Making Money And Reducing Risk In An Equity Superbubble

Navigating the career risk associated with bubbles (especially superbubbles) has always been tricky and is one of the biggest failings in the investment management industry.1 We at GMO dedicate ourselves to trying to get the big picture calls right. Extreme market environments, similar to the one we are experiencing currently, are where we have historically been able to add significant value to investors’ portfolios. As the table shows, we have made some unconventional moves and owned some very unconventional portfolios in the face of market extremes.

As we move through the fourth “bubble era” in GMO’s history, we have once again positioned our Asset Allocation portfolios to reduce risk and take advantage of what we believe will be a generational opportunity for adding alpha through asset allocation.

Equity Dislocation: Betting on the Bubble in Growth Stocks Bursting

While the overall U.S. market is in bubble territory as Jeremy Grantham recently outlined,2 the epicenter of the bubble – both at home and abroad – is concentrated in Growth stocks. As such, the largest risk position in our flagship Benchmark-Free Allocation Strategy (as well as in our Alternative Allocation Strategy) is long a global portfolio of Value stocks and short a global portfolio of Growth stocks. To build these portfolios, we use a proprietary definition of “Value” and “Growth” that aims to assess the intrinsic value of companies and provides, in our view, a better lens on valuation than traditional value metrics or indices. This approach has proved to be incredibly successful: in an unusual year like 2021, where Value beat Growth by 200 bps globally, our custom approach generated alpha of approximately 1,500 bps. We believe significant room remains for this holding to continue its strong outperformance. This portfolio is available for direct investment via the Equity Dislocation Strategy. We also have worked with a client to build a pure U.S. Growth short portfolio, with a focus on the most expensive names in the Growth universe. We believe this particular type of portfolio is an excellent hedge to the significant gains many have experienced via investments in technology-focused private equity and venture capital.