GMO has cut equity exposure across its multi-asset portfolios in response to what the management team sees as overly optimistic pricing in developed markets, which do not offer enough reward for the risk required at present.
After initially adding to risk assets when the coronavirus pandemic began to affect markets in March, Tommy Garvey, member of the asset allocation team at GMO, said the "huge recovery" in markets has led them to "determinately take risk off the table", reducing net equity exposure across benchmark-free strategies by 30% and 10% over benchmark-relatives ones.
"Crucially, it is whether you are getting adequately compensated for any risk so that the price of something reflects the potential reward and potential risks," he said.
"On emerging markets, we think we are getting paid for the risk. It has priced in some pretty bad news and if the news is only bad as opposed to very bad, we think we should be rewarded handsomely."
For the rest of the equity portfolio, the team added long/short positions. It also added to alternatives such as global macro and absolute return funds, which have begun to look "more attractive as beta becomes more expensive".
"People do not do a particularly good job of separating good companies from sound investments," Garvey said.
"Microsoft is a great company but it is sitting on more than 30 times last year's earnings with a dividend yield of perhaps 1% or less. It is very hard to see how you get paid by owning Microsoft."
Across its benchmark-relative strategies, the team has invested in a similar fashion but "in a less extreme way".
"When clients hire us for a benchmark strategy, they expect us to pay a bit of attention to what the benchmark is," Garvey said.
Part of the de-risking process included removing some fixed income from the portfolios, particularly US inflation-linked bonds, as there is "not much further protection to be had, even if things do go further south from here," he explained.
Garvey reassured investors that these moves "reflect current conditions" and that if the situation changes it "will be reflected in our portfolio".
"If equity markets crashed to a level where we thought they were sensibly priced again, we would take the shorts off and if the value/growth spread compressed, we would no longer necessarily want to be long/short."
"It is important to us that it is risk-reward driven. Are you being paid for the risks you are being asked to take? We do not believe that you are in most developed market equities."