You may not be familiar with the name "Grantham, Mayo, Van Otterloo & Co." -- but you should be.
Led by fund industry guru Jeremy Grantham, GMO is a Boston-based money management firm with nearly $100 billion in assets under management. Grantham and his colleagues didn't build that asset base through clever marketing techniques -- they simply outperformed the crowd year after year.
GMO takes a slightly different approach than most U.S.-based firms. Rather than scouring only the domestic financial landscape for winning investment ideas, they've been known to shift assets to other markets when the right opportunity strikes, having built a team of international research analysts back in 1981. The firm now has offices in the U.K., Australia, Singapore and Switzerland. That "on the ground" capability helps identify specific stocks and sectors in regions that many investors might miss.
Yet here's the rub. Grantham and his team have just made a call "from 10,000 feet," as they say in the money management business. One of his biggest current investment moves is purely macro, bypassing the micro-level of stock-picking.
Grantham's best new idea: the iShares MSCI Emerging Markets Index (NYSE: EEM). In the first quarter of 2013, his firm bought $200 million of this fund, right at a time when most other investors were pouring their money into U.S. and Japanese stocks.
The flow of funds into the U.S. market, while emerging markets have been mostly ignored, has led to a profound valuation disconnect. Over the past two years, the S&P 500 has outperformed this emerging-market ETF by a whopping 33 percentage points.
Let's take a closer look at why emerging markets have lagged, and whether this is in fact the right time to move funds into them.
Flight To Safety
Over the past few decades, the U.S. stock market has had a powerful impact on emerging markets. In periods of rising global economic growth, a rising U.S. stock market led to super-size gains in many emerging markets. And in times of economic despair, emerging markets have often slumped even more deeply than developed-market stocks.
Yet over the past few years, that connection has been severed. The huge sums of money being poured into the U.S. market via the Federal Reserve's quantitative easing programs has played a hand in our markets' impressive recent gains, even as global economic growth has been quite muted. The weak global economy, in turn, has led to diminished interest in emerging markets, which need growth to succeed.
Still, it's fair to question whether this is a good time to be investing abroad, especially as China has just issued another tepid economic report. After all, China is a key trading partner with many emerging economies, especially in Asia and Latin America.
Then again, the U.S. economy appears to be building a modest head of steam, and even beleaguered Europe has shown a few recent "green shoots." The U.S. still accounts for 25% of global trade, and Europe accounts for another 20%. So it's simplistic to assume that emerging economies are headed for trouble even as China's torrid pace of growth cools.
Here's how investors should look at the matter: Emerging markets still possess the most robust long-term growth prospects -- especially when compared with the slower-growing developed economies. Anytime you can buy the faster-growing markets at a cheaper price than the slower-growing markets, you need to be bold.
Can emerging markets fall from current levels? Sure, which is why you need to be thinking of these as long-term investments. It's quite unlikely that Grantham will move to unwind his new $200 million position in emerging markets in the next few quarters. History shows he may choose to stick around for several years, if that's how long it takes for his investment to pay off handsomely.
The iShares MSCI Emerging Markets Index ETF is actually positioned to be a lot less volatile than the typical emerging-market fund, as it mostly focuses on globally dominant blue chips. Top holdings include South Korea's Samsung, Taiwan Semiconductor, Mexico's América Móvil, Brazil's Petrobras (NYSE: PBR) and Russia's Gazprom. Further down the portfolio are smaller, nimbler companies that are a direct proxy for economic growth in emerging markets.
Risks to Consider: Emerging markets are often volatile so it's crucial that you have a multi-year time horizon when holding them. Conversely, they can also rise in value quite quickly, and it's often profitable to exit these volatile markets after periods of strong outperformance.
Action to Take --> I recently noted that investors are fixating on what is working in this market and ignoring the investment themes that aren't gaining traction. And emerging markets have surely become an unloved asset class -- relative to U.S. stocks. Grantham's $200 million investment simply reflects a desire to go where the crowd isn't.
It's also noteworthy that his fund's biggest stock investment in the most recent quarter also involves an emerging-market stock. Also in this year's first quarter, GMO bought nearly $50 million of Yandex (Nasdaq: YNDX), which is often called the "Google of Russia."
I profiled Yandex in early 2012. The company went on to boost sales 43% last year to $916 million, and analysts anticipate 30% sales growth this year and additional growth of 20% in 2014. Grantham's investment means Yandex deserves a fresh look.