Saturday, January 19, 2013
GMO Mutual Funds Review
GMO is a much older (and bigger) firm than AQR Capital Management that I reviewed a week ago. They also have a lot more funds, many of which do not have direct passive benchmarks. As before, I tried to make most fair benchmark choices possible. A couple of times I used Vanguard VTRIX as international benchmark -- even though it is an actively managed fund -- becase GMO's international funds in question were a whole decade older than Vanguard's broad international index fund VGTSX. A couple other times I moved up the starting point from inception to a year or two later, so I could use VGTSX.
The biggest problem with analyzing any active fund family (and many investments in general) that's more than a few years old is survivorship bias. What happens is that over time some funds have performance so poor that they are abandoned by investors and eventually shuttered. So when you look at something that has a history of well over 20 years you are only seeing the funds that made it and not the ones that didn't. It would be a bit like looking at all currently active professional football players and calculating the length of average pro-football career from that sample. It sounds reasonable but it would be very misleading because it would omit hundreds of players who only stuck around for a short time because of lack of talent or injuries and would not be included in this count. The "survivors" would dominate your calculations, making average careers appear longer than they actually are.
At least with pro football players it's not particularly hard to account for this bias. With mutual funds the situation is very different. If there is an official record-keeper of deceased mutual funds, I am not aware of it. Each individual fund house probably keeps track of its own failures, but even that is hardly guaranteed. In fact it's against the company's interest for the public to learn of all its failures, so such an record-keeping effort would likely not be given high priority -- and certainly not released to the public. How few or how many funds has GMO shuttered I couldn't even begin to guesstimate.
In part to get a feel for survivorship bias and in even bigger part to see whether GMO's outstanding performance of yore is continuing today I have broken down my analysis into 3 time periods: returns of 3 years to date (or however far back the history of the newest funds goes), returns of up to 5 years to date, and returns since inception (or my "adjusted inception" date I mentioned above). Here are the results -- and I'm positive I've made some algebraic or coloring mistakes just because there was so much data involved, so my apologies in advance:
There are a lot of very interesting (to me anyway) trends that could be observed from even this relatively superficial analysis. First and foremost, is that either GMO has shuttered quite a few funds over the years resulting in strong survivorship bias or the ability of its managers to deliver alpha declined over the years. I suspect it's a bit of both. Looking over the entire history of GMO's funds fully 75% of them beat their benchmarks (as chosen by me from Vanguard funds) and in many case by astoundingly high margins. Looking at the most recent 5 years that percentage declines to 63%. And looking at the most recent 3 years it declines to 60% with only the Emerging Country Devt III fund (GMCDX) truly crushing its benchmark (admittedly there is no good passive benchmark for emerging country debt -- I used a frankenmark of half emerging country equities and half US bond market).
Another trend that emerges is that across the board GMO's bond funds (with exception of GUSTX) invest in much more riskier securities than my go-to bond benchmark of VBMFX. All of GMO's bond funds have had much largers drops during the panic of late 2008 than did VBMFX.
Another trend is that most of GMO's funds have tracked indices very closely over the recent years years. Unlike their performance during the 1980s and 1990s, their charts from recent years look exactly like the chart of corresponding index benchmarks, wiggle for wiggle so to speak. This is of course the expected behavior for any large fund that necessarily becomes a closet index funds as it runs out of "opportunities" and has to start investing in more and more companies. This trend dovetails with my earlier mention of apparent decline in skills of GMO's managers. You may find my Catch-22 of Active Mutual Funds post interesting as it discusses some of the same issues.
Nevertheless, despite these caveats and the apparent decline in GMO's ability to deliver alpha, its funds still performed impressively well overall. They beat their closest passive benchmarks more than half the time for all time periods examined.
Would I invest with GMO now? Probably not. Beating benchmarks 60% of the time with assistance of higher risk bonds and probably non-zero survivorship bias, even for just the past 3 years is just not quite enough for me. The one exception I would make is if I were interested in investing in emerging country debt and had 8 figures to throw into GMO's GMCDX. It has had a truly impressive 19-year run, has a more-or-less reasonable for its asset class 0.64% expense ratio, has continued to deliver outstanding returns in the recent years, and simply has no passively managed equivalent. The $10,000,000 minimum initial investment does put a damper on it, however. But it does give me an idea to look more closely into both the history and future prospects of emerging countries debt investments.