The Exchanges

Q What happened from there? Clearly, GMO has become a lot more than the two hundred and fifty million dollars compounded.

A We fairly quickly got into discomfort with each other having slightly different approach to investing. By accident, we hit on a clever formula, which was to have three divisions. So Van Otelo ran the international, which was brand new. No one did international. Dick Mayo inherited our joint portfolio and managed it for another 15 years. And I started a quantitative division, which started by developing an expert system By telling the computer what we thought were sensible, selective characteristics for a good stock, the computer would come back initially with some terrible ideas. How did that get in? How would we exclude it? So we redefined the formula until slowly but surely over a few months, we got it to kick out a portfolio, which was 90% the same as ours. Interestingly, the 10% that was different did just as well as our 10%. We called it the finished product, and we threw it into battle. Very slowly, we got a handful of big clients. After a while, as we got more confident, we used exactly the same model to test on different stocks. So we had a growth fund, as well as a value fund, and then we had a small cap growth and a small cap value, REIT fund, eventually an emerging market fund. All using quantitative approaches, but also willing to use the brain and look for exceptions on what was going wrong and change the model. Somewhere between a modern quant model and an expert …

AI assessment note: “By accident, we hit on a clever formula, which was to have three divisions.”

Q What aspect of that setup do you think influenced how you thought?

A I think frugality was the big thing in the war. I was up in the north in a coal mining town. Yorkshire, our county, is famous for its frugality anyway. That was two strikes. Then the man in the family, my grandfather, my father was overseas and then died fairly soon in World War II, had been brought up a Quaker. So that was strike three. By the time you had a Quaker In a Yorkshire coal mining town in World War II, you pretty well know that you're going to have frugality deep into your backbone. When I go into a restaurant, I still look at the menu and take price into account. I know there's quite a lot of us who do that. For some of us, it's not a question of whether you've got money in the piggyback. It's a question of what is right, and wasting money by paying more for some silly meal gets pretty high up on the agenda.

AI assessment note: “I think frugality was the big thing in the war.”

Q When you think about taking advantage of the other side of something that statistically is a valuation bubble, you run into the challenges of not knowing how long it's going to go and how far it'll go. How have you thought about those realities in investing capital on behalf of your LPs?

A Seeing the bubble is easy. Getting the timing right is apparently impossible. We have worked on many iterations of that. Keynes said that clients' patience is not as long as the market's ability to be irrational. And that's absolutely true. And in the great bubbles, they don't just reach two sigma, which is bubble territory. They go on to two and a half or three segment, but they go on for years. They're the only ones that really matter. It's the last year or two. That really counts. The clients have become impatient, and they can't stand it. They start to fire you. As we got older and wiser, we were perhaps more careful in how we phrased it. We made it very clear that US stocks are not the thing to own. For a long time now, you should be owning non-US stocks, developed value stocks, and emerging country value stocks. When I'm arguing with people, I don't get the time to say, It's not what you don't own, as in the US stock market, it's what you do own that counts. If you own stuff that does better, who cares that you don't own the US? The US is simply too high priced from top to toe. If you had to own US, and a lot of people do, then you have to own quality stocks, because they have survivability. What people found in 1929 Is the value stocks had a dangerous tendency to go bust in the Great Depression, and the Coca-Colas that were horrendously expensive did not go bust. In the …

AI assessment note: “As we got older and wiser, we were perhaps more careful in how we phrased it.”

Q When you had value in your veins very early on, what led you to the intrigue about the investment world?

A I was into numbers. I grew up playing Monopoly seriously, checking off numbers with a little roulette wheel while pretending to watch games of cricket that went on forever. My cousin and I would be spinning the roulette wheel and checking in a little book, the numbers that came up. We had in our silly thirteen-year-old minds the idea that we could develop an infallible system, which is good to get it out of your system at 13 and 14. And I did. I remember the first day I went into a casino in France. By then I was 20. I had accumulated a few pounds that I was willing to invest in an experience. So at two 30 when it opened, I went in, accompanied by about five little old ladies. They took off the cover from the tables that they used to keep the sunlight from fading the green tops, and I played roulette for the first time in my life in the real place, lost a few pounds, and left feeling that it had been worth the experience. I grew up thinking about numbers, thinking about the whys and wherefores of gambling. When I came across the opportunity to buy a stock, when I was 16, I took it to see what it was like.

AI assessment note: “When I came across the opportunity to buy a stock, when I was 16”

Q What was your path from the first days in investing until the founding of GMO?

A In between, I was a co-founder of Battery March with Dean LeBaron. That only took me nine months. I went from consulting to Keystone funds, and they offered me a 50% increase in salary, which wove me up. I thought, what the hell is that? I would have been happy to come at the same price, perhaps even less. The extra 50% was amazing. I looked around, and I found the entire industry was like that. Everybody in investment was getting paid about 50% more than the equivalent work and the equivalent talent anywhere else. What's not to like about that, by the way? I did one or two novel things, so I got off to a running start. After eight months, I propositioned one of the senior guys, Dean LeBaron, to come and work with a friend I'd met who was also in the investment business at a different firm, and we thought we could start a little firm. Talk about cocky. He'd been in the business two or three years. I'd been in six months, and we were going to start a firm. We propositioned Dean, and he said he'd think about it, and he'd do it, and no, he wouldn't do it, and yes, he would do something similar. He'd do his own firm, and would I come and work for him? Dean and I and a secretary started out in a single room up the road, After eight years, I had fallen out with Dean, mainly on the distribution of loot and intellectual credit. So I left my co-partner, Dick Mayo, left also, and four or…

AI assessment note: “I went from consulting to Keystone funds... co-founder of Battery March with Dean LeBaron”

Q Where does that leave us today if the bubble as defined by that two standard deviation move didn't quite go back all the way to trend before it bounced?

A No, it didn't. By a considerable margin, it didn't get to trend. It would have had to go down another 20% to get a checkpoint. Let's say it was halfway. Where it leaves us now is with a unique event that's never happened before, which is historians love to have repetitions so you can design a battle plan based on things behaving, quote, like normal. There's never been a second bubble coming in like that. I don't think it would ever work unless it was a truly tremendous new idea. AI Moving at warp speed, involving a greater CapEx program than has ever happened before outside of war. This is the real McCoy. That doesn't mean that you can't have a bubble associated with AI. It's quite the reverse. If you look back in history, what you find is that the great bubbles are associated with great investment ideas that get overdone. It has to be serious. And ideally, it has to be obviously serious. Railroads are the best example, followed by the internet. If you see that railroads are going to change the world, then of course you want to invest the ordinary guys. You're going to have enormous momentum, so all the momentum guys are in there too. And you build, as the joke goes, six tracks between Leeds and Manchester. You could badly use one, and two wouldn't be too bad. But everybody loses money, and they all get cleaned out. Doesn't mean that railroads didn't change the world. Of course…

AI assessment note: “Where it leaves us now is with a unique event that's never happened before”

Q will be valuable to our community. One is Oldwell Labs, or OWL. OWL is the very best software I've seen for allocators to find and track managers, and I've seen a lot of them. Trust me, it'll be worth the look. There's a link in the show notes so you can learn more. And here are those closing questions. What's your favorite hobby or activity outside of work and family?

A I love to play tennis doubles these days with friends. Life is too short to play with people just because they can hit the ball over the net. Tennis is widely thought recently to be the best for living a long life, and partly because it has the right kind of camaraderie. Soccer is not so bad, but you don't really talk much in a soccer game. I played soccer twice a weekend up until my hips went. But tennis on a clay court, you can go on for a long, long time. It's a great experience. Other than that, I spend too much time glued to my iPad reading good books and a bit of science fiction, beginning to spend too much time maybe chatting with Claude and Deep Seeked where they disagree.

AI assessment note: “I love to play tennis doubles these days with friends.”

Q What were some of your other early ventures in investing before it became a profession?

A When I was at business school, I got together with a fellow Englishman. There weren't many of us. We shared investment ideas, went into the library, read what we thought were the unfair advantage publications, vastly expensive publications that gave all the stockbrokers recommendations. Of course, I wouldn't give a plug nickel for it today. But at the time, I thought it guaranteed our success, so we took the money that we had earned in a summer job and invested in a few famous at the time stocks, Magnavox. We kidded ourselves if we were slick professionals by knowing the nickname, in that case, Maggie's, for the stocks that we bought. Incidentally, the ACRO engineering, which went bust, had this interesting twist to it that when I came to America, I sold it to my mother. Who had acquired a small holding herself. The commissions were quite big, so we made a big fuss about saving the commission. I had tripled my investment from 16 to 24. Nothing great, nothing terrible, and she bought it off me at a bargain commission free rate, and unfortunately went bankrupt with it, as it were.

AI assessment note: “we took the money that we had earned in a summer job and invested”

Q At what point in time did you see that perhaps your models weren't infallible as you had hoped from the early days?

A We had always had these lulls in the value business. Value had won for 80 years or so, but it only won two out of three years. Every now and then, there'd be a two or three year interval where it would do very badly, and then it would surge back. It was beating the pants off growth stocks in those days. It was winning by three or four points a year, so enough to really count. There weren't many long intervals that were too much for us. The first one came with the great tech bubble of 98, 99, 2000. Even that was only two and a half years. A spectacularly painful two and a half years. That introduced us to a new environment where clients could get very quickly fed up with you and quite vicious about it. In the internet bubble of 99, By the end, they were treating us as if we'd done it deliberately to cost them money. This was not the usual slight disgruntlement that had gone on when you lagged for a year or two. This was something new to us. This was, what the hell are you guys trying to do to us? You seem to have completely lost the plot. Everyone in the world knows that growth stocks and the internet is going to inherit the earth, and you seem to be stuck in a world of value that is lagging behind. Interestingly, they weren't going down. We were making good money more than the pension funds were assuming they had to make, but we weren't making nearly as much as the hotshots at …

AI assessment note: “The first one came with the great tech bubble of 98, 99, 2000.”

Q How about on the investment side, your biggest investment pet peeve?

A My biggest investment peeve is that the Greenspans and the Larry Summers, they get away with murder. I call them the Teflon men. I was heartbroken when they kept getting reappointed by new presidents that I had higher hopes for, even as they had just presided over the great financial crash. To put this into perspective, Greenspan and Summers and Levitt of the SEC waged war against the CFTC doing its job of regulating subprime instruments. They each, in turn, called up Brooksley Bourne, who was the boss, a lady of iron nerve and principle. They harangued her, saying, what are you talking about? The financial industry knows what's in its best interest. If this is dangerous, they will not do those dangerous things. I'm not kidding you. That was the argument that they used. When she told them to get lost, they took it to Congress and got the law changed. They were so emphatic that you should leave the banks uncontrolled in this area, so then we wouldn't have to worry about subprime instruments being too racy, too risky, and too designed to make money for the wrong people at the expense of ordinary homeowners. What a price we paid. It nearly brought the entire financial system to its knees. Because of that kind of crazy attitude, the banks would be naturally so smart that they would be well-behaved. And of course, they were badly behaved. Yet, Greenspan got knighted by the Queen, an…

AI assessment note: “My biggest investment peeve is that the Greenspans and the Larry Summers, they get away”

Q How do you think about trying to use your philanthropic work to change the inflection of those trajectories?

A The foundation does it two ways. We address The most enterprising on-topic people as a grant. I'm pleased to say that we might reach a billion dollars of grant checks written by the end of this year, cumulatively. Then with our portfolio, we try and back it up by investing in green tech, where it would make a marvelous difference if it works. The more important the idea, the more points it gets from us. The riskier the idea, in a way, the more points it gets for us. We want to be doing the things that in a purely capitalist world might fail, even though if they could succeed, it would make a hell of a difference. It's just not going to make you any money in the early stages. Perfect. So we do that, and we've done a 120 ourselves, and a lot of them will fail. The great majority will fail. But one or two of them, if they worked, would change everything. Cheap infinite supply of green energy would change everything. Some forms of geothermal or fusion would change everything. One or two other ideas that change the effectiveness of energy, that they lose less in the process. Extracting CO₂ from the atmosphere effectively. If you could do that cheaply enough, you could fly the odd plane and extract and charge the ticket for the cost of extracting. If it was practically cheap, there are chances that that will happen, and we want to be backing them.

AI assessment note: “The foundation does it two ways. We address The most enterprising on-topic people”

Q How does that reflect on how you see people treating the environment?

A The hatred of long-term and unpleasantness. Think about that in climate change. I don't want to hear that. Oh, God, they've been saying bad things about the climate forever. Can't possibly be any sustained deterioration just because of burning a few gallons. It's all absolutely predictable, programmable. You know what the effect of each part per million really is of CO₂ in the atmosphere. You know what happens if you double it, and we're doing precisely that. The temperature is rising, give or take what they would have predicted 50 years ago, 80 years ago, and 10 years ago, but people are prepared to ignore it. Today, the floods and fires are not going to make my life unbearable tomorrow unless I live in a fire zone or a flood zone and can't get insurance this year. So it's beginning to bite, but only just beginning. Then you think of everything else that really matters in the long run. Another one would be toxicity that is ruining our health. We've created a toxic stew, and we're losing the ability to procreate. No one will talk about that. I asked AI over the weekend to explain why Baby production was dropping and made it take the lead, and it gradually filled in, very professionally, all of the dozens of ideas, economic and social reasons for not having children, like you did in the old days, to which, of course, one agrees. Then I got to say, have you missed anything? It fo…

AI assessment note: “The hatred of long-term and unpleasantness. Think about that in climate change.”