- What has been the performance of Grantham, Mayo, Van Otterloo (GMV) in the five years since 1996?
- Describe the portfolio management style being employed by GMV.
- Should they abandon or modify their strategy? Should they offer other products (based on different strategies) to clients?
- What are the risks and potential returns to GMV based on your recommendation
Case study has been attached below. I have to answer the questions above.
GMO-CASE.pdf Downloaded by Pritesh Maniar on 9/15/2022. Northeastern University, Prof. Shaun Hamilton, Fall 2022 9-202-049 R E V : O C T O B E R 1 6 , 2 0 0 7 ________________________________________________________________________________________________________________ Postdoctoral Fellow Joshua N. Musher and Professor André F. Perold prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2002, 2007 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. A N D R É F . P E R O L D J O S H U A N . M U S H E R Grantham, Mayo, Van Otterloo & Co., 2001 “Sit down. You’ve done a really bad job managing our money. Tell us why you are underperforming, and don’t give us any of that mean-reversion nonsense.” This admonition still echoed loudly as Jeremy Grantham and Benjamin Inker were preparing for a return visit to one of their firm’s important clients. At a previous meeting in early 2000, Grantham and Inker, respectively chief investment strategist and head of asset allocation research at Grantham, Mayo, Van Otterloo & Company’s (GMO), could not easily defend the firm’s poor performance and its value orientation. Value stocks had underperformed growth stocks by 5.9% per annum over the prior 10 years, and GMO’s asset allocation fund had underperformed its benchmark cumulatively by 25% since January 1998. As a result of this underperformance, the client took away half of its portfolio that GMO managed. Now, in late 2001, Grantham and Inker’s argument that the underperformance was the result of a short-term bubble seemed prescient. The recent dramatic decline of growth stocks and the rise of value stocks now gave the value style a 2.5% per annum lead over 10 years, and GMO’s global asset allocation account was cumulatively 6% ahead of its benchmark since January 1998. While they could look back and congratulate themselves, Grantham and Inker were concerned that GMO’s steadfast refusal to buy overvalued stocks during the bubble of the late 1990s may have won the battle but lost the war. Between 1997 and 2000, the firm had suffered $10 billion of net client withdrawals, and they wondered whether it made sense to change GMO’s business model of investing according to their honest beliefs which often meant making large portfolio bets that might take years to pay off. GMO was presently in an enviable position, with nearly all of its products showing outperformance on a one, three and five-year basis, and since inception. This seemed to be an opportune moment for the firm to reexamine its business strategy and focus. Early History GMO was founded in 1977 by Grantham, Richard Mayo, and Eyk Van Otterloo. Their approach was to invest with a conservative value-orientation in stocks that were out-of-favor or not widely followed. GMO’s first product invested in U.S. equities and was based on traditional company analysis combined with sector allocation decisions. Grantham was the macro strategist and Mayo selected the individual stocks. By 1981, assets under management reached $250 million, and the firm became concerned that additional asset growth might adversely affect investment performance. They decided to close the product to new accounts, and soon afterwards raised fees from 0.75% to 1% per annum without losing any clients. 3 Downloaded by Pritesh Maniar on 9/15/2022. Northeastern University, Prof. Shaun Hamilton, Fall 2022 202-049 Grantham, Mayo, Van Otterloo & Co., 2001 2 While GMO’s investment strategy had reached capacity in the domestic equity markets, it had yet to be applied internationally. Soon after closing its U.S. Active product, the firm started an International Active product, managed by Van Otterloo using the same investment approach. Because of their strong U.S. track record and because few other managers offered a disciplined approach to international investing, this product attracted a number of existing clients as well as new clients. GMO closed the International Active product to new accounts in 1985 when it reached $550 million in assets. In 1982, Grantham led an effort to leverage GMO’s investment strategies using recent advances in computer technology. Hiring researchers with diverse technical backgrounds, he created the firm’s U.S. Core product, one of the early funds to invest on the basis of quantitative models. GMO’s quantitative models greatly increased the firm’s capacity to manage money. Since the models did not rely on hands-on individual company analysis, they could quickly screen and select from thousands of stocks, which made it possible to create portfolios of many holdings. Quantitative processes thus allowed for more opportunities to be exploited relative to fundamental investment processes. In addition, the processes could be applied to other asset classes. By 2001, the firm’s product range had grown to encompass 40 distinct categories, including a variety of debt-related offerings, all based on essentially very similar techniques. Most recently, GMO began applying the models in its new market-neutral and long-short hedge funds, which allowed them to sell short the least attractive stocks in addition to buying the most attractive stocks. Finally, by codifying the investment process, GMO established intellectual capital that remained with the firm, even if an employee left. As the firm’s expertise and body of knowledge grew, it could seek and capitalize on more opportunities in diverse areas. Beginning in 1985, GMO offered its services through commingled funds in addition to separate accounts. These commingled funds included mutual funds and other similar pooled vehicles where clients held proportionate shares of a single portfolio. This structure minimized transaction costs related to inflows and outflows as these could be netted against each other. Additionally, the net flows could be used to buy or sell securities that GMO in any event would have wanted to trade when the portfolios underwent periodic rebalancing. Finally, with clients invested in a single fund (one for each product), there would be no dispersion of investment performance across accounts. As its products proliferated, some of GMO’s clients increasingly became dependent on the firm for asset allocation advice, and this in turn influenced how the firm thought about the introduction of new products. For example, in late 1988, the firm’s models suggested that U.S. growth stocks were undervalued. GMO introduced the U.S. Growth fund based on the same models that U.S. Core used selecting its growth stock holdings, but was careful to stress that growth stocks were not good investments in the long run. Indeed, in 1991, after a strong rally in growth stocks, GMO advised its clients to move their assets out of the U.S. Growth fund and into value stocks, which then outperformed. GMO did not charge for the advice it gave on asset allocation, that is, there were no fees levied beyond what clients were already paying in the underlying GMO funds. By the fall of 2001, GMO had opened offices in San Francisco, London and Sydney. It employed 75 investment and 41 client service professionals, up from 16 and zero, respectively, in the late 1980s. Fourteen of the investment professionals had Ph.D.s in fields such as physics, computer science and economics. Employees were paid on the basis of individual contribution as well as team performance. Part of the compensation was in equity of the firm. Each year, the firm diluted its ownership by issuing an incremental 4.35% of the equity to employees. Over time, younger employees could build up significant equity stakes, a factor that helped keep employee turnover very low. 4 Downloaded by Pritesh Maniar on 9/15/2022. Northeastern University, Prof. Shaun Hamilton, Fall 2022 Grantham, Mayo, Van Otterloo & Co., 2001 202-049 3 GMO had $20.6 billion under management, primarily for tax-exempt institutional investors. (Exhibits 1 and 2 show the firm’s accounts by client and product type.) GMO had always liked to concentrate on investing, and historically spent little time on sales and marketing. Many of the firm’s clients knew about GMO through investment consultants such as Cambridge Associates, a leading consultant for endowments and foundations. This distribution channel often brought in the kinds of clients that GMO considered most desirable—long-horizon, sophisticated, and stable. Investment Philosophy GMO’s experience over the years, together with a keen sense of fiduciary duty to their clients,1 helped refine their investment philosophy. They believed that: • The global capital markets were inefficient, that prices did not always reflect fair value and therefore excess returns could be generated; • As profitability or perception improved, a portfolio of undervalued securities would provide returns greater than the market, with less risk than the market; • Controlling risk included preserving capital. In addition, they believed in keeping assets under management reasonable in relation to the approach used to invest them and to avoid growth for growth’s sake. If the assets were too large, performance would suffer because funds would have to invest in some of their weaker ideas and would pay higher transaction costs when trying to establish (or exit) larger positions. When introducing new products, GMO paid careful attention to investment cycles. Ben Inker had documented 28 times when an asset class had broken out of its historical trend to outperform by two or more standard deviations. In every case, the performance had reverted back to its long-term average. (See Exhibits 3A and B for selected cases