Money For the Rest of Us

Contrarian Investing with GMO's Ben Inker – FEG Insight Bridge

Host: J. David Stein
Guest Host: Greg Dowling (FEG CIO)
Guest: Ben Inker (Co-Head of Asset Allocation, GMO)
Date: February 5, 2025

Episode Overview

This special episode features a rebroadcast of FEG Insight Bridge, with Greg Dowling interviewing Ben Inker of GMO. The conversation explores foundational principles of contrarian investing, market bubbles, valuation drivers, the challenges and benefits of diversification, the persistent debate over active vs. passive management, and why Japanese small caps are capturing GMO's attention. David Stein provides context about the value of decomposing asset returns and the challenge of predicting markets, reinforcing the importance of understanding underlying return drivers.

Key Discussion Points & Insights

1. Ben Inker’s Unlikely Start at GMO

• Inker recounts his unconventional hiring at GMO, shaped by his relationship with Yale's endowment manager David Swensen.

  • "David was entirely responsible. I cannot take any credit... I don't think there was anyone at GMO who wanted to hire me." (06:16)

• Reflections on 32 years at GMO, the firm’s evolving culture, and the legacy of co-founder Jeremy Grantham.

2. Lessons from Mentors: Jeremy Grantham & David Swensen

• Public Speaking & Professional Growth

  • Inker describes how witnessing Jeremy Grantham’s candidness during a speech helped him overcome public speaking anxiety.
  • "He just stops... and says, 'You know, I'm sorry, I forgot what I was talking about. Can anybody remind me?'" (09:19)

• Investment Lessons: Decomposing Returns

  • A central pillar at GMO is analyzing the drivers behind returns—cash flow, growth, and valuation changes.
  • "When you're looking at an asset, it is not enough to be looking at what its returns have been. The really important thing is to decompose those returns into the underlying drivers..." (10:19)

• Swensen’s Influence:

  • Made investing feel like a “fascinating puzzle” and reinforced the importance of partnering for problem-solving.
  • "He made investing seem like so much fun... just this really interesting problem." (13:09)

3. GMO’s Track Record: Right and Wrong Calls

• GMO has successfully identified market bubbles (2000, 2008, 2022) but has a history of exiting too early, notably with Japan and US equities in the past.
• "The biggest mistake has been to be too underweight the US for too long. And... being contrarian by nature... you can be too apt to kind of assume the market has something importantly wrong before it does." (16:00)
• Inker admits to missing the significance of monopoly power/profit persistence in U.S. corporations, which altered mean reversion assumptions for profit margins.

4. Market Concentration & the “Mag 7”

Historical Context & Risks:

• Large-cap concentration is not new, but the idiosyncratic risk and volatility of today’s tech leaders (Nvidia, Apple, Microsoft) are unprecedented.
• "The idiosyncratic risk associated with Nvidia today... is, as near as we can tell, the highest individual stock risk that has ever existed in any company or the history of the S and P composite." (21:06)

Indexing’s Role:

• Index investing might subtly increase valuation spreads, but the real driver is the exceptional business performance of these companies, not passive inflows alone.
• "Passive may have had an impact, but we got bubbles before we got passive." (27:51)

5. Valuations, Diversification, and Investor Dilemmas

• High U.S. valuations present tough choices: owning expensive winners vs. facing massive tracking error if avoided.
• Diversification as the Only Response:
  • “If you know there is uncertainty, you just have to diversify.” (29:18)
• Danger in holding stocks "priced as if we know what the world is going to look like in five years" (30:11). International and non-U.S. equities offer more reasonable valuations.

6. The Quality Factor

• Quality—companies with low economic risk and robust fundamentals—is a favored long-term bias, though not always “cheap.”
  • "I was going to recommend one bias to have in your portfolio forever, it would be quality." (31:49)
  • “It is the group in the market that should underperform in the long run and they don’t.” (32:24)
• Junky growth stocks are riskier and less attractively priced than high-quality companies.

7. Value & Deep Value Stocks

• “Deep value” (cheapest 20%) is at an extreme global discount and offers unique risk/reward, while "shallow value" is less attractive relative to history.
  • "Within that [value], we do see this bifurcation... the cheapest 20%... [is] trading at some of the biggest discounts we have ever seen, whereas the rest of value is actually trading expensive vs its history." (36:41)

8. Small Cap Equities – U.S. and Japan

• U.S. small caps trade at a record discount to large caps, partly justified—profitability and leverage trends are less favorable than before.
  • “Small deserves to trade at a bigger discount than it used to... [they] are junkier and riskier than they used to be.” (40:10)
• Japanese small caps are a standout:
  • Improved fundamentals (stronger earnings growth, repaired balance sheets), government reform pressure, and currency tailwinds.
  • “The yen is just stupid, cheap... that makes these companies really competitive. So it is a place we are quite excited about and a place we warmly recommend people giving an eye to.” (46:14)

Notable Quotes & Memorable Moments

• On Asset Return Drivers:

  • "Decompose those returns into the underlying drivers, because if you understand the underlying drivers, you can understand which pieces of this return are likely to persist, which ones might reverse, which ones were... random." —Ben Inker, (10:19)

• On Active vs. Passive & Tech Giants:

  • "You don't need indexing for these companies to have gotten where they are... Passive may have exacerbated this a little bit, but this is not qualitatively different from what we have seen markets do." —Ben Inker, (27:31)

• On Diversification:

  • "If you know there is a risk, you can try to hedge it. If you know there is uncertainty, you just have to diversify." —Ben Inker, (29:17)

• On Quality as a Persistent Anomaly:

  • "The strange thing is they [quality stocks] are the group in the market that should underperform in the long run and they don’t." —Ben Inker, (32:24)

• On Japanese Small Caps:

  • "The good news is they have no debt. It's really hard to drive them into bankruptcy... there are really straightforward ways for these companies to improve... So it is a place we are quite excited about." —Ben Inker, (45:26)

Timestamps for Key Segments

• Ben Inker's start at GMO & cultural insights ...................... [03:39–08:16]
• Lessons from Grantham & Swensen .................................... [08:17–14:12]
• GMO’s right/wrong calls & adapting models ......... [14:13–19:29]
• Market concentration, tech giants, & risk ................... [19:30–23:56]
• Passive investing’s impact on concentration ................ [23:57–28:02]
• Valuations, diversification, uncertainty themes .......... [28:03–31:48]
• Quality factor analysis ....................................................... [31:49–36:33]
• Value & deep value stocks globally .................................. [36:34–38:24]
• Small caps: US challenges, Japan opportunities ........ [38:25–47:36]
• Lightning round: hobbies, recommended book .......... [47:37–50:12]

Additional Highlights

• Inker’s personal “Fun Facts” hobby and puzzle-solving as core to both his investing philosophy and approach to life. [47:53–48:33]
• Top book recommendation: Peter Bernstein’s "Capital Ideas"—a classic on the evolution of investing thought. [49:35–50:12]

Conclusion

Ben Inker's rigorous, contrarian approach—rooted in decomposing returns and valuing humility in the face of uncertainty—provides timely and evergreen lessons for investors. The current environment, marked by extraordinary market concentration, demands thoughtful diversification. Listeners are encouraged to reconsider traditional market narratives, become more granular in their analysis, and look globally for overlooked opportunities, like Japanese small caps. Throughout, Inker’s candor and depth offer a masterclass in risk, behavioral discipline, and the evolution of value and quality investing.