Wednesday, November 28, 2012

GMO Bids Bonds Farewell


Yesterday's post described the robust appetite that individual investors have for municipal bond funds.


Investors remain worried about stock market volatility, and apparently would rather buy low yielding bond funds than look at stocks.

Merrill Lynch noted that $9.2 billion flowed out of equity funds a week ago, representing the largest weekly redemptions in 11 weeks.  This also represents the 19th straight week of equity fund fund redemptions.

Meanwhile, bond funds have seen inflow for 26 straight weeks, according to Merrill.

Interestingly, however, although the individual investor continues to pour funds into the fixed income market, some in the professional investment community are headed in the opposite direction.

Random Glenings has cited Jeremy Grantham of the large investment counseling firm GMO on numerous occasions.  I am a big admirer of both Grantham and GMO since they take a disciplined, quantitative approach to making their investment calls.  I can also say that I am not alone in my respect for their work.

So imagine my surprise yesterday morning when I saw the following headline in the Financial Times:

GMO turns its back on bond market

The article went on to say that GMO had decided to sell most of its investments in longer maturity fixed income in favor of simply leaving the money in cash.

Here's an excerpt from yesterday's FT:

GMO, the Boston-based asset manager, says it has "given up" on the bond market, making the call to ditch long-dated sovereign debt as investors continue to pour billions into government bonds including US Treasurys.

Ben Inker, co-head of asset allocation for the $104bn group, has told the Financial Times that it is holding large, high quality companies in the US but that its main bet is to keep money on the sidelines while it waits for better times.

http://www.ft.com/intl/cms/s/0/d6ae8e78-326c-11e2-ae2f-00144feabdc0.html#axzz2DQfXAROP

This is not the first time that GMO has abandoned a traditional asset class.  In 1996, GMO declared that the technology sector was in the midst of a massive bubble, and they sold all of their holdings in what they considered to be an overvalued group.

While GMO was eventually proved right, Jeremy Grantham will also point out that their call was four years too early.  The relative performance of GMO portfolios suffered greatly in the late 1990s as tech stocks continued to soar. Client dissatisfaction was widespread, and Grantham said that they lost probably 75% of their book of business during that period.

In short, while I suspect that GMO will eventually be proven correct, I am not sure of their timing.  The re-election of President Obama almost certainly means at least a couple more years of very accomodative Fed policy under Ben Bernanke.  It is hard to see yields moving sharply higher with Fed policy determined to keep interest rates at historically low levels.

At the same time, I think that you ignore the smart folks at GMO at your peril.