Opinion: This little known investment could double in seven years: GMO

Opinion: This little known investment could double in seven years: GMO

If you want to retire earlier or richer than you had expected, look east.

Like Spinal Tap, the famous and fake rock group, you want to be big in Japan. Or, even better, small in Japan.

So, at least, argue white-shoe, ultra-cautious Boston money managers GMO, in a surprising break from their generally gloomy outlook.

Cheap so-called “value” stocks in Japan, and especially cheap small value stocks in Japan, are a stunning investment bargain in a world of overpriced assets, GMO strategists Drew Edwards and Rick Friedman argue in a new research paper.

Thanks to low stock prices, booming profit margins, huge cash piles, and a backdrop of economic reform, Japanese value stocks could double your money over the next seven years, GMO’s number-crunchers estimate.

(In hard numbers they see large Japanese value stocks earning 5.2% a year on average after inflation, and small value stocks 8.2% a year. Meanwhile U.S. inflation expectations are currently about 2.3% a year.)

By contrast GMO thinks almost everything else is going to lose you money in relation to inflation. They see our broad U.S. stock index funds, such as the SPDR S&P 500 ETF

or the Vanguard Total Stock Market Index mutual fund
losing us 40% of our purchasing power by 2028.

The important caveat here is that everyone can make forecasts and many prove to be wrong. GMO has been too gloomy on stocks for most of the past 20 years. On the other hand, it has made some spectacularly good calls against the mainstream. The best known are the house’s predictions in advance of the 2000-3 dot com crash and the 2007-9 global financial crisis. But there are others. In the summer of 2007, for example, while (correctly) warning against markets in general, GMO singled out one area of comparative bargain: So-called U.S. “quality” stocks, a technical term rather than one of mere approbation, meaning U.S. stocks that met certain numerical standards in terms of balance sheet strength, cash flow, profitability and earnings stability.

If you’d followed their advice you’d be laughing. The MSCI index of U.S. quality stocks has quintupled your money since — vastly outperforming the S&P 500. (Oh, and they weathered the financial crisis much better as well.)

The trick for investors may be to treat forecasts like these as “directional” (as management consultants like to say) rather than specific. In a nutshell: GMO finds Japanese value stocks, and especially small value stocks, a bargain.

Corporate profit margins there have boomed since former Prime Minister Shinzo Abe was elected nearly a decade ago and introduced economic reforms, GMO calculates. About half the nonfinancial companies on the Tokyo stock exchange now have more cash on their balance sheets than debt (the figure for U.S. companies: Just 15%). Like U.S. companies after the Great Depression, Japanese companies responded to the 1990s collapse of their financial bubble by playing defense and hoarding cash. Many are now sitting pretty.

There are ways for ordinary investors to play this simply in a 401(k), IRA or other retirement account.

The iShares MSCI Japan Value ETF

is the most obvious. Fees are just 0.15% a year, or $15 a year on every $10,000 invested. This ETF is heavily weighted toward large-company stocks.

The WisdomTree Japan SmallCap Dividend Fund

wades into small company value stocks, where GMO finds the best bargains. But fees are higher, at 0.58%, or $58 a year per $10,000 invested.

Will we make it big by going small in Japan? We’ll have to wait and see.

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