Equity Dislocation Strategy Achieves 15.8% Return in 2025

The Equity Dislocation strategy achieved a gross return of 15.8% (net 13.4%) for the year 2025, reinforcing its long-term potential. Since its inception in October 2020, the strategy has delivered a cumulative gross return of 69.3% and a net return of 50.6%. Despite this positive performance, the valuation gap between value and growth stocks has not significantly narrowed, leading to concerns about potential investor disappointment in the future.

As a market-neutral strategy, Equity Dislocation seeks to take advantage of the notable dislocation in valuations between value and growth stocks. The team at GMO highlights the effectiveness of their proprietary valuation model and risk controls, which have contributed to the strategy’s success. Despite the current economic climate, the firm remains optimistic about the potential for growth as the valuation spread between these two categories continues to widen.

Reflecting on the past five years, the strategy initially appeared to be on track as value stocks rebounded following the challenges of the COVID-19 pandemic. Growth stocks, such as Zoom and Peloton, witnessed significant declines, allowing value stocks to outperform. From the strategy’s inception through December 2022, the MSCI ACWI Value index outpaced the MSCI ACWI Growth index, with the strategy returning 40.3% gross (net 34.1%).

However, the emergence of technologies like Chat GPT in early 2023 reignited investor interest in growth stocks, disrupting the momentum of value stocks. Consequently, over the last three calendar years, the MSCI ACWI Value index has underperformed the MSCI ACWI Growth index by an average of over 10% per annum. Despite these challenges, the Equity Dislocation strategy has managed to maintain a modest positive return during this period.

The concept of the rebalancing effect plays a crucial role in the strategy’s performance. This effect allows value stocks to benefit as underperforming growth companies become cheaper and enter the value index while some value companies exceed expectations and transition into the growth index. Such dynamics are especially pronounced when the valuation spreads are wide, and the strategy’s strong security selection continues to yield positive results.

Looking back at the final months of 2025, value stocks demonstrated a resurgence, with the MSCI ACWI Value index outperforming the MSCI ACWI Growth index by 5.0%. During this period, the Equity Dislocation strategy achieved a return of 8.7% gross (net 8.3%), underscoring its resilience and adaptability.

From a diversification standpoint, the strategy has shown a modest negative beta of -0.18 relative to the MSCI ACWI. Although the team does not specifically target negative beta, the strategy’s structure aims to be broadly dollar neutral. The overvaluation of growth stocks makes them more vulnerable to market downturns, as evidenced by the significant declines witnessed in 2022, when the MSCI ACWI dropped -18.4% and the MSCI ACWI Growth index fell -28.6%. In contrast, the Equity Dislocation strategy posted a gross return of 16.6% (net 14.2%) during that challenging year.

As January 2026 begins, the strategy remains a key component of GMO’s flagship unconstrained Benchmark-Free Allocation Strategy, with a substantial 20% allocation. The weight of expectation surrounding valuations suggests that substantial opportunities still exist as the chasm between value and growth stocks gradually narrows.

The analysis of valuation spreads reveals that when the strategy was launched, the relative valuation of the cheapest 50% of U.S. stocks compared to the most expensive 50% was at the 2nd percentile. Following strong performance for value in 2021 and 2022, this spread narrowed to the 14th percentile. However, the resurgence of growth stocks in 2023 and 2024 has pushed the spread back to a remarkably attractive 4th percentile.

To achieve a return to its median historic relative valuation, value stocks would need to outperform growth by 70% in the U.S. and 50% globally. The strategy’s long portfolio yielded an impressive 33.0% gross return, surpassing the 22.0% gross return of the MSCI ACWI Value index. The short portfolio also contributed positively, adding alpha with a return of 17.4%, while the MSCI ACWI Growth index rose by 22.4%.

In developed markets outside the U.S., the strategy performed as anticipated, with a gross addition of 10.1% to absolute performance. Notably, four of the top ten contributing long positions were in the Financials sector. Despite some tariff-related volatility, the strategy’s diversified exposure to Automobiles and Auto Components also proved beneficial.

In emerging markets, growth stocks slightly outperformed value, resulting in a -1.0% drag on absolute performance. The long portfolio performed well, rising 48.6% gross, but the short book gained 63.6% gross, driven in part by remarkable returns from three Korean industrial stocks.

In the U.S., the strategy achieved a commendable 3.4% contribution to absolute performance despite the MSCI USA Growth index outperforming the MSCI USA Value index by 8.0%. The thoughtful risk control measures, along with a focus on quality security selection, helped mitigate losses from some mega-cap tech stocks.

The Information Technology sector was particularly noteworthy, with the strategy holding short positions in 28 U.S. securities. Despite a strong year for equities, 18 of these stocks had negative performance, with others achieving only modest gains. HubSpot was among the worst performers, despite reporting a 20% increase in customers and revenues, illustrating the impact of heightened expectations on stock performance.

As the team concludes their analysis, they emphasize that the current market remains rife with speculative excess in certain stocks. The weight of expectation built into valuations is expected to lead to future investor disappointments.

Overall, the year 2025 proved satisfying in both absolute terms and relative to the MSCI ACWI Value minus MSCI ACWI Growth. With the widening value-growth spread in the U.S., GMO’s confidence in the Equity Dislocation Strategy is bolstered. Investors are encouraged to reach out to their GMO relationship manager or members of the Asset Allocation or Systematic Equity teams for further discussions.

Yours sincerely,
Ben Inker, Co-Head of Asset Allocation
George Sakoulis, Head of Investment Teams and Systematic Equity

Preliminary performance numbers are generally available on GMO’s website within fifteen business days after month-end. Investors should not rely on these preliminary numbers for investment decisions, as past performance does not predict future results.