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Perspective

Learning the hard way
GMO's second quarter letter highlights the investment lessons learnt by the co-founder over the past 47 years

Jeremy Grantham

In business school, I was lucky enough to get a great summer job in the oil department of Arthur D Little, which, in my opinion, was the place where you were likely in those days to get the best technical consulting advice. It was stacked with wise and very experienced oil men. I, and another Englishman from business school who had as sketchy an oil background as I, had the summer to make a forecast for European oil demand (me) and supply (Phillip…How are you, Phillip?). A real job for a summer job is more than one could ask and this one paid us at an $8,000 annual rate, four times what we had been earning in England. (Now, by the way, salaries are very similar.) We were both living very cheaply, so what were we going to do with this sudden excess? Yes! Invest it and turn it into the beginnings of a fortune. 

Phillip introduced me to the Wall Street Digest, which, amazingly to me, had all of this seemingly priceless information — the best research (presumably) that Wall Street had to offer. And it was all free in our business school library, along with a fair fraction of all of the research out there. So we researched away, compared the most mouthwatering tips, shared a stock broker, and invested. And most of our stocks went up. Seduced by a bull market, we thought that either our advice from Wall Street was superior or we were, or, more likely, both. So time passed to the summer of graduation, which found three of us with an even more ridiculously high-paying summer job, in this case working directly for the CEO of a large fertiliser company extending a business school course. The net effect was that at the end of summer, as I started my new job at a dignified consulting firm in Manhattan, a check for $6,000 arrived, which, when put into perspective, was enough then to pay for a full year at business school and, interestingly, exactly what I owed on my parents’ mortgage. Paying off the mortgage seemed out of the question because it was by then clear to me that I must have the touch for short-term investing. 

Living in an L-shaped, one-room apartment located almost in the Midtown Tunnel in Manhattan with a recently-acquired working German wife (met in England two years earlier) and spending nothing, the plan was to suffer and save and invest brilliantly in order to be able to return to Europe rich, or nearly so, and in a hurry. And because this could not be done with $6,000, it was necessary to borrow some more money. 

Fortunately (or unfortunately, depending on the time horizon), there was a loan loophole that allowed you to pledge mutual fund certificates (the old type that you could actually touch as opposed to electronic impulses) and borrow 80% of their face value for “home improvements.” Well, mine were for home improvements alright, but just not quite then. So, I borrowed and, after a little more good fortune, brought the new certificates to the bank and took another 80% against them too. 

By now my consulting job with that dignified firm began to feel awfully tame. The classmates who were having the most excitement were clearly those in the investment business. So, I was quite efficient for one of the two or three times in my life and ran a comprehensive job-seeking programme aimed at London, New York and Boston. After several interesting near misses in London and New York, and after a refusal by Fidelity (said to run then an impressive $1.9 billion) in an interview in which a then-famous fund manager could not stop looking at stock prices on his new Bunko-Ramo desktop device, I was offered a job at Keystone Funds (running an almost identical $1.8 billion — but what a difference in long-term outcomes, clearly a case of sic transit gloria). I joined the loose association of classmates scattered around the industry who had been sharing ideas for the critical 18 months I had wasted in consulting. Late 1966, 1967 and 1968 featured a normal bull market in large stocks, a real bull market in smaller stocks, and an epic silly-season bull market in tiny, under-the-counter pink sheets stocks. Most were newly minted and almost all ceased to exist in a few years. Many ventures had great names like “Palms of Pasadena.” With our buying and touting to all who would listen, our favourites tended to rise rapidly at first: rocket stocks that, like other rockets, would end up crashing back to earth quickly enough. 

Early success

The defining event for me was in the summer of 1968, when my wife and I took a three-week holiday back in England and Germany, shortly after joining Keystone. Lunching with some of the hot shots — being a newbie I was by no means a fully-fledged member — I was fascinated, indeed, almost overwhelmed, by the story du jour: American Raceways. The company was going to introduce Formula 1 Grand Prix racing to the US. It had acquired one existing track and had one race, hugely attended out of novelty as well as genuine interest. With a few more tracks we could calculate how much money — a lot — the company could make. It seemed to me as a foreigner to have little chance of failure. With noise, speed, danger and even the ultimate risk of death, it seemed, well, just so American. And every Brit’s hero, the then current champion Stirling Moss, was on the Board. So I bought 300 shares at $7. (For defining events in your life you do remember the details, sometimes even accurately.) By the time we returned from our vacation — in those days we were never in touch with business, it was just too difficult — the stock was at $21! 

Here was my opportunity to show that I had internalised early lessons, to demonstrate my resolve. So I did what any aspiring value-oriented stock analyst would do: I sold everything else I owned and tripled up! Nine hundred shares at $21, mostly on borrowed money. In a Victorian novel aimed at improving morals, ethics and general behaviour, this is where tragedy follows hubris. But real life is more confusing as to how it delivers lessons and it likes to tease, apparently. By Christmas, American Raceways hit $100 and we were rich by the standards of those days, and certainly compared to my expectations. You could still buy a reasonable four-bedroom house in the London suburbs for £10,000 and in Boston for $40,000, and we had about $85,000 after margin borrowings and before taxes due. But, the possibility of continuing the storyline by cashing in our chips and going home to England quickly became more complicated: a year after joining Keystone in April 1968, I left with one of the fund managers, Dean LeBaron, to start a new investment management company. We started a reconnaissance patrol in mid-1969 and by January we had an office in the Batterymarch building on Batterymarch Street in downtown Boston, bearing the unsurprising name of Batterymarch Financial Management. In deciding to leave Keystone, my new nest egg of late 1968 played a key role in my career even though it had begun to decline some in early 1969. 

Crash course

In fact, in April 1969 came another nearly defining event: my wife and I fell in love with a charming three-floor Victorian house in Newton, Mass., on a very quiet street next to an apple orchard and backing on to some undeveloped hillside. Asking price: $40,000 (today’s guess, perhaps $1 million or more). Our family capital account after its then recent decline would still have allowed us to: a) buy the house without a mortgage; b) buy a new BMW 2002 (small, fast, not too showy and remarkably cheap); and c) have a few thousand left over. But our $37,000 offer was turned down and we backed off. And, even as we reconsidered, our stock began to crumble and I was lucky, with hindsight, to be able to say goodbye to all might-have-beens and to scramble out in the low $60s a share. It turned out that American Raceway’s original crowd was based almost completely on novelty and curiosity and had nearly no hard-core followers; Americans liked their blood sports to be in cars that looked not like real racing cars, but in cars that looked just like their own. Who knew? Well, I was neither totally broke nor fully chastened, and was eager to make back my losses. 

Naturally, I bumped immediately into a real winner. The new idea was called Market Monitor Data Systems and this really was a breakthrough technology, even with hindsight. It was going to put a “monitor,” an electronic screen, on every broker’s desk, so that they could trade in options, making their own market. This brainchild of a mathematics professor had only one flaw: it was way ahead of its time. Fifteen years later the technology was completely accepted. Oh, well. After a good rise it became clear to stock holders that expenses rose rapidly with monitors installed and no business followed. Almost none at all. And, following the developments far more hawk-like than was typical for me, I managed to leap out two weeks before bankruptcy with enough to pay down margin and bank loans, leaving me with about $5,000. By then, however, I was in an entrepreneurial start-up that paid no salary and ended its first full year not with the $1 billion under management that had featured in our spreadsheets, but with one account from a friend of Dean’s of $100,000. Fortunately, my wife had a job at MIT Press, which paid about what one would expect. So, the Boston Globe would only be bought after important Celtics games, absolutely no new clothes were allowed, and once a week we would stock up on an all-you-can-eat meal at the English Tea Room in Back Bay. But, oh my, did I have lots of painful lessons to absorb and at least one not so painful. 

First, my wife had not been amused by the frugality that characterised our 18 months in New York, a city then and now where some spending money makes a big difference in the quality of life. For her, to go home with a nest egg was maybe worth it. Maybe. Her biggest gripe was cooking in almost every day after work. No working wife today would stand for it, and rightly so. All I can say in my defence is that it was the style in the 60s. Very weak, I know. But, when confronted with the total loss of our savings and, therefore, our main plan — saving to go home well-off — my wife said nothing. And I mean nothing at all. She put herself to the task of keeping our financially leaky boat afloat. My wife, however, accrued an inexhaustible supply of IOUs. Well, inexhaustible for the next 46 years anyway. So…  

 Lessons learned 

  • You can’t know how people who are important to you will behave under pressure. And if you have to pick one who will outperform, pick your wife. 
  • Local cultural differences can be enduring even between Britain and the US. Formula 1 is trying again in the US as I write, 46 years later. Soccer here has also been just around the corner for 50 years. 
  • Sometimes even a great idea will fail, like Market Monitor, because the technology infrastructure is just not there; that it is simply ahead of its time. 
  • Much more importantly, investing is serious. It can be, and often is, intellectually compelling. But it should not be driven by excitement, as it is for many individuals, and when treated that way will almost always end badly. My experience with American Raceways and Market Monitor and, more importantly, my experience at painfully wiping out myself and my wife financially did far more than teach or reteach some of the basic rules of investing. It turned me profoundly away from the speculative and gambling possibilities of investing and turned me permanently, and pretty much overnight, into a patient, long-term value investor. Luckily, the new style fitted nicely with my natural conservative and frugal upbringing. The value perspective is pretty much baked into the Yorkshire culture. Happily, it also seems to work most of the time. Rolling the dice, however, was appropriate, it seems, when applied to the question of whether or not to start a new investment firm, for the period 1970 to about 1990 was particularly favourable to the start-up of new, small firms. For a while then, institutional investors actually seemed to prefer start-ups to the giant banks, which dominated the business but that had done so badly in the 1974 decline. And my willingness to take the risk of a start-up had been strongly influenced by the very brief existence of my substantial nest egg. So, once again …
  • It is better to be lucky than good, but of course, more appropriate to aspire to both. 
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