GMO-CASE.pdf
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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.
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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
esult of a short-term bu
le seemed prescient. The recent dramatic decline of growth stocks and the
ise 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 bu
le 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
ecame 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.
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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
ely 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
elated 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.
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Grantham, Mayo, Van Otterloo & Co., XXXXXXXXXX
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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 Cam
idge Associates, a leading
consultant for endowments and foundations. This distribution channel often
ought 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
eturns 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
oken 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