO, it was really just investment people almost and all the sort of compliance, clients, service, legal kind of everything was done sort of on the side by investment people. And gradually we hired we professionalized.
Over time, you've become an enterprise. It's ten x what it once was in terms of headcount, it's much bigger in terms of assets. And I can tell you from personal experience US finance people, we're not great at accounting, legal, compliance, all the detailer and stuff that keeps a firm running.
The trick is we're not great, but we think we are. So that's where we get into trouble.
That's that's a lot that's really true. We hear a lot about Jeremy grantham thoughts on markets, but much less on how the firm is managed, how this growth came about, and the culture as a business. Tell us a little bit about GMO as a cultural enclave up in Boston.
Yeah. Well, one thing to start with there is the name GM and O and it's three people, and people know Jeremy Grantham, I think very well, but that Dick Mayo and Ike van Ottolou are the other two. And that's relevant to your question because from the very early days before I was there, they kind of operated separate investment teams. Dick Mayo was a traditional, i'd say, portfolio
strong portfolio manager focused on US stocks. Ike was similarly international stocks, and Jeremy is kind of the go everywhere, top down, big ideas guy, and that a bit of that culture. Dick and ike An both retire now, but a lot of that culture of different investment teams that do things a little bit differently is very much part of GMO. There is not one central view to the firm. Jeremy is a very strong, powerful persona and very deep thinker.
Jeremy's never really been a portfolio manager, his role has always been, in my experience, at least, it has always been much more of a gadflaw. He makes you think about things, he makes suggestions, he pushes you to come to your own conclusion. He leads you to watch. But he's not a hands on the portfolio person.
Huh. Really interesting. We had him down sometime last year, came by our offices and spoke, and I very much get the sense he has no interest in retiring. He loves what he does. He is very plugged into everything that's going on. He's gonna do this forever, isn't he?
That would be my guess. Yeah, I think he probably will outlast me in the industry. He is one of the smartest people I've ever met and one of the most driven people I've ever met. He has a I think and hope along professional life span ahead of him. I would say he is a little bit less focused on what you might call the day to day of investing at GMO, and he does a lot of stuff outside.
He's very involved with the Grantham Foundation, his charitable organization, both on their mission but also on the investing side of managing their portfolio.
So that raised a really interesting question. He's a big picture guy. He's always looking for what risks and what black swans might be coming at us that the investment community either hasn't found yet or isn't paying attention to. How do you translate that thirty thousand foot view as to what's going on in the world to something like quality and focused investing or is it really just there to sort of help you create a framework for looking at the universe.
Well, when I say he's a big picture guy, don't necessarily mean just that he's investing is to make macro calls. I mean more than he steps back from the fray a bit and thinks about the big ideas and what really matters, and that whole idea around quality investing. That's kind of Jeremy from the nineteen eighties early eighties and saying bangs say, hey, you know, I cut my teeth as he and Digmeo did on that traditional deep value investing.
But we're missing something here with these higher quality companies. How should we think about that? How can you invest about that? How can we improve our process? So that sort of philosopha call outside and around the box thinking is kind of what really led to us having a quality oriented strategy.
And quality is really a sub section of value. Is that is that what you're suggesting, it's.
An improvement of value or refinement on the definition of value. And people use these terms loosely, of course, and these all fall under the rubric of fundamental investing and buying companies that are great over long term at great prices. But the idea that companies that can compound at high rates of return and deserve premium multiples you should be willing to pay for them is the root of it.
The quality funds ticker gq ETX has returned thirteen point six percent a year over the past decade, putting it in the top one percent of its peers. So let's talk a little bit about what goes into that sort of performance. What are the core themes at GMO around focus and quality? Tell us a little bit about what differentiates GMO from the way other value investors invest.
If you're think about value investors, value investors traditionally are people who kind of know the price of everything and the value of nothing right. They're much too focused on ratios around trailing fundamentals and not on the plus side future growth opportunities. On the negative side, maybe competitive threat. So bringing the quality idea into that, thinking about what companies have a long trajectory to grow and to grow
at high return on capital, that's the key thing. Also differentiating between growth that's just sort of throwing money at the wall and seeing a little bit come back to you versus very efficient growth. That's the key to quality investing.
I could maybe flip that around a little bit since I think, particular post two thousand and two thousand and nine, the quality style of investing has become a lot more popular, certainly sending people talk a lot about the difference between our approach and a lot of quality managers is they're
really quality growth managers. So the quality but at a reasonable price, or you could interpret that is not just chasing the companies everybody knows are high quality, but finding a few maybe more neglected names That quality to reasonable price is a little bit of a different style than I see most people practicing out there.
So let's get into some of the definitions of this. How does GMO define quality?
Yeah, so we think about quality first off, the ability to deliver high returns on investment going forward. Then what enables that you have to have some asset ability, capability that competitors can't equally duplicate. I mean traditionally could have been like a physical asset or brand. Of course, these days in an IT world as much more about network effects of platform companies and such. But you have to
have that special sauce that's not reproducible. It has to be doing something that's relevant, Like you want to avoid the trap of companies that do one thing well and that thing's not growing, so they just try to do other stuff. And then management does also come into play. I do keep a strong balance sheet? Are you prudent? Do you invest when you should? Return capital when you should? And so as those assets, the relevance and then capital discipline are the key components for us.
Given that definition of quality, has that evolved or changed over time or has that been pretty much the definition going back to the eighties or nineties.
That's been pretty much the definition going back to the eighties and nineties. And I told you kind of the fundamental definition. There's also quantitative metrics that we look at. Those have evolved, but always within that capabilit cluster of high returns on investment stability across the economic cycle. Or consistent and strong balance sheets. What has changed over that period, too,
is what kinds of companies best meet that threshold. So if you go back to the eighties and nineties, we're talking about like the Cokes and Procter and Gambles and Johnson Johnson, right, and big consumer and healthcare and now those are still there, but a lot more of the big tech companies, the fang companies, more growth companies.
So for a long time it looked like Apple was a value stock, even as it became big and bigger than giants. But when we look at what people call the Magnificent seven, are you seeing any real value there? Companies like Microsoft and Nvidia and Netflix, I assume are quality companies by your definition, but are they quality at a reasonable price?
All the names you mentioned are quality companies, we believe, we don't all We don't hold all of them. It's the prices vary. If you think about Meta and Alphabet, those are kind of the value stocks.
And the band right there, well they got you laughed over the past couple of years before last year's recovery.
Yeah, and we also hold Microsoft and Apple. Apple is actually an interesting case study because we used them as an example of our investment at our investment conference fifteen years ago about what a high quality company isn't and then Steve Jobs turned the round in the iPhone and so forth with as the rest is history. The point is we were very wrong about them, and we were late to the party. But the party had such long it's such a long party that it's okay to be
late to it. You see. We still had a really good time with that company, which I think is a little bit of a lesson for quality investing. You don't have to be the first one in the door. There. These themes run for a long time, and if you're willing to admit your wrong and change your stripes is you can still make money.
So there were a few come at GMO, Warren Buffett were quote unquote late to Apple, but did exceedingly well with that. So you don't have to be at the there at the IPO, you don't have to be there when they crash in the dot com implosion. As long as the growth rate is there and the value is reasonable, there's an opportunity.
Yep. And speaking of the dot com employes like Microsoft, via a case study where we in previous strategies. We'd held Microsoft for a very long time. That's where the valuation could help us in the dot com bos So Microsoft now is thirty times earn it was over fifty in two thousand and I don't think it was a much better company than it's a pretty good company now. Rh there's great company. You have to at some point
be willing not to hold the stock. And yes, actually Microsoft by this point is outperformed since the peak of the cycle, but took a long long time for that to happen.
Well, the Boomer era was not where they really shined. New ceo seems to have done a great job over the past what is it five years the doll you's been there for.
Yeah, at least that I think at this point we held through the but and actually added in the Ballber era, So that would be our taking the view that at least in this case turned out to be right. That is something companies can fix if the core assets there, you know, the core network effects of everybody using their products, they're being so entrenched in IT systems departments around the world. That was still there. The easiest thing almost to fix.
As a CEO, So if his stock's training at thirteen times earnings and has all these great characteristics, and you think the CEO can change, that can be a great time.
To roll the bum out, bring someone else in, and the rest is history. So I love this quote of yours on the backwardization of risk. Quote. The expectation is that achieving higher returns requires taking more risk. But higher quality stocks have outperformed lower quality stocks by a considerable margin despite being less risky.
Explain, yeah, and that's that's a point that Jeremy Grantham kind of observed very long time ago and is emphasizing for a long time. And actually pen Inkers ahead of our a s allocation group, just wrote a very interesting piece on that too. This idea that at the big picture level, stocks versus bonds things kind of behave what you'd expect. You get more return, but there's more risk associated with it. But if you look within asset classes, that hasn't been true just empirically, Like why is it?
It's perplexing really that high quality companies which have been safer, right, they do better in recessions and such have you've not had to pay for that with lower return. And that's that was really the core of Jeremy's observation about quality stocks and why it's not just that quality is this silver bullet just beats the market all the time. I'm sure we necessarily believe that's true. But it does improve your portfolio with lower risk without having to give up return.
So the obvious answer is value makes a big difference within quality stocks. Is that what leads to the lower downside in a market dislocation? If you're buying it right, there's less room to fall.
Right in isolation, Quality on average gives you downside protection. Certainly did in two thousand and seven eight, for example, but then it didn't in when the tech bubble burst. It didn't last year in twenty twenty two, right. Then. The reason for that is a lot of the quality stocks are really expensive. So the trade off, compromise or combination of value in quality is what we think gives you that best downside protection, but without having to give up too much on the upside too.
Huh. So let's dive into the details of GMO's quality strategies. In twenty twenty two, core quality and quality value outperformed the S and P five hundred by a wide margin. Twenty twenty two was a down nineteen percent. I think in the S and P five hundred. But last year twenty twenty three, core quality and quality value slowed, but quality growth boomed somewhat different environment, and quality growth was where all the games were had. Is this a purposeful
style diversification within quality? How do you think about core quality, quality value and quality growth.
Yeah, when we think about the opportunity set for us of high quality companies, there are, as you say, really different kinds of companies within that quality is neither growth nor value, can find both within it. And so when we talk about quality growth, I think tech stocks, core quality, think defensive coke, consumer staples, value, think some of the
more cyclical names. We like the fact that there are high quality companies in all these areas, and generally we find them attractive, and we like the fact, as you point out, they tend to work at different parts of the market cycle. And so, yes, it is deliberate that we have exposure across these not that you know, if it's nineteen ninety nine, we're probably not going to have
much quality growth. So it's not a fixed allocation, but it does gives us diversification, and because we're familiar with stocks across this spectrum. It also gives us the ability to rebalance, and that's one of the things that we've been quite successful with over the last few years. Is not just that we hold both these kind of companies, but we've been leaning against the wind to buy the growth stocks. At the end of twenty twenty two, the
value stocks. More recently, just rebalancing has had a lot of value.
Really interesting. You mentioned Ben Anker, who I know publishes pretty regularly. You publish on a regular basis. Also, not too long ago, you put something out Quality for the Long Run, a little play on Professor Siegel's Stocks for the Long Run. Tell us a little bit about the valuation discipline quality investing offers and why that's so important when so many stocks have had such a great run up over the past couple of quarters.
Yeah, I think that's maybe a mistake I've made in my career has been too rooted in looking at what did well over the last few quarters, and if a stock did really well, thinking oh, it must be expensive. Whereas the reality of it, markets are efficient enough that the vast majority of our performance is driven by truly improved fundamental results. So we have to be with that
level of humility. I think the other thing to think about is that if you're a long term investor, getting the valuation exactly right matters less you know, they've beenessing. The entry exit point is less important if you're going to hold for five plus years, which is kind of what our ambition is to do with our stocks, But in extremists, which is the Microsoft in the two thousand example, and maybe some other AI related stocks today, it really
does matter. You really, like the long time where you have to hold to make up that valuation whole is so long that you just really shouldn't be involved. It's kind of basical philosophy.
Another research piece you put out I found kind of intriguing Quality investing for greed and fear. Explain that.
I mean, the fear part is kind of what we've been talking about, like if you're worried about market downturns, quality is a good sleep at night investment. And I think I laugh about is every time we think about writing an annual letter or something like that someone wants to write and these uncertain times that we're now in today, it's like, yeah, when is that not ever been the case? Right? The people are always worried, and so quality is always
good for that constituency. The only thing I'd say is if when those worries come to pass, if you hold quality stocks that you really believe in, you're less likely to sell at the wrong moment. So there's that psychological advantage to them that goes beyond just statistical analysis of return periods over time. And the greed is the quality is not just a defensive portfolio. If then, of the market's going down, you hold cash, right, you don't hold
high quality stocks. So the greed part is that high quality companies do participate in the upmarket. And so if you think, you know, AI is a great thing, if you think GLP ones are fantastic, if you think there's innovation going on all around the world and you want to participate in it, we think high quality companies are a great way to do that.
I have a recollection, and I think it was the onion Our long national nightmare of peace and prosperity is finally over was a two thousand headline, and it's true, how often can you say, well, thank goodness, we live in times where there's no uncertainty and everything is rational.
When we say that run for the hills.
That's exactly right. GMO has released last quarter their first retail product, an ETF. I love the symbol qlt y. Let's talk a little bit about the ETF and the thinking behind it. GMO has almost exclusively had institutional investors, very high networth family offices. I mentioned the quality mutual funds. That's a five million dollar minimum. What was the thinking behind, Hey, let's do an ETF that anyone could buy for fifty BIPs no minimum.
Yeah, you're exactly right. GMO has been an institutional manager. We started in the endowments and foundation space and have gone from then. But as you also said, institutional includes increasingly family offices and wealthy individuals who pay taxes, and so just structurally, the ETF is such a better vehicle to pool clients, and GMO has always been an advocate
of pooled investing. You get that, We think is that good a solution, and it allows more portfolio manager focus, not to have separate accounts, and so really the launch, the genesis of having an ETF for us was less about entering the retail market or accessing different clients, and more about better servicing the institutional tax paying clients. That said, we have a lot of respect for individual investors. I
think they get a bum wrap among institutional managers. Individual investors can be very sophisticated, discerning, thoughtful, and it's not a segment of the market we want to shy away from, other than just the operational complexity of having lots of small clients, and there the ETF market is matured to a point where we don't really face that complexity, and so we're glad to be able to be a lot
more accessible. The other thing i'd say about ETFs, and they've been on our radar screen for a while, of course, but originally they were for no particular reason, but kind of associated with passive or more commoditized quantitative factor strategies. It's really over the last few years that an active strategy in an ETF has been something people would pay any attention to.
So I mentioned previously the GMO quality mutual funds top one percent of its peers thirteen point six percent a year for the past decade. How does the quality ETF strategy differ from the mutual fund strategy.
Not very much. It's the same investment process, philosophy, team and everything. The one simplification we've made for the ETF is it only we only invest in US companies. So the quality fund is global's opportunity set has had up to twenty percent in non US domicile multinationals, think like the nesls of the world, that kind of company. Whereas the ETF is designed to be a more straightforward S and P five hundred US only equity strategy.
And it's concentrated thirty five large cap stocks. Is it limited to what's in the S and P five hundred or is it any US stock?
It's not limited to the S and P five hundred. What we'd like tends to be large cap to established, great businesses. So I think it is in fact all stocks are in the S and P five.
Hundred and fifty BIPs is not an unreasonable fee structure for an actively managed fund. Tell us the thinking behind this why go? I wouldn't call it a low cost, but it's not a high cost ETF. Some of the other active ETFs are a one hundred BIPs or more. What was the thinking that, Well.
We're pricing it similar to how we price our institutional accounts. As I mentioned a lot of our I think initial funds have come from tax paying investment advisors and such. You might have a choice which to use. We wanted to make that a not feed driven choice, but is picking the right vehicle. Another reason why we can keep
the costs low is these are very liquid stocks. It's not really capacity constraint around these, so it's not like we have to charge an exceedingly high rate to be a profitable business.
And how often do those thirty five stocks turnover? Is there any Hey, we're going to rebalance this once a year or once a quarter, or is it driven on whatever opportunities the quality stock team you work with decides we're gonna get.
Rid of X and replace it with Yeah, there's no calendar to it. It's driven by the opportunities as we see them. If we think about the mutual fund, and I don't think there would be any different here. We've been running turnover about twenty percent a year for the last few years, which consistent with my remarks earlier. When we buy a company, we're thinking about holding it for quite some time. In fact, probably about half that turnover.
It's not so much new stocks entering or stocks exiting, is more rebalancing around valuation moves in the portfolio.
I love the tick of qlty. It's amazing that was even available this late in the ETF world. How did you guys start first thinking about we have clients paying all this phantom tax on the mutual fund side. ETFs really seem to be much more efficient from a tax perspective. Tell us a little bit about the discussions that led up to let's create an ETF.
I'm acutely aware of the tax issues as I put the bulk of my investing in our own strategies too, including the mutual fund. Now I'm invested in the ETF. I think it would go back over a decade. Like we were well aware of ETFs for a very very long time, and while we got the best ticker out there, there are there qual the ETFs out there, which your advisors were talking to us as competitors. So we're kind of looking at the competitive landscape and seeing, Hey, what
do they do that's different from what we do? Why do we think our approach is better and we're more fundamental, we have the valuation, et cetera. There are a lot of differences. Felt like now was the time, I think largely because of the rise of active ETFs versus pure passive ones.
Now, this obviously isn't the exact same holdings as the Quality Funds mutual fund, but I'm going to assume they'll track pretty closely over time. It's the same process. It's some of the favorite ideas from quality go into the ETF. Can we expect similar performance from this?
Yeah? My expectations they won't differ is that we've never held more than twenty percent in non US stocks, and all the all the US stocks we hold in the fund we also hold in the ETF at similar weights. They are a couple of new names, so it's not just a carve out, but it's very, very similar in characteristics.
So, I know GMO has a variety of offers. You do equities, alts, fixed income. How does the quality screen work with other asset classes besides equities? Can you do that with alts? Can you do that with fixed income? Or is it just specific to value stock investing?
Focusing on quality characteristics as well as valuation and sort of quality at a reasonable price sort of big picture is an idea that cuts pretty much across all of GMO's strategies and the different asset classes in which we invest Of course, it means different things. If you're running a merger arms strategy with a short horizon, then long
term buy and hold investing like quote we do. But that's there another thing to think about that sort of unite GMO is a firm, is that a lot of our clients come through the door, if you will, in our multi asset class solutions we call ass allocation at GMO.
So a lot of the strategies that we've developed over the years at GMO, originally the quality strategy derived from us Jeremy and team Ben Anker and others seeing a top down opportunity in the market US forming a strategy if that's a conventional asset class or at the time a new asset or subasset class like quality investing. That's
how a lot of what we do get started. It's why we kind of have a complicated lineup for firm our size, But that does impose a certain i think, intellectual consistency on how we think about the world.
So given the success of this first ETF, and given this expertise in all these different areas, the obvious question is what's the next ETF that's going to come out of GMO, or are you guys good with quality and you're not looking for any other retail products.
Well, I'm not going to break news on your podcast, but I think, yeah, we do one with the idea certainly that we might do more.
If this continues to be successful. All these other asset classes that GMO plays in, some of them are really.
Ripe for any Yes, some more ripe than others. But I think there's a lot of opportunity out there. Maybe another way of asking that question is why did we start with this one? And there are a couple obvious reasons. One it is our largest strategy, but another it is US equities, which are kind of the simplest, most liquid asset class. They fit well for the transparency you have an ETF structure, it's the easiest to do the market making around them. So it was a very obvious place for us to start.
So the mutual fund is about eight billion dollars or so. Is there any limitation on how big the CTF can get? I'm assuming it's all large cap US stocks. Doesn't seem like there are a lot of constraints on how large this can scale.
Yeah, not practical constraints, of course, there's a constraint for everything, but we'd be talking about tens of billions of dollars where capacity would be.
Huh, really interesting. So let's talk a little bit about what's going on in value today. I'm impressed by this quote of yours and really curious if it's still true. US deep value stocks are unusually cheap in the US market. In particular, the cheapest twenty percent look cheaper than they ever have in ninety eight percent of the time through history. That's really surprising. And I keep hearing about how expensive stocks are. The bottom quintile of value is as cheap essentially as it ever gets.
Yeah, that's a quote that's coming out from our asked allocation team about how they think about positioning equity portfolios. To be maybe nuanced about that we're talking about is the valuation of that relative to the overall market. So it's kind of two sides of the same point. It's not so much that cheap stocks are really really cheap. It's that the spread of valuation ratios is very wide, So.
The non value stocks are very expensive.
And frankly, I think that is where most of the action is. It's the non value stocks are trading it much higher multiples than they normally have. And when we say deep value, it's almost like to people talk about indus because they divide the world fifty to fifty. There's no magic to that. I think right now, market cap sense market concentration. There are a lot more growth stocks.
So to find the true value stocks and making air quotes, you kind of have to go a little bit deeper into the percentiles of market cap than you would typically.
And when we're talking about value, you're still discussing with the quality overlay. So you could have quality stocks and the least expensive quality stocks on a valuation basis relatively attractive, but maybe not absolutely attractive. I don't want to put words in your mouth.
Yeah, may you apologize for confusing terminology on our part, because when we say deep value any people often think just the lowest price to book stocks out there. In the GMO terminology, that's deep value on a measure of what we call intrinsic value that blends a hefty version of quality into that. So that will include some stocks you hold in the quality and think metas of the world companies like that.
Gotcha? So I get the sense you guys don't pay a whole lot of attention to the macro economy or geopolitics or what the Fed's doing. How important are these other aspects to the way you manage assets?
Not that important. I think the thought experient for us is if this is something that feels cyclical, that isn't going to affect where the world's going to be five years from now, then we're only going to pay attention to it to the extent that if something happens, we react to it like it can create a dislocation. Right, people might overreact to an interest rate move in our opinion, but we're not going to try to forecast it or pick stocks based on that. You did mention geopolitics in
that list. Politics is in my mind a little bit different. And the reason that's a little bit different is I'm not sure that's going to be solved five years from now, right, that could get worse, or the trends that we're on are different from where we've been in the last twenty or thirty years. So that is say, of those things, the one for a scratch our head a little bit more. Not that I'm going to claim we have the answers there, but it is front of mine for us.
How do you think about interest rate risk or inflation or the whole transitory versus sticky debate. Does that become a key part of the asset allocation discussion or is it just kind of background noise that everybody else to deal with.
More background noise. Jim O is kind of famous for doing seven year forecasts, right, And the reasons we do seven year forecasts is that's sort of the horizon where we feel like, whatever the noise is that's going on now, that'll kind of all be gone. So the philosophy behind those is, eah, seven years from now, things will be kind of normal, and I'm not sure what the path is to get there, but if that's where they're going, this is what that would imply about returns over that horizon.
And one of your recent notes you mentioned Jeremy Grantham's super bubble thesis. How do you work in quality as a core equity allocation within the concept that, hey, maybe there's a super bubble going on out there? Is that consistent?
Yeah, I'm a humble portfolio manager works from the bottom up, so I'm not really thinking about super bubbles very much. Honestly, I'm thinking about. Are these stocks that we're investing in good quality business price to deliver a good return, and good I mean sort of double digit type return over the next five ish years. So if it turns out this is a super bubble, and I think Jeremy's technical definition of that is a very very big bubble, then
quality stocks are going to go down. We'll have been wrong to invest in them. The silver lining is, at least we'll have done better than pretty much anything else out there.
Quality will go down less than the rest of the.
Indices, particularly quality with a sense of valuation.
All right, so let me jump to my favorite questions that I ask all of my guests, starting with what have you been streaming these days? What's been keeping you entertained, either video or audio.
I have a twelve year old daughter, and she runs the family with an iron fist, and she likes to still watch TV together. So I've been watching a lot of Survivor episodes. Though unfortunately I actually like those, She's moving on to something else now that I like less. Well, I won't call it out in terms of I listened to a lot of pod cast too. That's where I get a little more sort of I'm sort of embarrassed to say it, but professionally takes a little bit of
the place of reading. I love econ Talk, which is sort of theoretical economics debate podcast for fun. I love Judge John Hodgman. There's all kinds of things out there. It's a great world.
Yeah, no, it really is. So let's talk a little bit about your career. Who were your early mentors who helped shape the path you've taken professionally.
I think in my case, law of the mentors come through kind of my academic career and teachers and professors going back and my high school math teacher, mister Hyde. He was the one who taught the computer programming course. He's the one who sort of encouraged me to take college courses when I was in high school. He also taught me Bridge, which is I don't really play that much anymore, but it is a great game, and let you think a lot of that things in a great way.
My PhD advisor at Harvard less Valiant, i'd also pick out. I mentioned Chris Darnell at GM. Rob Soussi was the name of my first manager there. He was a very wise, wise man. If I think about one of the things I gained from these people, to particular the professional ones. It's kind of when to be willing to say no to stuff too. My colleagues now wouldn't believe it, but I used to be probably over accommodating, and maybe I've learned that lesson a bit over learned it.
What are some of your favorite books? What are you reading currently?
Well, this is the holiday time. I just came back from a long playing flight and I read this really fun detective book that my wife gave me for Christmas. But then I was reading a biography of Samuel Sewell, who's one of the judges at the Salem witch Trials. Actually saw a colonial era figure. It's an interesting book to learn about that era. My favorite book of all time, and it is not even close, is a children's book called The Land of Green Ginger, which is written by
the screenwriter the original Wizard of Oz movies. It is a heirical, clever take on the kind of the PostScript to the Aladdin myth from the Arabian Nights, and I recommend all of your listeners if they can find it, which is easy read that book.
Huh, really interesting? What sort of advice would you give to a recent college grad interested in a career in investment and finance.
So investment finance is actually a very broad area. So the first advice is kind of narrow that down. And the west way to narrow it down is to get exposure to lots of different things. And I think the best way to enable yourself to get exposure is don't focus so much on finance and investment. Just figure out about learning. Learn all sorts of things. Learn math, learn history.
You can always learn a trade after that. Don't think, oh, I'm interested in finance, so I'm just going to spend all my time listening to investment podcasts and I'll answer or non tecular ten ks.
I don't imagine that anyone's going to listen to a couple of dozen podcasts and so only begin to outperform the benchmarkt It's a little more nuanced than that, isn't it.
I think all the great investors talk about reading and how much of their time they spend reading and just learning, and I think that is one of the things I like about the investment industry is you just spend so much of your time just learning about how businesses work. How the world works. You're kind of an observer. You're kind of a miserable critic rather an actual creator of value, but an analyzer of others work.
It's almost academic adjacent, given how much reading there is. And our final question, what do you know about the world of investing today? You wish you knew thirty years or so ago when you were first getting started.
That appreciation of quality businesses and the value to pay for them. I come my mindset is a little bit more contrarian, and I think from an investing perspective that manifests itself much more in a value orientation or value meaning low multiple underperforming socks cigar butt of philosophy, and I think realizing the value of time and compounding and it's just worth paying up for a higher quality business.
To say the very least, thank you Tom for being so generous with your time. We have been speaking with Tom Hancock, head of the Focused Equity team at GMO. If you enjoy this conversation, well check out any of the previous five hundred interviews we've conducted over the past nine years. You can find those at iTunes, Spotify, YouTube, wherever you find your favorite podcasts. Sign up from my daily reading list at ridults dot com. Follow me on
Twitter at rid Halts. I would be remiss if I do not thank the crack team who helps us put these conversations together each week. My audio engineer is Kaylie Laparo. Attika of albrun is my project manager. Sean Russo is my head of research. Anna Luke is our producer. I'm Barry Ridholts. You've been listening to Masters in Business on Bloomberg Radio.