Broken Data. Hidden Opportunity | GMO's Warren Chiang on Deep Value’s Historic Setup

Episode Summary

Executive Summary: Warren from GMO argued that value investing is still viable, but it must be done through better valuation methods that adjust for intangibles, quality, and distorted accounting. He said GMO’s deep-value opportunity is extreme—especially in the U.S.—and explained how the firm combines top-down asset-allocation research with bottom-up portfolio construction, while avoiding momentum and macro overlays in its value ETFs to preserve pure deep-value exposure.

Main Topics: Value investing’s long underperformance and process improvement: The discussion opened with lessons from 10–15 years of value underperformance. Warren said the key lesson was not to abandon value but to improve the process during difficult periods, emphasizing that GMO refined its methodology while staying committed to the theme. GMO’s valuation framework and the role of intangibles: Warren explained that GMO is really doing forward-looking valuation, not classic cheap-stock value. The team restates financial statements to better capture intangibles like R&D, advertising, patents, and goodwill, aiming to make comparisons more economically meaningful. Deep value as a structural opportunity: GMO’s asset-allocation team identified a major dislocation in the cheapest segment of the value universe, which it calls deep value. Warren said the U.S. deep-value segment is at unprecedented cheapness, while international deep value is also attractive but less extreme. Quality, momentum, and factor design: Quality is defined as high sustainable return on capital, measured via profitability, stability, and strong balance sheets. Momentum is intentionally excluded from the deep-value ETFs because it would dilute exposure to the intended theme, though it is used in other GMO products. ESG and macro factors as portfolio risk inputs: Warren framed ESG as an investment-risk issue rather than a moral mandate and said GMO uses proprietary ESG scores to manage exposure. Macro factors are not used directly in the value ETFs because they would reduce theme purity, though they matter more in other strategies such as beyond-China. Passive investing and market structure: He argued passive investing does not distort long-term asset prices because index funds are price takers, while informed active investors still set prices. He sees more passive assets as beneficial for active managers because fewer informed competitors remain. Beyond China and global supply-chain realignment: Warren described GMO’s beyond-China strategy as a response to manufacturing shifting away from China toward other emerging markets due to demographics, COVID-era supply-chain concerns, and geopolitics. He believes this is a long-term structural trend.

Key Arguments: Value has been a difficult theme, but the correct response is to improve the process rather than abandon the theme. Classic value metrics are flawed because financial statements understate intangible assets; restating R&D, advertising, and acquired intangibles improves comparability. GMO is not doing cheap-stock value; it is doing forward-looking valuation to identify stocks likely to reprice higher. Deep value is extremely cheap today, especially in the U.S., and GMO’s process aims to capture that segment without owning excessive value traps. Quality should be embedded in valuation because high-quality businesses deserve a premium and low-quality businesses deserve a discount. Momentum is excluded from the value ETFs because it would weaken exposure to the intended deep-value factor. ESG is treated as a risk-management and alpha-relevant input, not primarily as a political or moral framework. Passive investing may affect short-term flows, but active informed investors determine long-term prices; more passive participation can actually help active managers. The move away from China is structural, driven by aging demographics, supply-chain resilience after COVID, and geopolitical friction, benefiting other emerging markets. Tariffs and exogenous country risks should be modeled when possible, using multiple data sources to create risk betas and manage portfolio exposure.

Data Points: Value underperformance period: 10–15 years - Used to describe the long stretch of weak relative performance for value investing. U.S. deep value cheapness: Never been cheaper - Warren said the U.S. deep-value segment is at its cheapest level in history. International deep value cheapness: Top 5th percentile - International deep value is also extremely cheap, though less extreme than the U.S. Deep value prevalence: Cheaper only about 5% of the time - Warren described the deep-value cohort as historically rare in terms of cheapness. Turnover: About 50% per annum - He said the deep-value portfolios are slow-moving, supporting roughly monthly rebalancing. U.S. value ETF holdings: 160+ securities - Portfolio size for the U.S. deep-value ETF. International value ETF holdings: Close to 200 securities - Portfolio size for the international deep-value ETF. U.S. imports from China: 22% in 2018; 11% in March 2024 - Used to illustrate the decline in China’s share of U.S. imports. India electronics export implication: 6x growth needed - To reach 10% of China’s market share, India’s electronics export business would need to grow by six times. China population trend: Officially shrinking - Referenced as part of the structural reason manufacturing may continue to move away from China. Tariff-risk modeling: Single beta built from multiple inputs - GMO used sell-side baskets, text analysis, earnings revisions, and shipping data to estimate tariff exposure. Portfolio constraints: About 5% sector overweight limit - Value ETFs allow modest sector flexibility while keeping theme exposure.

Pivotal Quotes: "We didn't abandon value. We said, we could probably do it better." — Warren: Explaining GMO’s response to a decade of value underperformance. "There's been a divorce between reality and what's on the financial statements." — Warren: Describing why GMO restates financials to better capture intangible assets and economic reality. "You're getting this stuff cheaper than it's ever been. It's never been cheaper." — Warren: Referring to the deep-value opportunity set, especially in the U.S.

Implications: Listeners should expect GMO to keep favoring deep value, quality, and structural supply-chain winners while avoiding unnecessary factor dilution. The episode suggests future alpha may come from rigorous data adjustment, selective factor use, and long-horizon dislocations rather than broad market timing.