0:02

This is Master's in Business

0:04

with Barry rid Holds on Bloomberg

0:06

Radio.

0:10

This week on the podcast, I have

0:12

an extra special guest. I

0:15

love finding these people who are just

0:18

absolute rock stars within their

0:20

space that most

0:22

of the investing public probably

0:24

is not familiar with, haven't heard

0:26

about them. Maybe they're a little

0:28

below the radar or institutionally

0:31

facing, and so the average investor

0:33

is unaware of them. You certainly are familiar

0:36

with GMO. Jeremy Grantham shop

0:38

with Mayo and Ottolou

0:41

his partners. That shot was

0:43

founded in nineteen seventy seven. The

0:46

person who heads their

0:48

focus and quality strategies

0:51

this gentleman named Tom Hancock. He

0:53

also helps run some of their mutual

0:55

funds and helped put together their first

0:58

ETF and he as

1:00

really quite an astonishing track

1:02

record. The Quality Fund mutual

1:05

fund that GMO runs, that symbol

1:07

gq et X, it's just crushed

1:09

it over the past decade, thirteen

1:12

point six percent a year, way

1:14

over both its index and

1:17

its benchmark. It's in

1:19

the top one percent of its peers Morning

1:21

Star, five star, gold

1:24

rated, just really really

1:26

interesting. And Tom has helped

1:29

with the introduction of GMO's

1:31

first retail product

1:34

the Quality ETF stock

1:36

symbol QLTY. GMO

1:39

has been institutionals since they launched in

1:41

nineteen seventy seven. This is the first

1:43

time they're putting out a product

1:46

for retail, and Tom explains

1:49

what goes into quality stock

1:51

selection, why they went to the

1:53

ETF. You wouldn't be surprised to learn

1:56

the tax consequences of owning a mutual

1:58

fund is a part of it. Really

2:01

fascinating guy, tremendous track record,

2:03

unusual background comes

2:06

from computer science and software and

2:08

pivoted into quantitative investing.

2:12

I found this conversation to be really

2:14

fascinating if you're at all interested

2:16

in focused portfolios, the

2:19

concept of quality as a

2:21

sub sector, undervalue,

2:24

and just how you build

2:27

a portfolio, and a track record

2:29

that's tough to be. I think you'll find

2:31

this conversation as fascinating

2:34

as I did. With no further ado

2:36

my discussion with GMOs. Tom

2:39

Hancock, Thanks, Perry, it's great to be here.

2:42

So you have a really interesting and

2:44

unusual background. Let's start there.

2:46

Computer science bachelors from

2:49

RPI in eighty five, PhD

2:52

in computer science from Harvard in ninety two.

2:55

What was the career plan?

2:57

Yeah, well it wasn't doing investing

3:00

quality stocks in the early days, that's for sure.

3:03

I actually come from a very academic

3:05

family. My father was a university

3:07

professor. My mother worked

3:09

as an editor. Her father had been a university professor.

3:12

You have doctors in the family. I actually don't know that

3:15

anyone in my family actually had a job at

3:17

a private, for profit, traditional

3:19

company. Ever, I'm the first,

3:21

so I'm kind of the black sheep, So

3:24

that's where I started from. In fact, the

3:26

fact that I actually went into computer science

3:28

rather the more liberal arts discipline, was

3:30

a little bit non traditional, let's say.

3:32

And I think that was kind of an early wise

3:35

decision that I give myself credit for. Is

3:37

back in high school, I was really

3:39

interested in history and stuff, but I didn't

3:41

really want to be a historian, So it's like,

3:43

what do I actually like to do as opposed to think

3:45

was interesting? And that's where at the time your

3:47

computer programming was becoming a thing. I really

3:50

loved it. That led me down that

3:52

track, and really, while

3:55

I had a software engineering job, I was always sort

3:57

of pointing toward a research career. And

3:59

then at some point after my PhD

4:02

school studies, we could get into that if you

4:04

like, but I kind of decided to switch, and finance

4:06

was kind of what was available for me at that point.

4:08

Yeah, let's lead up to that transition.

4:10

Software engineer at IBM, then you get

4:12

your PhD. Then research

4:15

at SEMENS, which seems to be more of a technological

4:18

position than a finance position. What

4:21

was your focus within tech?

4:24

I worked the area in which I studied

4:26

in graduate school, and then worked at SEMENS,

4:28

which, as you say, it's a research lab, think like

4:30

Bell Labs, IBM, Watson, that kind of think

4:33

tank environment. I worked

4:35

on machine learning, which is a

4:37

sub field of of course, artificial

4:39

intelligence. So the nineties,

4:42

Yeah, that was a nineties So artificial intelligence is a

4:44

it's an area that's been around for a long time. I think the term

4:46

was coined in the nineteen fifties. But I was

4:48

doing it, at least,

4:50

I should say, working on a small part of it

4:53

back in the nineties in graduate

4:55

school is at a fairly theoretical

4:58

way. A Semens who was with more applications

5:01

in mind.

5:02

So, so how does the transition to

5:04

finance take place? It seems like maybe

5:06

you're going to tack into researcher academia.

5:10

How did you find your way to

5:12

both finance and GMO.

5:14

Yeah, so there's two parts of that. One is just sort of

5:16

why not the academic track, and then by

5:19

the finance part. So the why not the academic

5:22

track was in academia,

5:24

I was doing very theoretical stuff that was very

5:27

maybe intellectually interesting, but understood

5:29

by increasingly few people in the

5:31

world. So I just sort of wanted to be

5:33

something that was a little more relevant, and I

5:35

thought maybe the research lab

5:37

would provide that, and for various reasons,

5:40

it still didn't feel like that. So it was I was basically

5:42

looking for something that was relevant.

5:45

You know, I want to be loved like everyone white, So I want to

5:47

do something that I can talk to people about and they don't want

5:49

to be loved.

5:49

Do you want to go into finance? That's one or

5:51

the other.

5:52

Well, so, at least the other with finance,

5:54

which wasn't certainly

5:56

an opportunistic element to that, Like what

5:58

kind of industry he hires people

6:01

that values fancy academic degrees

6:04

that don't have necessary a lot of developed

6:06

specific skills and finance, I

6:08

said, management consulting is any of the other thing, at

6:10

least at that time, was the other career trajectory.

6:13

Just my personality more of an math

6:15

oriented introvert. Finance was the natural

6:18

fit for GMO particularly.

6:20

I got really lucky when I was in graduate

6:23

school, so I was at Harvard. Harvard has a

6:25

smaller computer science department. We do a lot down

6:27

the river at MIT, and I went to a research

6:30

group there. I was headed by Ron Revest,

6:32

who's perhaps known to some as you are

6:34

behind RSA cryptography, but he also

6:36

worked in machine learning in this area.

6:39

And he ran this research group of scruffy

6:41

grad students and postdocs that I would

6:43

go to. But there was this one guy who came from

6:46

downtown who wore a suit, and no one

6:48

quite knew who he was. I asked, so, who's that guy? You

6:50

think he's a banker, And he

6:53

was a very smart guy. My mental

6:55

image was that he worked in the back of

6:57

a bank approving mortgage applications. He

6:59

was really frushtra and this was his intellectual outlook.

7:02

It turns out that was not what he was. He was a guy

7:04

named Chris Darnell who was the start

7:06

of the quantitative research effort at

7:08

GMO. He was Jeremy Grantham's

7:10

right hand man in the early

7:12

eighties, but he was just he also

7:14

came for an academic family. He had broad interests.

7:17

He came to this group. I'm not even quite sure

7:19

how he found it, honestly, but in any

7:21

case, when I was sort of casting around at places

7:24

to look, that connection was rekindled

7:26

and that was my entree into GMO.

7:28

Really really interesting. And you joined GMO in

7:30

nineteen ninety five, you've been

7:33

there ever since. That's

7:35

kind of unusual these days in finance

7:37

to stay with one firm, for Gee,

7:39

it's almost thirty years. What makes

7:42

GMO so special? What's kept you there

7:44

for three decades?

7:46

It's been a great place to work, obviously, I've

7:48

thought so. I think GMO felt

7:50

very familiar to me when I joined

7:53

as a smaller firm I think maybe sixty people

7:55

at the time. It's very much of a intellectual

7:59

debate, academic

8:01

kind of vibe. It felt very comfortable

8:03

to me, and the firm's grown. I've kind

8:05

of grown with it. I think one of the things that

8:08

kept me engaged is I've actually done

8:10

different things, so kind of as we're alluding to, and

8:13

as you'd think, my background is very much on the quantitative

8:15

side. Now I do fundamental side research

8:17

portfolio management.

8:20

So you joined GMO, there's sixty people.

8:23

Thirty years, they've grown tremendously.

8:25

How big is GMO today versus

8:29

when you joined, and what was that process

8:31

like to experience all that growth?

8:33

Yeah, I think it's about five hundred people today.

8:36

The book are in Boston, which is where I sit, but

8:38

we have investment offices in

8:41

San Francisco, in London, in

8:44

Singapore and Sydney, Australia, so

8:46

it's a global firm of the

8:49

One of the things, these are things. When

8:51

I started at GMO, it was really

8:54

just investment people almost

8:56

and all the sort of compliance,

8:59

clients, service, legal

9:02

kind of everything was done

9:04

sort of on the side by investment

9:06

people. And gradually

9:08

we hired we professionalized.

9:10

Over time, you've become

9:12

an enterprise. It's ten x what it once was

9:15

in terms of headcount, it's much bigger

9:17

in terms of assets. And I

9:20

can tell you from personal experience US

9:22

finance people, we're not great at

9:25

accounting, legal, compliance, all

9:27

the detailer and stuff that keeps

9:29

a firm running.

9:30

The trick is we're not great, but we think we are.

9:32

So that's where we get into trouble.

9:33

That's that's a lot that's really true.

9:36

We hear a lot about Jeremy grantham thoughts

9:39

on markets, but much

9:41

less on how

9:43

the firm is managed, how this

9:45

growth came about, and

9:47

the culture as a business. Tell us a

9:49

little bit about GMO as

9:52

a cultural enclave up

9:54

in Boston.

9:55

Yeah. Well, one thing to start

9:57

with there is the name GM and O and it's three

9:59

people, and people know Jeremy Grantham,

10:01

I think very well, but that Dick Mayo

10:03

and Ike van Ottolou are the other two.

10:06

And that's relevant to your question because from the very

10:08

early days before I was there, they kind

10:10

of operated separate investment teams.

10:14

Dick Mayo was a traditional, i'd say, portfolio

10:16

strong portfolio manager focused

10:18

on US stocks. Ike was similarly

10:20

international stocks, and Jeremy is

10:22

kind of the go everywhere, top down, big ideas

10:25

guy, and that a bit of that culture.

10:27

Dick and ike An both retire now, but a lot of that

10:29

culture of different investment

10:32

teams that do things a little bit differently is

10:34

very much part of GMO. There

10:36

is not one central

10:38

view to the firm. Jeremy is

10:40

a very strong, powerful persona

10:45

and very deep thinker. Jeremy's

10:47

never really been a portfolio manager,

10:50

his role has always been, in my experience, at least,

10:52

it has always been much more of a gadflaw. He makes

10:54

you think about things, he makes suggestions,

10:57

he pushes you to come to your own conclusion.

10:59

He leads you to watch. But he's

11:01

not a hands on the portfolio

11:03

person.

11:04

Huh. Really interesting. We had him

11:06

down sometime last year, came by our offices

11:08

and spoke, and I very much get

11:11

the sense he has no interest

11:13

in retiring. He loves what he does. He

11:16

is very plugged into everything

11:18

that's going on. He's gonna

11:20

do this forever, isn't he?

11:23

That would be my guess. Yeah, I think he probably will

11:25

outlast me in the industry. He is

11:28

one of the smartest people I've ever

11:30

met and one of the most driven people

11:33

I've ever met. He has a

11:35

I think and hope along professional

11:37

life span ahead of him. I would say he is a

11:39

little bit less focused on what you might call

11:42

the day to day of investing at GMO, and he does

11:44

a lot of stuff outside. He's very involved

11:46

with the Grantham Foundation, his charitable

11:48

organization, both on their mission

11:50

but also on the investing side of managing their portfolio.

11:53

So that raised a really interesting question.

11:55

He's a big picture guy. He's

11:57

always looking for what risks and

11:59

what black swans might be

12:02

coming at us that the investment community

12:04

either hasn't found yet or isn't paying

12:06

attention to. How do you translate

12:09

that thirty thousand foot view

12:11

as to what's going on in the world

12:14

to something like quality and

12:16

focused investing or is it really

12:19

just there to sort of help you create

12:21

a framework for looking at the universe.

12:23

Well, when I say he's a big picture guy, don't necessarily

12:26

mean just that he's investing is to make macro

12:28

calls. I mean more than he steps

12:31

back from the fray a bit and

12:33

thinks about the big ideas and what really

12:35

matters, and that whole idea around

12:38

quality investing. That's

12:40

kind of Jeremy from the nineteen

12:42

eighties early eighties and saying bangs

12:44

say, hey, you know, I cut my teeth

12:47

as he and Digmeo did on that traditional

12:49

deep value investing. But we're missing

12:51

something here with these higher quality companies.

12:54

How should we think about that? How can you invest about

12:56

that? How can we improve our process? So that sort of

12:59

philosopha call outside and

13:01

around the box thinking is kind

13:03

of what really led to us having a quality

13:05

oriented strategy.

13:07

And quality is really a sub

13:10

section of value. Is that is that what you're suggesting,

13:13

it's.

13:13

An improvement of value or refinement

13:16

on the definition of value. And people use these

13:18

terms loosely, of course, and these all

13:20

fall under the rubric of fundamental

13:22

investing and buying companies

13:25

that are great over long term at great prices. But

13:27

the idea that companies that

13:29

can compound at high rates of return and deserve

13:31

premium multiples you should be willing to pay for them

13:34

is the root of it.

13:35

The quality funds ticker

13:38

gq ETX has returned

13:40

thirteen point six percent a

13:42

year over the past decade, putting it in

13:45

the top one percent of its

13:47

peers. So let's talk a little bit

13:49

about what goes into that sort of performance.

13:53

What are the core themes at GMO

13:56

around focus and quality?

13:58

Tell us a little bit about what differentiates

14:01

GMO from the way other

14:03

value investors invest.

14:05

If you're think about value investors, value

14:08

investors traditionally are people who kind of

14:10

know the price of everything and the value of nothing right.

14:12

They're much too focused on ratios

14:14

around trailing fundamentals and not

14:17

on the plus side future growth

14:19

opportunities. On the negative side, maybe competitive

14:22

threat. So bringing the quality

14:24

idea into that, thinking about

14:26

what companies have a long trajectory

14:28

to grow and to grow at high return

14:31

on capital, that's the key thing. Also differentiating

14:33

between growth

14:36

that's just sort of throwing money at the wall and

14:38

seeing a little bit come back to you versus very

14:40

efficient growth. That's the key to quality

14:43

investing. I could maybe flip

14:45

that around a little bit since I think, particular

14:47

post two thousand and two thousand and nine, the

14:49

quality style of investing has become a lot more popular,

14:52

certainly sending people talk a lot about the

14:55

difference between our approach

14:57

and a lot of quality managers

14:59

is they're really quality growth managers. So the quality

15:02

but at a reasonable price, or you could interpret

15:04

that is not just chasing the companies

15:07

everybody knows are high quality, but finding a few

15:09

maybe more neglected names That

15:11

quality to reasonable price is a little bit

15:13

of a different style than I see most people

15:15

practicing out there.

15:17

So let's get into some of the definitions

15:19

of this. How does GMO define

15:22

quality?

15:24

Yeah, so we think about quality first

15:26

off, the ability to deliver high returns

15:28

on investment going forward. Then what enables

15:30

that you have to have some asset

15:33

ability, capability that competitors

15:35

can't equally duplicate. I mean traditionally

15:38

could have been like a physical asset or brand. Of

15:40

course, these days in an IT world as

15:42

much more about network effects of

15:44

platform companies and such. But you have

15:46

to have that special sauce that's

15:49

not reproducible. It has to

15:51

be doing something that's relevant, Like you want to avoid

15:53

the trap of companies that do one thing well

15:55

and that thing's not growing, so they just try to do other stuff.

15:58

And then management does also come

16:00

into play. I do keep a strong balance sheet?

16:03

Are you prudent? Do you invest when you should? Return capital

16:05

when you should? And so as those assets,

16:07

the relevance and then capital discipline

16:10

are the key components for us.

16:11

Given that definition of quality, has

16:14

that evolved or changed over time or

16:16

has that been pretty much the definition

16:18

going back to the eighties or nineties.

16:20

That's been pretty much the definition going back to

16:22

the eighties and nineties. And I told you kind of the fundamental

16:24

definition. There's also quantitative metrics

16:27

that we look at. Those have evolved,

16:29

but always within that capabilit cluster

16:32

of high returns on investment stability

16:35

across the economic cycle. Or consistent

16:37

and strong balance sheets. What has

16:40

changed over that period, too, is

16:42

what kinds of companies best meet

16:44

that threshold. So if you go back to the eighties and nineties,

16:47

we're talking about like the Cokes and Procter and Gambles

16:49

and Johnson Johnson, right,

16:52

and big consumer and healthcare and now those are

16:54

still there, but a lot more of the big

16:56

tech companies, the fang companies,

16:58

more growth companies.

17:00

So for a long time it looked like

17:02

Apple was a value

17:05

stock, even as it became big

17:07

and bigger than giants. But when

17:09

we look at what people call the Magnificent

17:11

seven, are you seeing any

17:13

real value there? Companies like

17:15

Microsoft and Nvidia and Netflix, I

17:18

assume are quality companies

17:20

by your definition, but are they quality

17:23

at a reasonable price?

17:24

All the names you mentioned are quality companies,

17:26

we believe, we don't all We don't

17:28

hold all of them. It's the prices vary.

17:31

If you think about Meta and Alphabet,

17:33

those are kind of the value stocks.

17:35

And the band right there, well they got you laughed over the past

17:37

couple of years before last year's recovery.

17:40

Yeah, and we also hold

17:42

Microsoft and Apple. Apple

17:45

is actually an interesting case study because we used

17:47

them as an example of our investment at our investment

17:49

conference fifteen years ago about what a high quality

17:51

company isn't and then Steve Jobs

17:54

turned the round in the iPhone and so forth with

17:56

as the rest is history. The

17:58

point is we were very wrong about them, and

18:00

we were late to the party. But

18:02

the party had such long it's such a long

18:04

party that it's okay to be late to it. You see. We still

18:07

had a really good time with that company, which I think is

18:09

a little bit of a lesson for quality

18:11

investing. You don't have to be the first one in the

18:13

door. There. These themes run

18:15

for a long time, and if you're willing to admit your wrong

18:17

and change your stripes is you can

18:19

still make money.

18:20

So there were a few come at GMO, Warren

18:22

Buffett were quote unquote late

18:24

to Apple, but did exceedingly

18:27

well with that. So you don't have to

18:29

be at the there at the IPO, you don't have to be there

18:32

when they crash in the dot com implosion.

18:35

As long as the growth rate is there and

18:37

the value is reasonable,

18:39

there's an opportunity.

18:41

Yep. And speaking of the dot com employes like Microsoft,

18:43

via a case study where we in

18:46

previous strategies. We'd held Microsoft for a very

18:48

long time. That's where the valuation could help

18:50

us in the dot com bos So Microsoft now is

18:52

thirty times earn it was over fifty in

18:54

two thousand and I don't think it was a much better

18:57

company than it's a pretty good company now. Rh

19:00

there's great company. You have to at some

19:02

point be willing not to hold the stock. And yes,

19:04

actually Microsoft by this point is outperformed

19:06

since the peak of the cycle, but took a long long

19:09

time for that to happen.

19:10

Well, the Boomer era was

19:12

not where they really shined. New

19:14

ceo seems to have done a great job over

19:16

the past what is it five years the

19:19

doll you's been there for.

19:20

Yeah, at least that I think at this point

19:23

we held through the but and actually added in the Ballber

19:25

era, So that would be our

19:27

taking the view that at least in this case turned out

19:29

to be right. That is something companies

19:31

can fix if the core assets there,

19:34

you know, the core network effects of

19:36

everybody using their products, they're being so entrenched

19:38

in IT systems departments

19:40

around the world. That was still there. The

19:43

easiest thing almost to fix. As a CEO,

19:45

So if his stock's training at thirteen times earnings

19:47

and has all these great characteristics,

19:50

and you think the CEO can change, that can be a great

19:52

time.

19:52

To roll the bum out, bring someone else in, and

19:54

the rest is history. So I love

19:57

this quote of yours on the backwardization

19:59

of risk. Quote. The expectation

20:02

is that achieving higher returns

20:04

requires taking more

20:07

risk. But higher quality

20:09

stocks have outperformed

20:11

lower quality stocks by a considerable

20:14

margin despite being less

20:16

risky.

20:17

Explain, yeah, and that's that's

20:19

a point that Jeremy Grantham

20:22

kind of observed very long time

20:24

ago and is emphasizing for a long time.

20:26

And actually pen Inkers ahead of our a s allocation group,

20:28

just wrote a very interesting piece on that

20:30

too. This idea that at the big

20:33

picture level, stocks versus bonds

20:35

things kind of behave what you'd expect. You get

20:37

more return, but there's more risk associated

20:39

with it. But if you look within asset classes,

20:42

that hasn't been true just empirically, Like

20:44

why is it? It's perplexing

20:47

really that high quality companies which

20:49

have been safer, right, they do better in recessions

20:51

and such have you've not had to pay

20:53

for that with lower return. And

20:56

that's that was really the core of Jeremy's

20:59

observation about quality stocks and why it's

21:01

not just that quality is this silver bullet just

21:03

beats the market all the time. I'm sure we necessarily

21:05

believe that's true. But it does

21:07

improve your portfolio with lower risk without

21:09

having to give up return.

21:11

So the obvious answer is value

21:14

makes a big difference within quality

21:17

stocks. Is that what leads

21:19

to the lower downside

21:22

in a market dislocation? If you're

21:24

buying it right, there's less room to fall.

21:26

Right in isolation, Quality on

21:28

average gives you downside protection. Certainly

21:30

did in two thousand and seven eight, for example, but

21:33

then it didn't in when the tech bubble burst. It didn't

21:35

last year in twenty twenty two, right.

21:37

Then. The reason for that is a lot of the quality stocks

21:40

are really expensive. So the trade off, compromise

21:42

or combination of value in quality is what we

21:44

think gives you that best downside protection,

21:47

but without having to give up too much on the upside

21:50

too.

21:50

Huh. So let's dive into the details of

21:53

GMO's quality strategies. In

21:55

twenty twenty two, core

21:58

quality and quality value

22:01

outperformed the S and P five hundred by a wide

22:03

margin. Twenty twenty two was a

22:05

down nineteen percent. I think in the

22:08

S and P five hundred. But

22:10

last year twenty twenty three, core

22:12

quality and quality value slowed,

22:15

but quality growth boomed

22:17

somewhat different environment, and quality

22:20

growth was where all

22:22

the games were had. Is this

22:24

a purposeful style diversification

22:27

within quality? How do you think

22:29

about core quality, quality value

22:31

and quality growth.

22:32

Yeah, when we think about the opportunity

22:35

set for us of high quality companies, there

22:37

are, as you say, really different kinds

22:39

of companies within that quality is neither growth

22:41

nor value, can find both within it. And

22:43

so when we talk about quality growth, I think

22:45

tech stocks, core quality, think defensive

22:48

coke, consumer staples, value, think

22:50

some of the more cyclical names.

22:53

We like the fact that there are high quality

22:55

companies in all these areas, and generally we

22:57

find them attractive, and we like the fact,

23:00

as you point out, they tend to work at different parts

23:02

of the market cycle. And so, yes,

23:04

it is deliberate that we have exposure

23:07

across these not that you know, if it's nineteen

23:09

ninety nine, we're probably not going to have much quality growth.

23:11

So it's not a fixed allocation, but

23:14

it does gives us diversification, and

23:17

because we're familiar with stocks across

23:19

this spectrum. It also gives us the ability

23:21

to rebalance, and that's one of the things that we've been

23:24

quite successful with over the last few years. Is

23:26

not just that we hold both these kind of companies, but

23:28

we've been leaning against the wind to buy

23:31

the growth stocks. At the end of twenty twenty two,

23:33

the value stocks. More recently, just

23:36

rebalancing has had a lot of value.

23:38

Really interesting. You mentioned Ben

23:40

Anker, who I know publishes pretty regularly.

23:43

You publish on a regular

23:45

basis. Also, not too long ago,

23:48

you put something out Quality

23:50

for the Long Run, a little play on Professor

23:52

Siegel's Stocks for the Long Run. Tell us

23:54

a little bit about the valuation discipline

23:56

quality investing offers

23:59

and why that's so important when

24:01

so many stocks have had such a great run up

24:03

over the past couple of quarters.

24:05

Yeah, I think that's maybe a mistake

24:07

I've made in my career

24:09

has been too rooted in looking at what

24:12

did well over the last few quarters, and if a stock did

24:14

really well, thinking oh, it must be expensive.

24:16

Whereas the reality of it, markets

24:18

are efficient enough that the vast majority

24:20

of our performance is driven by truly improved

24:23

fundamental results. So we

24:25

have to be with that level of humility.

24:28

I think the other thing to think about is

24:30

that if you're a long term investor,

24:33

getting the valuation exactly right

24:36

matters less you know, they've beenessing.

24:38

The entry exit point is less important if

24:40

you're going to hold for five plus years, which is kind

24:42

of what our ambition is to do with our stocks,

24:45

But in extremists, which is the Microsoft

24:48

in the two thousand example, and

24:50

maybe some other AI related stocks

24:52

today, it really does matter.

24:55

You really, like the long time where you have to hold

24:57

to make up that valuation whole

24:59

is so long that you just really shouldn't be involved.

25:01

It's kind of basical philosophy.

25:03

Another research piece you put out I found

25:05

kind of intriguing Quality investing

25:08

for greed and fear. Explain

25:10

that.

25:10

I mean, the fear part is kind of what we've been talking about,

25:13

like if you're worried about market downturns,

25:16

quality is a good sleep at night investment.

25:18

And I think I laugh about is every time we think

25:20

about writing an annual letter or something like that

25:23

someone wants to write and these uncertain times

25:25

that we're now in today, it's like, yeah,

25:28

when is that not ever been the case? Right?

25:30

The people are always worried, and so quality

25:33

is always good for that constituency.

25:35

The only thing I'd say is if when those worries

25:37

come to pass, if you hold quality stocks

25:40

that you really believe in, you're less likely to sell at

25:42

the wrong moment. So there's that psychological

25:44

advantage to them that goes beyond just

25:47

statistical analysis of return periods

25:49

over time. And the greed is

25:51

the quality is not just a defensive

25:53

portfolio. If then, of the market's going down, you hold cash,

25:55

right, you don't hold high quality stocks. So the

25:58

greed part is that high

26:00

quality companies do participate in

26:02

the upmarket. And so if you

26:04

think, you know, AI is a great thing, if you

26:06

think GLP ones are fantastic, if you think

26:08

there's innovation going on all around the world and

26:10

you want to participate in it, we think high quality

26:12

companies are a great way to do that.

26:14

I have a recollection, and I

26:16

think it was the onion Our long national

26:19

nightmare of peace and prosperity is finally

26:21

over was a two thousand headline,

26:24

and it's true, how

26:26

often can you say, well, thank goodness,

26:28

we live in times where there's no uncertainty

26:31

and everything is rational.

26:33

When we say that run for the hills.

26:34

That's exactly right. GMO

26:37

has released last quarter their

26:39

first retail product, an

26:41

ETF. I love the symbol

26:44

qlt y. Let's talk

26:46

a little bit about the

26:48

ETF and the thinking behind

26:51

it. GMO has almost

26:53

exclusively had institutional

26:55

investors, very high

26:58

networth family offices. I mentioned

27:01

the quality mutual funds. That's

27:03

a five million dollar minimum.

27:05

What was the thinking behind, Hey, let's do an

27:07

ETF that anyone could buy for fifty BIPs

27:09

no minimum.

27:10

Yeah, you're exactly right. GMO has been an institutional

27:14

manager. We started in the endowments and foundation

27:16

space and have gone from then. But as

27:18

you also said, institutional

27:21

includes increasingly family offices

27:24

and wealthy individuals who

27:26

pay taxes, and so just

27:28

structurally, the ETF

27:30

is such a better vehicle to pool

27:32

clients, and GMO has always been an advocate

27:34

of pooled investing. You get that, We think

27:37

is that good a solution, and it allows more

27:39

portfolio manager focus, not to have

27:41

separate accounts, and so really

27:43

the launch, the genesis of having an

27:45

ETF for us was less about entering the

27:47

retail market or accessing different

27:50

clients, and more about better servicing

27:52

the institutional tax paying clients.

27:55

That said, we have a lot of respect for individual

27:57

investors. I think they get a bum wrap

28:00

among institutional managers. Individual

28:02

investors can be very sophisticated,

28:05

discerning, thoughtful, and it's

28:08

not a segment of the market we want to shy away

28:10

from, other than just the operational complexity

28:12

of having lots of small clients, and there

28:15

the ETF market is matured to a point

28:17

where we don't really face that complexity, and so

28:19

we're glad to be able to be a lot

28:21

more accessible. The other thing i'd

28:23

say about ETFs, and they've been on our radar

28:25

screen for a while, of course, but originally

28:29

they were for no particular reason,

28:31

but kind of associated with passive or more

28:33

commoditized quantitative factor strategies.

28:36

It's really over the last few years that an active

28:38

strategy in an ETF has

28:41

been something people would pay any attention to.

28:43

So I mentioned previously the GMO

28:46

quality mutual funds top

28:48

one percent of its peers thirteen point six

28:50

percent a year for the past decade. How

28:53

does the quality ETF strategy

28:55

differ from the mutual fund strategy.

28:57

Not very much. It's the same investment process,

29:00

philosophy, team and everything. The

29:03

one simplification we've made for the ETF

29:05

is it only we only invest in US companies.

29:08

So the quality fund is

29:10

global's opportunity set has had up

29:12

to twenty percent in non US domicile

29:15

multinationals, think like the nesls

29:17

of the world, that kind of company. Whereas the

29:19

ETF is designed to be a

29:21

more straightforward S and P five

29:24

hundred US only equity strategy.

29:26

And it's concentrated thirty five large

29:28

cap stocks. Is it limited to what's

29:30

in the S and P five hundred or is it any

29:33

US stock?

29:34

It's not limited to the S and P five hundred. What

29:37

we'd like tends to be large cap to established,

29:39

great businesses. So I think it

29:41

is in fact all stocks are in the S and P five.

29:44

Hundred and fifty BIPs is not

29:46

an unreasonable fee structure

29:48

for an actively managed fund.

29:51

Tell us the thinking behind this why go? I

29:53

wouldn't call it a low cost, but

29:56

it's not a high cost ETF. Some of the other

29:58

active ETFs are a one hundred

30:00

BIPs or more. What was the thinking that,

30:03

Well.

30:03

We're pricing it similar to how we price our institutional

30:06

accounts. As I mentioned a lot of our

30:08

I think initial funds have come

30:10

from tax paying investment

30:13

advisors and such. You might have a choice which

30:15

to use. We wanted to make that a not

30:17

feed driven choice, but is picking the right

30:19

vehicle. Another reason why we

30:22

can keep the costs low is these are very

30:24

liquid stocks. It's not really capacity

30:26

constraint around these, so it's

30:29

not like we have to charge an exceedingly

30:31

high rate to be a profitable business.

30:33

And how often do those thirty five stocks

30:36

turnover? Is there any Hey,

30:38

we're going to rebalance this once a year

30:40

or once a quarter, or is it driven on

30:42

whatever opportunities the

30:45

quality stock team you work with decides

30:48

we're gonna get.

30:48

Rid of X and replace it with Yeah, there's no calendar

30:51

to it. It's driven by the opportunities

30:53

as we see them. If we think about the mutual

30:55

fund, and I don't think there would be any different here.

30:58

We've been running turnover about twenty

31:00

percent a year for the last few years,

31:02

which consistent with my remarks earlier. When

31:04

we buy a company, we're thinking about holding it

31:06

for quite some time. In fact, probably

31:09

about half that turnover. It's not so much new stocks

31:11

entering or stocks exiting, is more

31:13

rebalancing around valuation moves

31:15

in the portfolio.

31:16

I love the tick of qlty. It's amazing

31:19

that was even available this

31:21

late in the ETF world. How

31:24

did you guys start first thinking about

31:26

we have clients paying all this phantom tax

31:29

on the mutual fund side. ETFs

31:31

really seem to be much more efficient

31:34

from a tax perspective. Tell us

31:36

a little bit about the discussions

31:38

that led up to let's create

31:41

an ETF.

31:42

I'm acutely aware of the tax issues

31:44

as I put the bulk of my investing in

31:47

our own strategies too, including the mutual

31:49

fund. Now I'm invested in the ETF.

31:51

I think it would go back over a decade. Like we

31:53

were well aware of ETFs for a very

31:56

very long time, and while we got

31:58

the best ticker out there, there are there qual the ETFs

32:00

out there, which your advisors were

32:02

talking to us as competitors. So we're kind

32:04

of looking at the competitive landscape and seeing,

32:06

Hey, what do they do that's different from

32:09

what we do? Why do we think our approach is

32:11

better and we're more fundamental, we

32:13

have the valuation, et cetera. There are a lot of differences.

32:15

Felt like now was the time, I think largely

32:18

because of the rise of active ETFs versus

32:20

pure passive ones.

32:21

Now, this obviously isn't the exact same

32:24

holdings as the Quality Funds mutual

32:26

fund, but I'm going to assume they'll

32:29

track pretty closely over time. It's

32:31

the same process. It's some of the favorite

32:33

ideas from quality go into the

32:35

ETF. Can we expect similar

32:38

performance from this?

32:39

Yeah? My expectations they won't

32:42

differ is that we've never held more than twenty percent

32:44

in non US stocks, and

32:46

all the all the US stocks we

32:48

hold in the fund we also hold in the ETF

32:50

at similar weights. They are a couple of

32:52

new names, so it's not just a carve out, but

32:54

it's very, very similar in characteristics.

32:57

So, I know GMO has a variety

32:59

of offers. You do equities, alts,

33:01

fixed income. How does the

33:04

quality screen work

33:06

with other asset classes besides

33:09

equities? Can you do that with alts? Can you do

33:11

that with fixed income? Or is it just

33:13

specific to value stock

33:16

investing?

33:16

Focusing on quality characteristics

33:19

as well as valuation and sort of quality

33:22

at a reasonable price sort of big picture is

33:24

an idea that cuts pretty much across

33:27

all of GMO's strategies and the different

33:29

asset classes in which we invest

33:31

Of course, it means different things. If you're running

33:34

a merger arms strategy with a

33:36

short horizon, then long term

33:38

buy and hold investing like quote we do.

33:41

But that's there another

33:43

thing to think about that sort of unite GMO

33:46

is a firm, is that a

33:48

lot of our clients come

33:51

through the door, if you will, in our multi

33:53

asset class solutions we call ass

33:55

allocation at GMO. So a lot of the strategies

33:57

that we've developed over the years at GMO, originally

34:00

the quality strategy derived

34:02

from us Jeremy

34:05

and team Ben Anker and others seeing a top

34:07

down opportunity in the market US forming

34:10

a strategy if that's a conventional asset class

34:12

or at the time a new asset or subasset class

34:14

like quality investing. That's how a

34:16

lot of what we do get started. It's why

34:19

we kind of have a complicated lineup for firm

34:21

our size, But that does impose a

34:23

certain i think, intellectual consistency

34:25

on how we think about the world.

34:27

So given the success of

34:29

this first ETF, and given this expertise

34:32

in all these different areas, the obvious

34:34

question is what's the next

34:36

ETF that's going to come out of GMO, or

34:39

are you guys good with quality and you're

34:41

not looking for any other retail

34:44

products.

34:45

Well, I'm not going to break news on your podcast,

34:47

but I think, yeah, we do one with

34:49

the idea certainly that we might

34:52

do more.

34:52

If this continues to be successful. All

34:55

these other asset classes that GMO plays

34:57

in, some of them are really.

35:00

Ripe for any Yes, some more ripe than others. But I

35:02

think there's a lot of opportunity out there. Maybe

35:04

another way of asking that question is why did we start with

35:06

this one? And there are a couple obvious reasons.

35:08

One it is our largest strategy, but

35:11

another it is US equities,

35:13

which are kind of the simplest, most liquid

35:15

asset class. They fit well for the transparency

35:17

you have an ETF structure, it's the easiest

35:19

to do the market making around them. So it

35:21

was a very obvious place for us to start.

35:23

So the mutual fund is about eight billion

35:25

dollars or so. Is there any

35:28

limitation on how big the CTF

35:30

can get? I'm assuming it's all

35:32

large cap US stocks. Doesn't

35:35

seem like there are a lot of constraints on how large

35:37

this can scale.

35:38

Yeah, not practical constraints, of course, there's

35:40

a constraint for everything, but we'd be talking

35:42

about tens of billions of dollars where

35:45

capacity would be.

35:46

Huh, really interesting. So let's talk a

35:48

little bit about what's going on in value

35:50

today. I'm impressed by this

35:53

quote of yours and really curious if

35:55

it's still true. US

35:57

deep value stocks are unusually

35:59

cheap in the US market.

36:02

In particular, the cheapest

36:04

twenty percent look cheaper

36:07

than they ever have in ninety

36:09

eight percent of the time through history. That's

36:12

really surprising. And I keep hearing about how expensive

36:14

stocks are. The bottom quintile

36:16

of value is as cheap essentially as

36:18

it ever gets.

36:20

Yeah, that's a quote that's coming out from our asked allocation

36:22

team about how they think about positioning equity

36:24

portfolios. To be maybe nuanced

36:28

about that we're talking about is the

36:30

valuation of that relative to the overall

36:32

market. So it's kind of two sides of

36:34

the same point. It's not so much that cheap stocks are

36:36

really really cheap. It's that the spread

36:38

of valuation ratios is very

36:40

wide, So.

36:41

The non value stocks are very expensive.

36:44

And frankly, I think that is where most of the action

36:46

is. It's the non value stocks are trading

36:48

it much higher multiples than they normally

36:50

have. And when we say deep value,

36:52

it's almost like to people talk about indus

36:54

because they divide the world fifty to fifty. There's

36:57

no magic to that. I think right now, market

37:00

cap sense market concentration. There are a lot more

37:02

growth stocks. So to find the true value

37:04

stocks and making air quotes, you kind of have

37:06

to go a little bit deeper into the percentiles

37:09

of market cap than you would typically.

37:11

And when we're talking about value, you're

37:13

still discussing with the quality

37:15

overlay. So you could have quality stocks

37:17

and the least expensive quality

37:19

stocks on a valuation basis

37:23

relatively attractive, but maybe not absolutely

37:26

attractive. I don't want to put words in your mouth.

37:28

Yeah, may you apologize for confusing

37:30

terminology on our part, because when we say deep value

37:32

any people often think just the lowest price to book

37:34

stocks out there. In the GMO terminology,

37:37

that's deep value on a measure

37:40

of what we call intrinsic value that blends

37:42

a hefty version of quality into

37:44

that. So that will include some stocks

37:46

you hold in the quality and think metas of the world

37:48

companies like that.

37:49

Gotcha? So I get the sense

37:52

you guys don't pay a whole lot of attention to

37:54

the macro economy

37:56

or geopolitics or what the

37:59

Fed's doing. How important

38:01

are these other aspects

38:03

to the way you manage assets?

38:05

Not that important. I think the thought experient

38:08

for us is if this is something that feels

38:10

cyclical, that isn't going to affect

38:12

where the world's going to be five years from now,

38:15

then we're only going to pay attention

38:17

to it to the extent that if something happens,

38:19

we react to it like it can create

38:22

a dislocation. Right, people might overreact to

38:24

an interest rate move in our opinion, but we're not

38:26

going to try to forecast it or pick stocks

38:28

based on that. You did mention geopolitics

38:31

in that list. Politics is in my

38:33

mind a little bit different. And the reason that's a little bit different

38:35

is I'm not sure that's going to be solved five

38:37

years from now, right, that could get worse,

38:40

or the trends that we're on are

38:42

different from where we've been in the last twenty

38:45

or thirty years. So that is say,

38:47

of those things, the one for a scratch our head a little

38:49

bit more. Not that I'm going to claim we have the answers there,

38:51

but it is front of mine for us.

38:53

How do you think about interest rate risk or

38:55

inflation or the whole

38:57

transitory versus sticky debate. Does

39:00

that become a key

39:02

part of the asset allocation

39:05

discussion or is it just kind of

39:07

background noise that everybody else to deal with.

39:10

More background noise. Jim O is kind

39:12

of famous for doing seven year forecasts, right,

39:14

And the reasons we do seven year forecasts is

39:17

that's sort of the horizon where we feel like, whatever

39:19

the noise is that's going on now, that'll

39:21

kind of all be gone. So the philosophy

39:24

behind those is, eah, seven years from

39:26

now, things will be kind of normal, and I'm not sure

39:28

what the path is to get there, but if that's

39:30

where they're going, this is what that would imply

39:32

about returns over that horizon.

39:34

And one of your recent notes you mentioned

39:36

Jeremy Grantham's super bubble thesis.

39:39

How do you work in quality as

39:42

a core equity allocation within

39:44

the concept that, hey, maybe there's a super bubble

39:47

going on out there? Is that consistent?

39:49

Yeah, I'm a humble portfolio manager

39:52

works from the bottom up, so I'm not really

39:54

thinking about super bubbles very much. Honestly,

39:56

I'm thinking about. Are these stocks that

39:58

we're investing in good quality business

40:01

price to deliver a good return, and good I

40:03

mean sort of double digit type return over the next

40:05

five ish years. So if

40:08

it turns out this is a super bubble, and I think Jeremy's

40:10

technical definition of that is a very very big

40:12

bubble, then quality

40:15

stocks are going to go down. We'll have been wrong

40:17

to invest in them. The silver lining

40:20

is, at least we'll have done better than pretty much anything else

40:22

out there.

40:23

Quality will go down less than the

40:25

rest of the.

40:26

Indices, particularly quality with

40:28

a sense of valuation.

40:30

All right, so let me jump to

40:32

my favorite questions that I ask

40:35

all of my guests, starting with what

40:38

have you been streaming these days? What's been keeping

40:40

you entertained, either video or audio.

40:43

I have a twelve year old daughter, and she runs the family

40:45

with an iron fist, and she likes

40:47

to still watch TV together. So I've been watching a lot

40:50

of Survivor episodes. Though unfortunately

40:52

I actually like those, She's moving on to something else now

40:54

that I like less. Well, I won't call it out in

40:57

terms of I listened to a lot of pod

41:00

cast too. That's where I get a little more sort

41:02

of I'm sort

41:04

of embarrassed to say it, but professionally takes a little

41:06

bit of the place of reading. I love

41:09

econ Talk, which is sort of theoretical

41:11

economics debate podcast

41:14

for fun. I love Judge John Hodgman.

41:17

There's all kinds of things out there. It's a great world.

41:19

Yeah, no, it really is. So let's talk a little

41:22

bit about your career. Who were your early

41:24

mentors who helped shape the

41:26

path you've taken professionally.

41:30

I think in my case, law of the mentors come

41:32

through kind of my academic career

41:34

and teachers and professors going

41:36

back and my high school math teacher,

41:39

mister Hyde. He was the one who taught the computer

41:41

programming course. He's the one who sort of encouraged me

41:44

to take college courses when I was in high school.

41:46

He also taught me Bridge, which is I don't really

41:48

play that much anymore, but it is a great game, and let

41:51

you think a lot of that things in a great way.

41:54

My PhD advisor at Harvard

41:57

less Valiant, i'd also pick

41:59

out. I mentioned Chris Darnell at GM. Rob

42:01

Soussi was the name of my first manager there.

42:03

He was a very wise, wise

42:06

man. If I think about one

42:08

of the things I gained from these people,

42:11

to particular the professional ones. It's kind

42:14

of when to be willing to say no to stuff too.

42:17

My colleagues now wouldn't believe it, but I used to be

42:19

probably over accommodating, and maybe

42:21

I've learned that lesson a bit over learned it.

42:23

What are some of your favorite books? What are you reading

42:26

currently?

42:27

Well, this is the holiday time. I

42:30

just came back from a long

42:32

playing flight and I read this really fun

42:34

detective book that my wife gave me for

42:37

Christmas. But then I was reading a biography

42:39

of Samuel Sewell, who's one of the

42:41

judges at the Salem witch Trials. Actually

42:43

saw a colonial era figure. It's an interesting

42:46

book to learn about that era. My

42:48

favorite book of all time, and it is not even

42:50

close, is a children's book called The Land of

42:53

Green Ginger, which is written

42:55

by the screenwriter the original Wizard

42:57

of Oz movies. It is a

43:00

heirical, clever take

43:02

on the kind of the PostScript to the Aladdin myth

43:05

from the Arabian Nights, and I

43:07

recommend all of your listeners if they can find

43:09

it, which is easy read that book.

43:11

Huh, really interesting? What sort of

43:13

advice would you give to a recent college

43:15

grad interested in a career

43:18

in investment and finance.

43:20

So investment finance is actually a very broad

43:22

area. So the first advice is kind

43:24

of narrow that down. And

43:26

the west way to narrow it down is

43:29

to get exposure to lots of different things.

43:32

And I think the best way to enable yourself

43:35

to get exposure is don't

43:37

focus so much on finance and investment. Just figure

43:39

out about learning. Learn all sorts of

43:41

things. Learn math, learn history.

43:44

You can always learn a trade after

43:46

that. Don't think, oh, I'm interested in finance,

43:49

so I'm just going to spend all my time listening to investment

43:51

podcasts and I'll answer or non

43:54

tecular ten ks.

43:56

I don't imagine that anyone's going to listen to a

43:58

couple of dozen podcasts and so only

44:00

begin to outperform the benchmarkt

44:03

It's a little more nuanced than that, isn't it.

44:05

I think all the great investors talk about

44:07

reading and how much of their time they spend

44:09

reading and just learning, and I think that

44:12

is one of the things I like about the investment

44:14

industry is you just spend so much of your time

44:16

just learning about how businesses work. How the

44:18

world works. You're kind of an observer. You're

44:21

kind of a miserable critic rather an actual creator

44:23

of value, but an analyzer of others

44:25

work.

44:26

It's almost academic adjacent, given

44:28

how much reading there is. And our final question,

44:31

what do you know about the world of investing today?

44:33

You wish you knew thirty years or

44:36

so ago when you were first getting started.

44:38

That appreciation of quality businesses

44:40

and the value to pay for them. I come my

44:43

mindset is a little bit more contrarian, and

44:45

I think from an investing perspective

44:47

that manifests itself much more in a

44:49

value orientation or value meaning

44:51

low multiple underperforming

44:54

socks cigar butt of philosophy,

44:56

and I think realizing the value of time

44:58

and compounding and it's

45:01

just worth paying up for a higher quality business.

45:03

To say the very least, thank you Tom

45:06

for being so generous with your time. We

45:08

have been speaking with Tom Hancock, head

45:10

of the Focused Equity team at GMO.

45:13

If you enjoy this conversation, well check

45:15

out any of the previous five hundred

45:18

interviews we've conducted over the past

45:20

nine years. You can find those

45:22

at iTunes, Spotify,

45:25

YouTube, wherever you find

45:27

your favorite podcasts. Sign

45:30

up from my daily reading list at ridults

45:32

dot com. Follow me on Twitter at

45:34

rid Halts. I would be remiss if I

45:36

do not thank the crack team who helps

45:38

us put these conversations together each

45:40

week. My audio engineer is

45:42

Kaylie Laparo. Attika of albrun

45:45

is my project manager. Sean Russo

45:47

is my head of research. Anna Luke is

45:49

our producer. I'm Barry

45:52

Ridholts. You've been listening to Masters

45:54

in Business on Bloomberg Radio.