Catherine LeGraw

Yes, I am an asset allocation strategist at GMO. The asset allocation function is maybe a bit different than how you think about most investment roles. A lot of folks in the investment industry are focusing on specific securities, looking at particular stocks and bonds. I'm looking at things top down at the asset class level and looking for great opportunities from a valuation perspective on asset classes or groups of stocks. And then my team runs multi-asset portfolios where we're dynamically shifting the allocation as opportunities change. Valuation is really our guide in picking these allocation changes. I joined GMO in 2013.

Awesome background. And thanks for sharing it with me. But before we jump into all things value and GMO and the firm, I got to ask, when you're not behind the desk, what do you like to do? Any hobbies, things you enjoy?

I do love to get away from the desk and I like to literally go outside. I love hiking. I think it's a great way to disconnect and clear your mind. I particularly like exploring new and different trails. So that's a favorite hobby of mine.

Yeah, no hiking for me for the foreseeable future. It is freezing cold in Pittsburgh and I cannot... I'm not a cold guy, but somehow I still live here.

I strap on the snowshoes or micro spikes and I go. Yeah. Well, you're braver than I am.

So let's talk about GMO as a whole. So I know you guys have a suite of ETFs, but what all do you do to help service clients? I know it's more than just ETFs and these types of products. So as a firm, what are you doing to help on a massive different slew of things?

Yeah. The ETFs are actually a brand new initiative for us. And so that's part of the reason we're excited to be talking to you. We're a global investment management firm across many asset classes founded in 1977. So we have investment teams focused on asset allocation in addition to dedicated teams focused on equities, rates, credit, and hedge funds. So I'd say basically everything in liquid assets we do for our clients. And it's the full spectrum. We have some active, ready-to-go strategies that clients will just select and say, hey, that's a good fit for my portfolio. We also partner with a lot of our clients, be it institutions like foundations, endowments, pension funds, wealth management firms.

So you alluded to it earlier, at GMO value kind of reigns king, right? So we're going to talk today mostly about GMOV, which is your U.S. value ETF. So since we know that GMO is value-based, what makes GMOV kind of unique compared to other value-focused ETFs out there on the market?

Yeah, I think there are three things that are really differentiated in our approach to capturing value in GMOV. First and foremost, we take a top-down approach and we look for entire groups that are dislocated or misvalued. And I think that is pretty unique to GMO and it comes from that asset allocation capability that we have. To date, that steers us to deep value stocks, the cheapest 20% cohort. That cohort is completely dislocated. It is extremely cheap relative to its history. And we think phenomenal opportunity. Value wins. Deep value always wins. So we're really focusing on that deep value cohort in GMOV.

So you mentioned this quickly about deep value opportunities. So how does GMOV balance deep value opportunities with other things such as quality and growth characteristics in the overall portfolio construction?

Yeah. I'd say there are a few things that we use to balance deep value with these quality and growth characteristics. I think part of what you're getting at is, hey, you don't want to buy something that's cheap for a very good reason. You want to buy something that's truly attractive fundamentals and happens to be trading in a wonderful valuation relative to those fundamentals. So by not using those simple ratio-based accounting metrics, we're not looking at simple price-to-book, price-to-sales, price-to-earnings. That's one thing that helps. We're actually building our own estimate of what the fundamental value is and looking for a company that's trading in an attractive price relative to our estimate of its fundamental value. And that fundamental value estimate does incorporate a lot of characteristics of quality and growth.

So when kind of constructing GMOV and the holdings underneath, how do you handle kind of the common sector biases that come with value, right? So such as overweights to utilities and underweights to tech. So how are you trying to balance that inside the portfolio?

Our view is we're willing to take sector bets and sector overweights and underweights if they are supported by our view of valuations. So one example there would be financials. We have a lot of financials exposure in GMOV, and we think we can find a lot of banks and financial companies that are genuinely cheap trading in attractive valuations relative to their underlying fundamentals. However, on the other hand, most value approaches, value indexes and many other value strategies will be overweight, something like utilities. That's something we're currently in GMOV. We have no exposure to utilities, even though it's typically an overweight in value portfolios.

So I was going to ask a question on the role of sentiment and some other things and not getting stuck in a value trap. I think you did a great job already answering that. So I'm going to skip ahead. We have been in a long period of relative underperformance of value versus growth. even in our funds that we run, we run everything equal weight, and market cap has run right over us. So what is your perspective on this extended underperformance of value over really the past decade? And do you see this as a massive opportunity? At least I do see it as a massive opportunity for those of us that are value investors or those of us that are more equal weight tilted investors.

I absolutely do see it as a massive opportunity today. In terms of my diagnosis for what's happened, like how if we had such a long sustained period of value underperformance, how has it gone on this long? I have a theory. And the theory is, in particular for this deep value cohort, these stocks have just gotten left behind, partially because it has been such a long-term period of value underperformance. In this long cycle of value underperformance, many investors, allocators, have stepped away. They've allocated away from value strategies. They've allocated away from the deepest value strategies and switched to core or even growth. We can actually see this in the numbers.

Well, even to take this a step further is you have value underperformance versus growth, but also you have massive U.S. outperformance over international at historic levels. And I know you guys have another ETF and we'll get back to GMOV in a second, but I know you have GMOI. How do you how are you viewing that as an opportunity with both of these being kind of wide dislocations over the last, I don't know, three years or maybe more?

So it's in it's a similar story outside the U.S. In the sense that deep value is extraordinarily cheap there as well. So we've got kind of top decile cheapness in deep value, both in U.S. markets and international markets. One difference is outside the U.S. value has been working. And even though value has been working, this deepest value cohort is still incredibly cheap. And as you stated, overall equities outside the U.S. are just cheaper than U.S. equities. Plus, you've got the fact that the U.S. dollar is pretty expensive as well. So if you are willing to invest in stocks outside the U.S., you could have a potential additional tailwind for currencies. So if you ask me purely on an absolute return basis, what do I think is the better opportunity today, GMOV, the U.S. value or GMOI, the international value?

Yeah. even with all the advisors that I talk to on a daily basis, it's like they don't even want to own international anymore in a diversified portfolio because it's dragging on benchmark return. They are consistently, continually overweighting tech into this because they want to keep up, right? And I just think, as you've stated eloquently, more eloquent than I can, that there are definitely opportunities. And now I think would be the time to start diversifying into value, start picking up some international tilt and getting this portfolio a little bit more balanced out. Because I think a lot of model portfolios out there have drifted from model and have gotten pretty top-heavy U.S. growth and specifically market cap-weighted growth.

So staying on value, and you had mentioned passive.

So in your view, why do passive approaches to value investing kind of fail to capture true economic value? Like, why GMOV over, not to put any competitors out there, but this is the first one, like a VTV, right? Just buy, value passively. Why do you think an active approach to this is going to yield, better opportunity going forward?

There are a few things I think passive value is missing. One, passive value tends to rely a lot on reported book value. And I think reported book value misses a lot and could even be meaningless. I gave some examples, but a lot of companies, they have many assets that are not on their balance sheet in a reported book value sense. Their intellectual property, their brand value, things that they have invested in, but all that investment has just been viewed by standard accounting as an expense. So that information is lost. The second thing I worry about with passive value is they use primarily backward-looking metrics. And I think sometimes you have to think about the future. What is the potential profitability going forward for this company?

So speaking about capturing today's opportunities, given current market conditions, where does GMO kind of see the greatest value dislocations? And how are you positioning GMOV today in order to try to capitalize on those?

It's really all about that deep value cohort, really focusing on that cheapest 20 percent. Because in a reversion scenario, that's where you can make the most money. Deep value is like high beta value. And when I look through historic periods, whenever value wins, deep value wins, I'm more. So that's why we're really focusing on getting that very cheapest cohort. That's why we're willing to take asymmetric parameters around the benchmark so that we don't end up holding any of the more shallow value or really pretty expensive stocks in the value index just to do risk control. If you're looking for more of a sector point of view there, we are having a lot of exposure to things like financials.

So from a portfolio construction perspective inside of GMOV, about how many names in this portfolio at any given time is it? are you buying, a bunch of stuff or are you very concentrated?

We're diversified. We're taking a quantitative approach. And you should expect to see, round numbers, about 150 names in the portfolio at a time. So it's not all the eggs in one basket. We're trying to capture that deep value cohort, but we're doing it with many, many different securities.

And when, weighting those 150 securities, how are you making weighting decisions inside this portfolio? Are you making a bet? Is it market cap? Is it equal weight? Like, how would you see this portfolio constructed?

It is a risk managed approach relative to a benchmark. So while it's not a pure market cap approach, there's that element of market cap to it because we're managing relative to a market cap benchmark. And it is a trade-off between our projected alpha, which is based on how cheap the company is, and the tracking error it creates relative to the benchmark. And we have those wonderful asymmetric parameters where our philosophy is underweight anything we think is expensive down to zero. There's no way to hold it at all. But we are going to put an upside cap on how much we'll hold of anyone's security, any industry, any sector. We don't want too much concentration in one idea in this portfolio that that's not what we're getting at.

So I know the portfolio is active. So in terms of turnover, how often are you guys adding, removing, reweighting? I'm sure it's a daily process, but is there a more quarterly or weekly or annual or monthly snapshot and look where you're doing a lot of work?

You're catching the right theme because with value for the value investor, and I think we as value investors don't always think about this that much, but that turnover, that rebalancing, that is the largest source of relative return for a value investor. When you think about the sources of relative return for a value investor compared to the market or compared to the growth, value stocks always fundamentally undergrowth. By definition, these stocks are trading at a discount for good reason. They always outyield the market. They have higher yields than the average stock or than growth stocks. But the big source of relative return, the big source of positive return for a value investor is this rebalancing. It's the turnover that you will buy some stocks at a discount that don't disappoint investors quite as much as they're expecting.

So you're sitting down with an advisor or somebody constructing, model portfolios. How would you recommend they use GMOV or even GMOI in this case as well inside an already diversified portfolio?

I think there's three good uses for these ETFs today. First and foremost, you could use GMOV or GMOI as a substitute for existing passive or active value exposure. The key to our approach that I think is going to be different than what you hold right now is that we are going deeper into value. And so we expect to outperform when value wins. We'll outperform passive and traditional active value. So when I look at GMOV and GMOI compared to other passive value indexes, we're trading at about a 15 to 30 percent discount to value. It's really a much cheaper portfolio. Second, if you don't have value exposure, value is extraordinarily cheap today.

Well, Catherine, I really appreciate your time. This was enlightening, and I think you guys are – I just looked. you've launched pretty recently, so I think you've got pretty good timing. But I can't let you go unless people learn about where they can learn more about GMO, where they can find your ETFs and get all the information they need.

Well, please visit us at GMO.com. You can learn about our ETFs. You can also find our quarterly letters and our asset class forecasts and other resources.

Well, again, thank you very much. Thank you. Thank you.