It’s been an unpleasant ride the past decade and beyond for value investors, acknowledged asset allocators at GMO, but a new long-short strategy is poised to take advantage of the bursting of a “growth” bubble they see in the stock market.
“It has truly been a hellish time for value,” wrote GMO’s Ben Inker and John Pease, in the firm’s quarterly investment letter, released Tuesday. “After years of disappointing investors, value just experienced its worst 12-month performance in history.”
Value stocks are shares of companies that are seen trading below their worth, according to various metrics. Growth stocks are shares of companies expected to outperform their peers due to faster growth of revenue or earnings. Value has suffered as growth stocks have soared.
That’s created what GMO, the firm co-founded by investing legend Jeremy Grantham, contends is a bubble in growth stocks.
In the second part of the letter, Inker, GMO’s head of asset allocation, laid out the firm’s new “Equity Dislocation Strategy,” a long/short strategy that aims to benefit from the bursting of that bubble. It goes long stocks viewed as cheap while shorting stocks viewed as expensive, and remains sensitive to the top-heavy nature of growth indexes as a result of vast gains by tech and internet-related large-cap stocks.
Through the end of the third quarter, Apple Inc.
AAPL,
accounted for around 11% of the Russell 1000 Growth Index
RLG,
while the “FAANGM” names — Facebook Inc.
FB,
Apple, Amazon.com Inc.
AMZN,
Netflix Inc.
NFLX,
Google parent Alphabet Inc.
GOOG,
GOOGL,
and Microsoft Corp.
MSFT,
were about 40%.
“Even assuming you believe Apple or the FAANGMs are significantly overvalued, there is certainly a meaningful chance they can outperform despite that fact,” Inker wrote. “Why would you want to allow an error on one or a few companies to blow a hole in your strategy’s performance?”
The approach, Inker said, is to limit both individual stock weightings and the size of the net biases for or against industries, sectors and other return factors.
For investors who still believe in the concept of reversion to the mean, the strategy can be a way to “turbocharge” a portfolio that already has built into a value bias, he said.
For those who no longer or perhaps never did believe in reversion to the mean, Inker said a value/growth long/short portfolio should have a slightly positive expected return if relative valuations are stable from here, would take some losses if value spreads continue to widen, but would generate outsize gains if spreads shrink.