US-based equity investors GMO has taken bond house PIMCO to task over comments made about the supposedly dire health of equities.
In a white paper entitled ‘Reports of the death of equities have been greatly exaggerated: explaining equity returns’, the investment firm, co-founded by Jeremy Grantham (pictured), set out to dispel what it perceived to be the major misconceptions regarding equity performance.
The document, penned by head of asset allocation Ben Inker, is seen as a direct response to a comment piece from PIMCO’s Bill Gross, in which the veteran bond investor slammed equities as an asset class.
In a typically outspoken piece, Gross claimed: 'The cult of equity is dying.'
'Several generations were weaned and in fact grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk.'
Although there is no overt mention to Gross, Inker does reference the phrase ‘death of equities’ on a number of occasions as part of his commentary.
‘Disappointing returns from equity markets over a period of time should not be viewed as a signal of the “death of equities”,’ he said.
‘Such losses are necessary for overpriced equity markets to revert to sustainable levels, and are therefore a necessary condition for the long-term return to equities to be stable.’
One key element Inker said investors need to understand is the relationship between equity returns and GDP growth – or, more specifically, the lack of one.
This is another point which Gross (pictured below) raised, as he said real GDP growth can constrain asset class performance.
Inker said: ‘Stock returns do not require a particular level of GDP growth, nor does a particular level of GDP growth imply anything about stock market returns. This has been true empirically, as the Dimson-Marsh-Staunton data from 1900-2000 shows.’
‘Many investors are utterly convinced that strong GDP growth is the primary reason why one country’s stock market will outperform another. This was certainly not the case in the 20th century,’
Equities vs. bonds
In the commentary, Inker does make reference to the relationship between equities and fixed income performance over time and states long-term returns for equities are, on average 3% higher than higher quality fixed income over time.
‘We can’t be entirely sure we are correct, but it would be decidedly odd if equities didn’t offer a significantly higher return than high quality fixed income.'
'It’s not simply that equities are more volatile and have greater uncertainty than fixed income, but in recessions, depressions, and financial crises, high quality fixed income tends to go up rather than down.’
Inker did state equities were an ‘ugly asset class’, possible of losing investors more money than they will return. However, the GMO manager said this is also part of their charm.
‘Whether GDP growth in the U.S. and other developed economies is going to be slower in the future is not, in and of itself, a reason to expect a lower return to equities.’
‘Likewise, the fact that historic equity returns have been higher than GDP does not mean that the equity market has been some sort of long-term Ponzi scheme.’
The comments by Inker mark a departure from the thrust of more recent commentary pieces issued by GMO which have seen veteran investor Jeremy Grantham concentrate on the issues surrounding food scarcity.
To read the whole response from Ben Inker on behalf of GMO, please click here.