Ben Inker: 'The Portfolio We're Running Today Is Abnormal Even for Us'

Episode Summary

Executive Summary: Ben Inker argues that investors are still being paid for risk, but the payoff has shifted: U.S. stocks and bonds both look expensive, while emerging-market value and liquid alternatives look far more attractive. He defends ESG as likely neutral-to-positive over time, explains value investing’s slump through valuation compression and weaker rebalancing effects, and emphasizes durable forecasting based on economic service, required return, and starting valuation.

Main Topics: Why equities should still earn a risk premium (Priority: 5/5): Inker explains that policymakers cannot eliminate risk, and stocks should outperform bonds because they represent levered claims on volatile cash flows that tend to disappoint when investors most need stability. ESG and expected returns (Priority: 4/5): He argues ESG portfolios should not systematically underperform random non-ESG portfolios; better long-term corporate thinking can offset reduced opportunity sets, and the effect may be beneficial for the real world. Market cycles, volatility, and mean reversion (Priority: 4/5): Inker pushes back on the idea that the current bull market has fundamentally altered cycles, noting bull and bear markets vary greatly in duration and that volatility remains a core driver of mean reversion. Weak outlook for the traditional 60/40 portfolio (Priority: 5/5): He says both equities and bonds are expensive, leading GMO to forecast negative real returns for a classic balanced portfolio over a seven-year horizon. Why emerging-market value is attractive (Priority: 5/5): Inker makes the case for EM value using low valuations, strong earnings yields, decent ROE, modest leverage, and generous dividend yield as reasons to expect strong long-term real returns. Why value investing has struggled (Priority: 5/5): He traces value’s underperformance to shrinking relative discounts, weaker rebalancing benefits, and especially valuation compression within the style, not to fundamentally worse business growth. Portfolio construction and liquid alternatives (Priority: 4/5): He describes GMO’s unusually large allocation to long-short equity and alternative strategies as a way to seek returns with less broad-market beta when traditional assets look overpriced.

Key Arguments: Policymakers cannot truly stamp out risk, so stocks should continue to offer a risk premium over bonds because they are levered claims on uncertain cash flows. ESG screens are not random; if they tilt toward companies that think long term, expected returns should be similar or slightly better than unconstrained portfolios. The current U.S. market environment makes traditional stock/bond portfolios unattractive because both sides of 60/40 are expensive on a real-return basis. Global diversification matters because non-U.S. equities are cheaper than U.S. equities, and U.S. large-cap valuations leave little room for error. Emerging-market value is compelling because low multiples, high earnings yields, and solid profitability reduce the risk of severe multiple compression. Value investing’s poor recent performance is explained more by valuation changes and weaker style rebalancing effects than by weaker underlying growth. When broad beta looks poor, long-short equity and other liquid alternatives can provide a better risk-reward trade-off than holding more cash or bonds. Durable forecasts should begin with the economic service being provided by an asset, then assess the return that service should earn and whether current pricing supports it.

Data Points: Morningstar Investment Conference price: $149 - Annual conference for investment professionals, offered virtually. Conference dates: September 16-17 - Morningstar Investment Conference mentioned in the intro. GMO forecast for 60/40 real return: -4.2% per year - Projected real return for a U.S. 60/40 portfolio over the seven-year forecast horizon. Potential real value loss for 60/40: ~26% by May 2027 - Illustrative cumulative loss implied by the forecasted real return. SP 500 expected real return: -1.5% to -5% - Range GMO thinks U.S. large-cap equities may deliver on a real basis depending on normalization assumptions. Normalized P/E of S&P 500: ~26x - Inker’s estimate of U.S. large-cap valuation on normalized earnings. Bond yield normalization target: 2.5% to 3% real/yield context - He says even a move from current levels toward this range would still imply strongly negative real returns for bonds. Historical normal bond yields: 5.5% to 6% - Referenced as a prior historical norm for U.S. bond yields over the last 25 years. Emerging-market value P/E: 8.8x trailing earnings - Valuation level of the EM value portfolio he discusses. EM value dividend yield: just under 6% - Trail dividend yield used to illustrate the income available while waiting for mean reversion. SP 500 dividend yield: 1.9% - Used in comparison with emerging-market value and in the forecast discussion. Value portfolio dividend yield: about 3% in the U.S. market context - He notes value offers roughly 50% more income than the broader market today. Value undergrowth vs market: about 5 percentage points per year - He says value stocks undergrew the broader market by roughly this amount in both 1982-2006 and 2007-present periods. Value expected outperformance from stable valuation: ~1 percentage point per year - If value’s relative valuation stops getting cheaper, he thinks value should outperform modestly. Value expected outperformance if mean reverts: 2-3 points per year plus - If value’s valuation reverts, he expects materially stronger relative returns. Alternative strategy allocation in flagship fund: 19% - Share allocated to alternatives, including systematic global macro. Long-short equity allocation in flagship fund: 40% - Largest allocation in the benchmark-free fund. Emerging-market value allocation: 25 points of the portfolio - He says GMO holds a very large exposure to EM value relative to traditional portfolios. Value expected to beat market: around 4 points a year for the next five years - His estimate of value’s expected edge over the market from current spreads. Historical price-to-book claim: less than book value - He cites this as part of the EM value opportunity set.

Pivotal Quotes: "It is impossible for policymakers to truly stamp out risk." — Ben Inker: Explaining why stocks should still earn a premium over bonds. "We think value stocks deserve to beat the market by, let's say, around four points a year for the next five years." — Ben Inker: Describing GMO’s high-conviction opportunity in value investing. "I don't see how you can today forecast a strong return from the S&P 500 unless you're prepared to assume that things only get better for US large cap companies." — Ben Inker: Summarizing his bearish stance on U.S. large-cap expected returns.

Implications: Listeners should expect lower forward returns from traditional U.S. balanced portfolios and consider global diversification, value tilts, and liquid alternatives. For managers, starting valuation and economic function matter more than recent momentum when building durable forecasts.