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The Secret of an Investment Genius

Jeremy Grantham has an amazing track record on Wall Street. Here's how he does it.

Emerging markets

For the most part, Grantham and his team believe that financial assets have climbed so far they’re overpriced. The only area of the stock market where GMO is predicting generous returns during the next seven years is emerging markets, which had a rough 2013. GMO predicts annual returns of 6.5% after adjusting for inflation—or around 8.7% when you add in the firm’s assumption that inflation will eventually revert to 2.2%.

The best way to own emerging-market stocks is through the Vanguard Emerging Markets Fund (VEIEX). An index fund, it charges rock-bottom fees of 0.33%. Its biggest positions include Taiwan Semiconductor, Russia’s Gazprom, and Brazil’s Banco Bradesco. The stockpickers at Harding Loevner Emerging Markets (HLEMX) have outpaced the index in the past three, five, and 10 years. But you’ll pay 1.49% per year to bet they can continue to do so. Their top two holdings are Samsung and Chinese search engine Baidu.

Timber

Grantham, a staunch environmentalist, is a longtime fan of timber as an investment, as am I. Should inflation return, it will be good to own hard assets like gold, oil, and wood because if the dollar loses value, well, such things are just worth more dollars. When the economy is booming, wood, like other commodities, is in demand. But wood is also nice to own when demand dries up because, unlike gold or oil, trees keep growing. GMO estimates timber will return 5.9% a year after inflation during the next seven years.

The tough part is finding a way to invest. GMO, which has more than $100 billion under management, just goes out and buys forests. For the rest of us, one imperfect but decent proxy is Plum Creek Timber (PCL), which owns and manages forests. It's structured as a real-estate investment trust and pays a decent 3.6% dividend. It’s not cheap by conventional measures, however.

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U.S. high-quality stocks

This is a subjective category, and Grantham declines to offer much of a definition. He and others at GMO, however, have described Coca-Cola, Microsoft, Procter & Gamble, and Johnson & Johnson as quality companies. GMO says this category is priced to return 3.3% a year after inflation. If that sounds lame, keep in mind the after-inflation caveat: It feels better if you think about it as 5.5%.

Here are two ways to get exposure: The Jensen Quality Growth Fund ( JENSX) is a picky mutual fund that gets a gold rating from Morningstar. Without getting into the nitty-gritty of its stock selection, it's so demanding that fewer than 200 companies (out of 10,000) have a good enough track record to even merit consideration. And among its 28 holdings are Coke, Microsoft, and P&G. Another option: Buy shares of Warren Buffett’s company, Berkshire Hathaway. Buffett collects quality companies like John Mayer collects ex-girlfriends, and he owns Coke and P&G.

Not much else looks good to Grantham. He expects international stocks will return less than 2% a year and bonds will return close to nothing. The scary part: He sees U.S. stocks (excluding the aforementioned quality companies) racking up negative returns during the next seven years.

To be sure, there’s no guarantee GMO is right this time. Even if the firm’s methodology is on target, the unprecedented efforts of the Federal Reserve and other central banks around the world to stimulate the economy could cause markets to act in unpredictable ways.

So rather than betting your life savings that the firm nails it again, just tweak your investments to benefit if Grantham is right. There’s no need for speed, either. Add to your holdings the next few years through dollar-cost averaging, and if the market dips, you’ll be buying cheaper. Who knows, your returns may even outpace Jeremy Grantham’s.

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