GMO’s quarterly performance update for the third quarter ended September 30, 2015.
GMO Benchmark-Free Allocation Strategy
Performance data quoted represents past performance and is not predictive of future performance. Returns are shown after the deduction of management fees, transaction costs and other expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns assume the reinvestment of dividends and other income.
The chart above shows the past performance of the Benchmark?Free Allocation Composite (the “Composite”). Prior to January 1, 2012, the accounts in the Composite served as the principal component of a broader real return strategy. Beginning January 1, 2012, accounts in the composite have been managed as a standalone investment.
The CPI (Consumer Price Index) for All Urban Consumers U.S. All Items is published monthly by the U.S. government as an indicator of changes in price levels (or inflation) paid by urban consumers for a representative basket of goods and services.
GMO – Equity
Characteristics: Despite selling off during the quarter, equities remain expensive so we continue to concentrate our allocations in the most attractively priced areas: emerging markets value, international value primarily across Europe and Japan, U.S. high quality, and select opportunistic positions.
Positioning: At the end of the third quarter, equities represented 40.4% of the portfolio. Regional weights changed modestly over the quarter due to market movements. U.S. equity exposures increased while non-U5. developed and emerging equity exposures fell as those markets came under more intense selling pressure. Within U.S. equities, we rotated some of our US. Quality exposure to fundamentally-sourced stock positions. In addition, we made improvements in the implementation of our existing process to provide more flexibility to our Global Equity team. The enhancements allow for simpler inclusion of issuers within countries for which the Asset Allocation team does not publish a unique forecast, resulting in an increase in the overall name count. As part of the change, we also added Financials into our portfolios (largely insurance companies, but some banks as well) as many of our fundamental concerns have abated.
GMO – Alternative Strategies
Characteristics: We remain underwhelmed by the opportunities available across equity markets and look for other ways to get paid for taking risk. Alternative strategies represent diversifying ways to generate returns.
Positioning: Alternative strategies are comprised of merger arbitrage, Systematic Global Macro Opportunity Strategy, Special Opportunities Strategy, relative value interest rates and FX, and put selling. Our weight in alternatives increased 6.3% during the quarter to 19.996 of the portfolio due largely to the reclassification of our relative value interest rates and FX exposure, which had previously been within our fixed income cross sectional rates and Fx category. In addition, when market volatility spiked in August, we added approximately 3% to our put selling strategy‘,
which writes puts on global markets (58:? 500 and Euro Stoxx 5oin this case). As markets calmed late in the quarter, we let those positions expire. Other alternative position sizes remained relatively constant during the quarter.
Results: During the quarter, alternative strategies detracted modestly from portfolio returns, falling 1.9%. Systematic Global Macro Opportunity declined 0.2% due to a net long equity position in a falling market. Currency (short AUD/long USD), bond (long U.S. treasury futures/short Japanese bond futures), and commodity (net short) positions provided important offsets as all were additive during the quarter. Merger arbitrage modestly detracted as deal spreads widened during the quarter. Special Opportunities fell 3.9% in sympathy with broad equity market declines. Relative
value interest rates and FX were reclassified from fixed income to alternative strategies starting on August 31, 2015 and declined 2.5% in September due primarily to losses in interest rate strategies (due to flatter yield curves in the Eurozone). Our transitory put selling position had no impact on the portfolio during the quarter.
Results: Equities accounted for the majority of the overall decline in portfolio returns for the quarter. With the MSCI ACWI down 9.4% during the quarter, any broad allocation to equities would have detracted from absolute returns but our significant weight in emerging market equities (MSCI Emerging Markets down 17.9%) added to the decline. While outperforming U.S. and global equities, our exposure to U.S. Quality declined 5.2%, detracting from overall returns. Our U.S. opportunistic value stock exposure did even better though, coming in essentially flat for the quarter. Stock selection in general also negatively contributed. Canada Health Care, exposure to global auto and energy stocks, and Spain Telecommunication positions contributed most to absolute and relative declines within our international portfolio. Poor stock selection in China IT, China Energy, and Brazil Utilities detracted from emerging equity returns.
GMO – Fixed Income
Characteristics: The fixed income portfolio is comprised principally of rates and credit positions. Rates globally remain low, leaving few opportunities for traditional duration exposures. While rates fell during the quarter, credit spreads widened. Spreads in some credit assets look attractive, but underlying duration exposures and concerns about potentially rising default rates limit our enthusiasm.
Positioning: The overall exposure to, and positioning within, our fixed income allocation evolved during the quarter. As previously mentioned, we reclassified the crosssectional rates and Fx position into a relative value interest rate and rx exposure within alternatives, stripping out the unencumbered cash that was previously attributed to that strategy. We used some of that cash to build a 10.3% position in U.S. TIPS. While our expected returns for TIPS remain quite muted, they look particularly attractive relative to the negative real returns we forecast for cash. In credit, we hold Emerging Country Debt, asset-backed securities, and a select number of distressed credit opportunities. All in, fixed income represented 21.8% of the portfolio at quarter end.
Results: The fixed income allocation (inclusive of two months of exposure to the relative value rates and FX positions that were reclassified at the end of August) detracted from portfolio performance. Within the cross-sectional rates and FX strategy, flatter long dated euro and British sterling curves negatively impacted our short positions. In credit, TIPS declined 0.6% as inflation expectations fell, leading to lower breakeven rates. Emerging Country Debt declined 3.4% as spreads of the JP. Morgan EMBI Global widened 82 bps. Positions in asset-backed and distressed credit holdings were down only modestly despite spread widening, with neither meaningfully impacting overall portfolio returns. GMO – Cash / Cash Plus
Characteristics: We hold a combination of cash and Alpha Only Strategy. Alpha Only seeks modestly positive returns over cash by taking long positions in attractively priced equities while shorting market exposure through futures or direct equity positions.
Positioning: The portfolio’s cash/cash plus position increased 1.7% during the quarter to 18.0% as some unencumbered cash in our cross sectional rates and FX was reclassified into outright cash. We continue to have conviction in the Alpha Only Strategy, but we reduced its weight in favor of the liquidity and dry powder characteristics of cash.
Results: The allocation to cash/cash plus detracted modestly from portfolio returns. Alpha Only detracted due primarily to the underperformance of international and emerging value equities (held long) relative to us. small and mid-cap stocks (held short).
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