The following is excerpted from Jeremy Grantham's latest GMO Quarterly Letter. To read the full letter, click here.
GMO Performance in 2011 Was Quite Good
In Asset Allocation, being overweight in emerging hurt us, as did lack of duration and underweighting the U.S. But a massive overweight in global quality stocks, 80% of which are in the U.S., was huge. They outperformed the U.S. market by about 10% (and the non-quality component by almost 14%), for in the end it was indeed a risk-off year. During the year, it was steadily three steps forward, two and a half steps back for these quality stocks relative to the rest. We also got a lot of little things right so in the end, despite a cluster of things where we could have been smarter or luckier, we did decently enough. In asset allocation (dragged along mostly, I admit, by quality) most of our allocation strategies won against their benchmarks, with our flagship Global Balanced Asset Allocation Strategy adding 3.9% relative, net of fees. Far more of our equity strategies outperformed their benchmarks than underperformed. As usual, we tend to do better in tougher years, which is the way we like it. This was especially noticeable in the sharp summer decline. It was in all an interesting year. I look forward to this one.
Summary of Recommendations
1. Heavily underweight U.S equities, but not the high quality quartile, which is almost fair price. Non-quality equities, in contrast, have a negative imputed 7-year return after their handsome rally in the last 3 months through to mid-February.
2. Slightly overweight other global equities, which are almost fair price, down from a little cheap at year end.
3. In total, be about neutral in global equities. Yes, there is more than our normal fair share of potential negatives lurking around, but on our data: a) most of the negatives are reflected in stock prices; and b) all fixed income duration is dangerously overpriced. This last situation is, of course, engineered by the Fed, which hopes to drive us all into taking more risk, notably by buying more equities. I hate to oblige, but at current equity prices it just makes sense to do what they want. As mentioned earlier, equities are also good long-term hedges against inflation.
4. Underweight as much as you dare long-term bonds, especially higher-grade sovereign bonds.
5. In the long term, resources in the ground, forestry, and agricultural land are attractive, but come with the usual caveats of the risk of short-term over pricing, so average in.
Jeremy Grantham is the chief investment strategist of GMO.
