GMO

Quarterly Update

Third Quarter 2010

GMO offers institutionally-oriented strategies investing in
equities and fixed income in the U.S., developed international,
and emerging markets. For client inquiries, please contact
your Client Relationship Manager. For new business inquiries,
please contact your Relationship Manager or Holly Carson at
(617) 346-7501 or holly.carson@gmo.com
Contents
Global Market Review ................................................................. 6
Asset Allocation............................................................................ 7
Performance Review and Outlook............................................. 9
Strategy Performance Details.................................................... 19
Table of Benchmarks ................................................................. 71
2 GMO Quarterly Update

2010 Performance of GMO Strategies and Benchmarks

Total Return Net of Fees Average Annual Total Return
GMO U.S. Equity Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
U.S. Core 9/30/85 11.96 0.99 -2.90 9.74 -0.62 -0.28 10.62
S&P 500 11.29 3.89 10.16 0.64 -0.43 10.19
Intrinsic Value 5/31/99 12.93 2.39 -2.10 9.50 -2.28 2.21 2.37
Russell 1000 Value 10.13 4.49 8.90 -0.48 2.59 2.38
Quality 2/29/04 11.40 -0.80 -4.69 8.19 1.75 n/a 1.58
S&P 500 11.29 3.89 10.16 0.64 n/a 2.00
Growth 12/31/88 12.72 3.73 -0.63 12.15 0.19 -4.03 9.12
Russell 1000 Growth 13.00 4.36 12.65 2.06 -3.44 8.59
Small/Mid Cap Value 12/31/91 13.14 11.61 1.97 16.97 -1.81 5.98 10.30
Russell 2500 Value + 11.39 9.64 14.74 1.38 8.02 10.68
Small/Mid Cap Growth 12/31/96 15.13 14.18 3.09 19.44 -1.82 -0.53 4.12
Russell 2500 Growth 13.15 11.09 17.27 3.09 0.47 5.19
Real Estate 5/31/96 13.20 18.71 -0.92 28.56 2.33 9.65 9.00
MSCI U.S. REIT 13.17 19.63 30.54 1.88 10.20 10.06
Tax-Managed U.S. Equities 7/31/98 12.73 1.00 -3.78 9.60 -0.79 -0.66 2.30
Russell 3000 + 11.53 4.78 10.96 0.95 -0.28 2.06

GMO International Equity Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
International Active EAFE 5/31/81 16.26 -0.37 -1.44 1.77 1.58 5.82 12.63
MSCI EAFE 16.48 1.07 3.27 1.97 2.56 9.28
Int'l. Active Foreign Small Companies 1/31/95 17.75 12.24 2.80 14.64 6.89 12.51 11.82
S&P Developed ex-U.S. Small Cap 17.40 9.45 9.85 4.24 7.48 6.95
International Intrinsic Value 3/31/87 15.79 1.38 3.32 0.99 0.97 6.76 8.27
MSCI EAFE Value 16.36 -1.94 -1.67 1.09 3.87 7.12
MSCI EAFE 16.48 1.07 3.27 1.97 2.56 5.08
International Growth 11/30/01 16.85 5.16 1.08 9.47 3.09 n/a 7.33
MSCI EAFE Growth 16.59 4.08 8.41 2.78 n/a 5.55
MSCI EAFE 16.48 1.07 3.27 1.97 n/a 6.15
International Core Equity 1/31/02 16.47 2.72 1.65 3.64 1.63 n/a 8.38
MSCI EAFE 16.48 1.07 3.27 1.97 n/a 6.87
Currency Hedged Int'l. Equity 6/30/95 7.75 2.21 2.32 4.91 0.78 3.99 7.42
MSCI EAFE (Hedged) 7.50 -0.12 2.81 0.40 -0.35 5.69
Japan Equity 12/31/05 3.10 5.70 2.12 -0.50 n/a n/a -4.33
MSCI Japan IMI++ 5.45 3.58 -0.17 n/a n/a -4.50
Int'l. Small Companies 10/31/91 17.64 6.79 -2.37 4.78 3.79 11.08 9.35
MSCI EAFE Small Cap + 17.51 9.16 8.04 4.71 7.73 6.57
MSCI EAFE 16.48 1.07 3.27 1.97 2.56 5.21
Tax-Managed Int'l. Equities 8/31/98 16.11 2.05 0.99 3.19 2.18 7.32 7.74
MSCI EAFE 16.48 1.07 3.27 1.97 2.56 4.42

Performance data quoted represents past performance and is not predictive of future performance. Returns are shown after the deduction of
management fees, transaction costs and other expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns assume
the reinvestment of dividends and other income. A GIPS® compliant presentation is available at www.gmo.com.
Copyright © 2010 by GMO. All rights reserved. This document may not be reproduced, distributed or transmitted, in whole or in portion, by any
means, without written permission from GMO.
GMO Quarterly Update 3

2010 Performance of GMO Strategies and Benchmarks

Total Return Net of Fees Average Annual Total Return
GMO Emerging Equity Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
Emerging Markets 12/31/93 19.85 11.52 -0.25 18.93 10.59 16.12 9.77
S&P/IFCI Composite 18.34 11.78 21.49 13.76 15.07 7.10
Emerging Countries 9/30/97 19.83 10.92 -0.86 18.58 10.02 15.00 10.96
S&P/IFCI Composite 18.34 11.78 21.49 13.76 15.07 9.84

GMO Global Equity Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
Global Active Equity 8/31/00 13.92 1.88 -0.70 5.11 1.69 7.78 7.98
MSCI World 13.78 2.58 6.76 1.30 0.79 0.24
Global Equity 7/31/96 14.33 2.90 0.32 6.82 0.62 3.84 6.68
MSCI World 13.78 2.58 6.76 1.30 0.79 4.93
Global Growth 7/31/04 15.70 4.39 0.38 10.31 2.24 n/a 5.42
MSCI World Growth 14.81 4.01 10.22 2.17 n/a 4.86
MSCI World 13.78 2.58 6.76 1.30 n/a 4.32

GMO Fixed Income Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
Core Plus Bond 4/30/97 4.31 13.78 5.84 16.68 3.65 5.86 6.01
Barclays Capital U.S. Aggregate 2.48 7.94 8.16 6.20 6.41 6.53
Inflation Indexed Plus Bond 5/31/06 4.61 13.37 6.37 18.58 n/a n/a 4.03
Barclays Capital U.S. Treasury Inflation Notes 2.48 7.00 8.89 n/a n/a 6.84
U.S. Treasury 3/31/09 0.01 0.06 -0.03 0.13 n/a n/a 0.22
Citigroup 3 Mo. T-Bill 0.04 0.09 0.12 n/a n/a 0.14
International Bond 12/31/93 12.41 15.33 7.08 15.48 5.83 8.10 7.61
J.P. Morgan Non-U.S. Gov't. Bond 10.37 8.25 5.91 7.71 8.23 6.67
Currency Hedged Int'l. Bond 9/30/94 4.29 14.23 7.20 16.36 3.07 5.38 8.30
J.P. Morgan Non-U.S. Gov't. 2.66 7.03 6.97 4.94 5.62 7.44
Bond (Hedged) (ex-Japan) +
Global Bond* 12/31/95 9.90 15.22 6.87 16.46 5.18 7.22 6.35
J.P. Morgan Global Gov't. Bond 7.95 8.35 6.28 7.32 7.79 6.12
Emerging Country Debt* 4/30/94 12.31 23.06 8.91 28.39 8.70 14.33 16.97
J.P. Morgan EMBI Global + 8.33 14.14 15.88 9.17 10.70 12.28
Emerging Country Local Debt Investment** 2/29/08 13.61 16.62 2.66 23.10 n/a n/a 4.81
J.P. Morgan GBI-EM Diversified 12.45 13.96 17.26 n/a n/a 9.67
Asset Allocation Bond 3/31/09 1.83 4.48 4.38 7.16 n/a n/a 7.33
Citigroup 3 Mo. T-Bill 0.04 0.09 0.12 n/a n/a 0.14

* Returns for one of the accounts in the composite are based on estimated market values for the period from and including October 2008 through February 2009.
** Returns for the composite are based on estimated market values for the period from and including October 2008 through February 2009.

Performance data quoted represents past performance and is not predictive of future performance. Returns are shown after the deduction of
management fees, transaction costs and other expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns assume
the reinvestment of dividends and other income. A GIPS® compliant presentation is available at www.gmo.com.
4 GMO Quarterly Update

2010 Performance of GMO Strategies and Benchmarks

Total Return Net of Fees Average Annual Total Return
GMO Asset Allocation Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
Global Balanced Asset Allocation 6/30/88 9.81 3.88 -1.65 8.54 4.78 7.77 10.07
Blended Benchmark 10.15 5.53 8.79 3.65 3.22 8.17
Real Return Global Balanced Asset Alloc. 6/30/04 8.47 1.70 -1.87 6.02 4.70 n/a 6.45
Blended Benchmark 8.95 3.57 6.16 2.76 n/a 4.13
Global Allocation Absolute Return 7/31/01 5.26 0.97 -3.16 5.51 5.95 n/a 10.51
CPI Plus 5% 1.90 4.12 6.25 7.01 n/a 7.40
Real Return Asset Allocation 12/31/09 4.73 -8.84 -9.22 n/a n/a n/a -8.84
CPI 0.67 0.38 n/a n/a n/a 0.38
Global All Country Equity Allocation 12/31/93 14.92 2.89 -0.75 8.22 3.54 7.19 8.86
Blended Benchmark 14.23 3.64 8.46 2.12 1.70 6.72
Global Developed Equity Allocation 3/31/87 14.37 2.07 -0.51 7.23 2.16 6.43 9.10
Blended Benchmark 13.77 2.59 6.77 1.29 0.75 6.74
International All Country Equity Alloc. 2/28/94 17.84 5.09 1.66 7.65 4.03 9.25 7.93
Blended Benchmark 16.62 3.43 7.13 4.08 5.02 5.83
International Developed Equity Allocation 11/30/91 17.17 3.20 1.96 4.03 2.23 7.73 8.33
Blended Benchmark 16.48 1.24 3.15 2.24 3.02 6.22
U.S. Equity Allocation 2/28/89 11.75 0.19 -4.25 8.99 -0.09 1.58 9.83
Blended Benchmark 11.47 4.43 10.66 0.81 -0.16 9.05
Flexible Equities 12/31/08 -4.57 -6.71 -9.29 -10.96 n/a n/a -8.95
MSCI World 13.78 2.58 6.76 n/a n/a 17.87
Special Situations 8/31/07 1.91 -0.51 -0.61 0.40 n/a n/a 9.50
Citigroup 3 Month T-Bill 0.04 0.09 0.12 n/a n/a 1.11
Alternative Asset Opportunity 4/30/05 6.94 3.11 2.20 8.94 0.58 n/a 2.62
Alternative Asset Opportunity Index 5.88 0.91 5.45 1.12 n/a 2.80
Alpha Only 7/31/94 -0.21 -2.21 -2.31 -1.01 2.49 5.60 4.39
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 2.41 3.49
Tax-Managed Global Balanced 12/31/02 9.19 3.41 -2.09 6.45 4.31 n/a 8.20
Tax-Managed Global Balanced Index 10.09 5.51 8.14 3.61 n/a 6.79

Performance data quoted represents past performance and is not predictive of future performance. Returns are shown after the deduction of
management fees, transaction costs and other expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns assume
the reinvestment of dividends and other income. A GIPS® compliant presentation is available at www.gmo.com.
GMO Quarterly Update 5

2010 Performance of GMO Strategies and Benchmarks

Total Return Net of Fees Average Annual Total Return
GMO Absolute Return Inception 3Q YTD YTD Value One Five Ten Since
Strategies/Benchmarks Date 2010 2010 Added Year Year Year Inception
Aggressive Long/Short 9/30/00 3.22 1.58 1.49 3.51 0.04 5.91 5.91
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 2.41 2.41
Tactical Opportunities 9/30/04 -4.60 -16.86 -16.96 -14.32 -6.15 n/a -7.76
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 n/a 2.48
Emerging Country Debt Long/Short 3/31/96 6.15 12.94 12.58 17.47 6.13 9.92 11.76
J.P. Morgan U.S. 3 Month Cash 0.20 0.36 0.46 3.56 3.17 4.02
Currency Hedge 7/31/03 4.01 2.09 1.73 9.70 -2.34 n/a 0.26
J.P. Morgan U.S. 3 Month Cash 0.20 0.36 0.46 3.56 n/a 3.09
Fixed Income Hedge 8/31/05 2.41 8.77 8.40 10.86 -5.90 n/a -5.97
J.P. Morgan U.S. 3 Month Cash 0.20 0.36 0.46 3.56 n/a 3.56
Emerging Currency Hedge 3/31/06 8.22 8.49 8.12 13.69 n/a n/a 4.43
J.P. Morgan U.S. 3 Month Cash 0.20 0.36 0.46 n/a n/a 3.47
Mean Reversion 2/28/02 -2.07 -6.37 -6.46 0.54 3.76 n/a 9.26
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 n/a 2.12
Systematic Global Macro 3/31/02 -0.50 8.21 8.12 8.20 8.04 n/a 8.31
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 n/a 2.12
Completion 8/31/07 -0.98 -1.50 -1.59 1.98 n/a n/a 17.00
Citigroup 3 Month T-Bill 0.04 0.09 0.12 n/a n/a 1.11
Multi-Strategy 10/31/02 0.59 -0.10 -0.19 3.58 2.51 n/a 3.23
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 n/a 2.15
Tax-Managed Absolute Return 3/31/01 1.73 -1.61 -1.71 1.07 -3.72 n/a -0.85
Citigroup 3 Month T-Bill 0.04 0.09 0.12 2.48 n/a 2.22

Performance data quoted represents past performance and is not predictive of future performance. Returns are shown after the deduction of
management fees, transaction costs and other expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns assume
the reinvestment of dividends and other income. A GIPS® compliant presentation is available at www.gmo.com.
6 GMO Quarterly Update

Global Market Review a reduction in the trade deficit. Hardly the signs of a
healthy recovery, normally driven by increases in the
First there were green shoots and, in short order, three Cs: construction, consumption, and confidence.
a fully blooming V-shaped recovery. It has been over a High and persistent unemployment was similarly
year since the chairman of the Federal Reserve employed dismissed in the face of ever-rising corporate profits. But
his horticultural metaphor and economists began to now that the fiscal stimulus has begun to fade and the
speculate about the shape of the recovery. In the interim, variety of programs designed to reach into the future and
asset prices have substantially recovered, the real pull demand into the present have ended, the underlying
economy has stabilized, and even the recession dating weaknesses are once again exposed. Without the artificial
committee at the NBER called June 2009 as the trough support, second quarter GDP was revised down from
of the recession. Given our belief that mean reversion 2.4% to 1.7%.
drives almost everything, we suppose it is only to be
expected that by the time the third quarter of 2010 rolled Investors responded to the renewed uncertainty with
around, the pendulum has swung all the way back to talk characteristic poise, as sentiment swung from hysteria to
of another recession. Just as night follows day, recovery apoplexy before settling on Panglossian exuberance. The
has been supplanted by relapse. The warning signs were one area where this was most apparent was the sovereign
there from the beginning. After all, GDP growth had bond market. Having pushed yields lower in the
been almost entirely made up of an inventory rebuild and previous quarter, investors continued to welcome
the warm embrace of what appears on the surface to be
Global Balanced Asset Allocation: One Example the one remaining safe asset. The move in yields even
Recommendations as of September 30, 2010 provoked suggestions that the bond market was entering
Benchmark: 65% MSCI AC World Index /
35% Barclays Capital Aggregate a bubble. While it is hard to see how an asset class with
an almost infallible cash flow stream such as a
Benchmark GMO Active
government bond can be subject to an irrational bubble,
U.S. Weighting Decisions
Equities it does seem almost certain that bond investors will have
Fixed
27.2%
Income to make do with very low real returns if they insist on
35.0% U.S.
Equities paying such high prices. Other signs of stress included
-2.2%
persistently high correlations and volatilities across most
Emerging
risky asset classes, together with low bond yields, all
International
Equities Equities traditional markers of a market meltdown. And yet,
8.9% 28.9%
Int'l. August notwithstanding, equities managed to reverse all
Equities
-3.4% of the second quarter losses and then some. In the
GMO Allocation twisted logic of the bulls, the worse things are, the more
Cash & monetary authorities stand ready to come to the rescue,
Special Equivalents
Situations
4.7%
2.8% Quality
25.0%
Emerging
offering greater and greater amounts of liquidity. Zero
Alpha Only
12.7%
Equities
+3.2%
interest rates not enough? Start increasing the central
Asset
International
Allocation Bond
4.4%
Intrinsic Value
4.2%
bank’s balance sheet. Quantitative easing not having the
Emerging
Country Debt
International
Growth
desired effect? Simply increase asset purchases until it
0.5% 4.3%

Inflation
International
does. Although running the printing presses may well
Indexed Plus
Core Equity
1.1%
Strategic
15.7%
Fixed
Income
put a floor under the equity market for a while, it seems
Flexible
Fixed Income +2.4%
7.5%
Domestic
Bond
Emerging
Equities
1.3%
inconceivable that currency debasement and beggar-thy-
Markets
3.7%
12.1%
neighbor trade policies will end up boosting final
-10% -5% 0% 5% 10% aggregate demand. A weakening dollar may well borrow
growth from the rest of the world in the short term, but
Note: Asset Allocation ranges are ±20% for U.S. and
international equities and ±15% for fixed income. it’s unlikely to solve the problem of too much debt of all
types.
GMO Quarterly Update
After taking a serious tumble in August, equities came
roaring back in September as it became increasingly clear
that the Federal Reserve had no intention of sitting by as
the economy drifted toward a double dip. The S&P 500
rocketed up 11.3% for the quarter, pushing the index
back into the green for the year. Interestingly, while
value, small cap, and junk equities have led in previous
rallies, this time around the pattern was significantly
different. Growth stocks had a nearly three-point lead on
value stocks as the Russell 1000 Value index was up only
10.1% versus the Russell Growth’s +13.0% return.
Unusually for such a strong move, small capitalization
stocks actually had the same return as the large caps, with
the Russell 2000 index gaining 11.3%.
Developed markets outside the U.S. also rallied in
sympathy, despite lingering concerns around sovereign
debt levels in the European periphery. A crumbling
dollar meant that the EAFE index was up an impressive
16.5% while in local terms the same index did not even
manage to return half that, rising only 7.1%. Both value
and growth indices were up similar amounts, with the
EAFE Value index gaining 16.4% and the EAFE Growth
index increasing 16.6%. Emerging market equities were
the stand-outs once again, with a total return for the
quarter for the S&P/IFCI Composite of +18.3%. The
performance of emerging equities will no doubt further
solidify the idea that emerging countries will continue to
outpace the developed world.
The yield on 10-year U.S. Treasuries had already fallen
to below 3% by the end of the second quarter on flight to
safety flows. During the third quarter, yields continued
their precipitous drop and fell almost another 44 basis
points to 2.5%. The U.S. was certainly not alone, and all
major sovereign bond markets saw their yields plunge. In
Switzerland, the 10-year yield even traded below 1%
briefly. Falling sovereign yields in the U.S. meant that the
J.P. Morgan U.S. Government Bond index returned a
respectable +2.8%, while the J.P. Morgan non-US
Government Bond index managed an eye-popping
+10.4%, helped in large part by the weak dollar.
7
Faced with still lower interest rates, investors
continued to look for yield wherever they could find it.
Although the Barclays Capital U.S. Aggregate gained a
modest 2.5%, investors seemed to have just discovered
the higher yields in emerging market bonds, and the J.P.
Morgan EMBI Global raced ahead, returning +8.3% for
the quarter.
Asset Allocation
Review
Recoveries from financial recessions are never easy or
quick. The financial architecture that usually enables the
interest-rate-sensitive sectors of the economy to jump-
start aggregate demand remains gummed up. Without a
well-functioning and healthy credit system, real estate and
capital investment along with consumer durables remain
anemic and the real economy struggles to grow. The
acute phase of the financial crisis saw the full Keynesian
apparatus wheeled out to combat a free-falling real
economy. But while stimulus can support liquidity, it is
not much use in the face of insolvency. The real
economy cannot escape the pain generated by a hobbled
banking sector trying to rebuild its balance sheet. On the
other hand, asset markets, at least in the short run,
invariably shear their fundamental moorings. Equities, in
particular, are especially prone to short-, medium-, and
long-term cycles of fear and greed. This time has been
no different and, while the secular outlook for the global
economy has remained broadly unchanged, equity
markets have swung between mild depression and
outright elation.
Rather than favor any particular macro theme, our
portfolios have always relied on valuation to determine
how, where, and when we are positioned. Over the last
few quarters this has been a humbling experience more
often than not. While the market has chosen to favor
risky smaller companies with volatile profits and stock
prices, we have remained unwavering in our penchant for
high quality. Although we did take advantage of the
second quarter European turmoil to tactically redeploy a
8 GMO Quarterly Update
few points of our high quality exposure toward
international developed and emerging market equities,
our broad portfolio positioning is remarkably the same.
Unlike previous quarters, however, where every lurch
higher in equity prices left quality in the dust, high quality
for once was able to hold its ground in a strong quarter
for equities overall. Could it be that the market is waking
up to high quality’s fundamental cheapness? We won’t
know for some time, but for now we can at least take
some solace in the results for quality this quarter.
Strategies
“I’ll huff and I’ll puff, and I’ll blow your house … and
stock … and bond prices higher.” The expectation of
further quantitative easing breathed life into the markets
this quarter, leading to the “reflation” of virtually all risky
assets globally. September’s stock rally was the best
September since 1939 as the Fed all but signaled that
further intervention was a near certainty, with the
markets simply to debate what precisely would be on the
shopping list. U.S. Treasuries continued their rally, with
yields on the 2-year notes ending the quarter at 0.41%,
and corporations have been re-financing their debt at a
furious pace with investors shockingly eager to buy up
paltry yields.
In our opinion, all this huffing and puffing is simply
making expensive assets even more so. U.S. stocks, we
believe, are still trading significantly above their fair value,
especially small caps. And bond yields are at 60-year
lows. Can yields go lower? Clearly, as we found out this
quarter. Yet to load up on bonds at this stage strikes us
as folly. We simply want to avoid that inevitable day of
reckoning when investors who are essentially being
prodded by the Fed to reach for yield (either through
taking credit or duration risk) will be burned. While not
overtly, I guess you could say that we’ve been fighting the
Fed.
The wall of worry still stands tall – a fragile and tepid
economic recovery, high and seemingly more entrenched
unemployment, moribund housing prices, prospects of
global currency debasement, the echo of widening credit
worries from the periphery of Europe – these are all, of
course, real headwinds for the markets. But they are, in
the end, shorter term in nature. Longer term, the slower-
burn worries would include the moral hazard of a market
that now anticipates, indeed, depends upon, intervention
and all of its nasty cousins. The huffing and puffing of
central governments around the planet is certainly having
some short-term beneficial effects, but at what cost?
And at what point will their efforts appear winded?
Our broad strategies are:
!"
Continue bias towards high quality stocks. While
historically, high quality stocks – those companies
exhibiting high, consistent ROE and low debt – have
traded at a significant premium to the market,
valuations today are cheap. Quality stocks represent
one of the few areas within the U.S. equity market that
is trading below its fair value, and the portfolio’s U.S.
exposure will continue to tilt toward quality. While we
will admit frustration that the markets have not been
interested in discerning quality from junk, there are
increasing drumbeats among respected opinion
formers that quality companies may indeed be some
of the few bargains left in an otherwise inflated
market. And while we take no joy in our thesis not
holding up over the last year or so, we welcome the
fact that other important voices have been joining the
quality chorus of late.
!"
Maintain exposure to emerging markets. We are
overweight emerging markets within global equity
mandates as they represent a sub-asset class trading
near or even below their fair value. Despite the more
narrow concern about a possible “bubble” in an
overheated Chinese real estate market, we remain
positive on the asset class. Strangely, emerging
countries, long perceived as the more unstable and
profligate economies, are literally emerging from the
global financial crisis as beacons of growth, stability,
and prosperity. This, combined with the more secular
phenomenon of a growing middle class, continues to
bode well.
GMO Quarterly Update
!"
Inflation not a worry … for now. While there is a
powerful argument to be made that the extreme
indebtedness of the U.S. government (and sovereign
nations, more generally), the sheer volume of
economic stimulus, and the growth of the money
supply and subsequent debasement of fiat currencies
pose a potent (but latent) inflation threat, in the
shorter term inflation will likely remain at bay. Still,
timing the eventual escape of the inflation genie is a
terrifically difficult game, so we don’t play it. Instead,
we will continue to position our bond portfolio
defensively by simply buying the cheapest of an
expensive opportunity set, albeit begrudgingly. This
means continued emphasis on shorter- and
intermediate-duration TIPS. In the interim, however,
we’ve been able to identify bonds in Australia and
New Zealand that have attractive yields, but could also
act as a deflation hedge should that scenario play out.
!"
Hold cash and cash “plus” as dry powder. It is
admittedly distasteful to be owning any cash or fixed
income at these levels. But if you believe, as we do,
that they offer some degree of “optionality” – that is,
they act as dry powder in the event we find more
favorable pricing of assets in the future – then one can
make sense of it.
!"
Where possible, invest in conservative absolute
return strategies, which can provide equity-like
returns while improving diversification through low
correlations with equity markets. Try to ensure that
alternative strategies are providing true diversification
with low correlation to traditional asset classes.
Performance Review and Outlook
U.S. Equities
Market Review
U.S. investors shook off their European sovereign
debt hangover in the third quarter. After the favored
recipe of government intervention quelled investor fear
that European troubles could spill into the global
economy, U.S. stocks bounced back strongly from their
second quarter losses. The S&P 500 posted a gain of
9
11.3% for the period, clawing its way back into positive
territory for the year in full. Statements and expectations
about future action by the Federal Reserve lifted investor
spirits during the period. The Fed’s promise to intervene
if economic conditions worsened was viewed by
investors as a promising protection against the prospect
of a double-dip recession.
U.S. Equity Markets
Third Quarter 2010 Performance
15%
13.0% 13.1% 13.2%
11.7% 11.4%
11.3%
10.1%
10%
5%
0%
S&P Dow Russell 1000 Russell 2500 MSCI
500 Jones Value Growth Value Growth U.S.
U.S. TSM REIT
While a palatable resolution to the European
sovereign debt crisis sent stocks higher during the
quarter, investment factor spreads were narrow. There
was little difference between the relative returns of high
and low quality stocks, as both groups lagged a rising
market. High quality’s modest underperformance in a
rising market is of particular note. The group
experienced an unexpectedly poor second quarter, as
worries about U.S. high quality multinationals’ European
exposure trumped their defensive business characteristics
in investors’ minds. With markets rising in the third
quarter, investors might have expected another poor
performance – a “heads I win, tails you lose” scenario –
as buyers who avoided quality in the second quarter
market decline due to its “risky” exposure to Europe now
found it insufficiently risky in a rising market. Notably,
this was not the case. While high quality stocks
underperformed during the quarter, it was by a modest
margin in comparison with past flights to risk. Quality’s
second and third quarter experience highlights both the
folly of over-emphasizing short periods of relative return
10 GMO Quarterly Update

U.S. Equities
Relative Performance of Selected Groups versus the S&P 500
Year-to-Date September 30, 2010
Largest 100 Russell 2500
1.0 8.0

0.5
6.0
0.0
4.0
Size

-0.5

-1.0 2.0
-1.5
0.0
-2.0

-2.5 -2.0
12/09 3/10 6/10 9/10 12/09 3/10 6/10 9/10
Investment Disciplines

Cheap on Price/Intrinsic Value High Price Momentum

3.0 6.0

2.0

1.0
3.0
0.0

-1.0
0.0
-2.0

-3.0

-4.0 -3.0
12/09 3/10 6/10 9/10 12/09 3/10 6/10 9/10

Consumer Discretionary Financials

12.0 10.0

10.0

8.0
5.0
6.0

4.0
0.0
2.0

0.0
Sectors

-2.0 -5.0
12/09 3/10 6/10 9/10 12/09 3/10 6/10 9/10

Information Technology MSCI U.S. REIT Index

0.0 24.0
20.0

-2.0 16.0
12.0

-4.0 8.0
4.0
-6.0 0.0
-4.0
-8.0 -8.0
12/09 3/10 6/10 9/10 12/09 3/10 6/10 9/10
GMO Quarterly Update
and the importance of a value-based philosophy, where
short-term underperformance merely serves as an
opportunity to buy more of a good thing at an even
better price. Keeping on the value theme, bottom-up
valuation metrics (i.e., models that seek undervalued
individual stocks) also exhibited tight spreads during the
period, delivering mixed relative returns that, for most
metrics, were neither extremely bad nor extremely good.
Simple measures of “value” like price/book and price/
earnings were strong participants in the 2009 market rally,
owing to their heavy exposure to the more beaten-down,
cyclical areas of the market. But their 2010 performance
has reflected a less extreme environment than the rapid
rotations between greed and fear that marked the 2008-
09 period. Finally, momentum metrics posted similarly
modest relative returns for the period, though for the
most part they outperformed. Momentum’s “calming-
down” is another notable comparison to the greed-fear
pendulum of 2008-09 where momentum metrics were
alternately woeful (caught holding heavy commodities
exposure as the market began to unwind in 2008), heroic
(rotating into defensive positioning in the depths of the
crisis), and even more woeful (getting heavily defensive
just as the market turned in March of 2009). While
11
hand. In the long run, investment returns have three
sources: dividends, fundamental growth, and changes in
price multiple. Simple does not mean easy. There are
innumerable factors that influence a company’s ability to
pay dividends and grow, and the multiple the market is
willing to pay for it. But at the heart of a value
investment philosophy is an understanding of what is
knowable, what is unknowable, the risks to both the
known and the unknown, and where we derive an edge.
Doing simple things well is a big enough task without
layering on an urge to parse the latest economic data to
fit a macro theory, distorting any edge we might have
obtained. Our focus remains on understanding the
knowable, acknowledging the unknown, weighing the
associated risks, and finding investments trading for less
than they’re worth. We’ll leave prognostications to the
prognosticators. After all, it’s a crowded field.
International Equities
Market Review
International Equity Markets
Third Quarter 2010 Performance
30%

momentum’s modest third quarter outperformance might 22.1%

19.4%
be a let-down for adrenaline addicts, its more modest 20% 18.3%
16.5%
outperformance harkens back to the days when
9.1% 10.6%
momentum models tracked individual companies and 10% 7.1%
5.8%
were not simply a beta pass-through … an interesting
-0.1%
trend to watch moving forward.
0%
In Local Terms
In Dollars
Outlook
-10%
MSCI S&P/IFCI
In these uncertain times, macroeconomic EAFE Europe Pacific Japan Composite
ex-Japan (Emerging)
prognostication seems to be the topic du jour. Inflation
vs. deflation. Gold vs. bonds. Government intervention
vs. free markets. Stock picking vs. factor selection. A
The third quarter was a period of solid returns for
vibrant economic recovery vs. a double-dip recession vs.
global equity markets thanks to the months of July and
Armageddon 2.0. A repentant urge drives investors and
September. July featured a relief rally on the back of
scholars to wade into areas complex and unknown in
stress tests on European banks and a sense that the crisis
hopes of finding that single idea that would have
phase of the Greek and other sovereign debt event had
prevented the 2008-09 calamity (or at least made money
passed. August featured concerns about anemic
when it occurred). Lost in this macro quagmire,
economic recovery in the U.S., and global markets
however, is the fundamental simplicity of the task at
12
generally retrenched. September featured more positive
economic and corporate data, however, and performance
was strong.
For the entire quarter, the MSCI EAFE index
returned +16.5% in U.S. dollars terms. A good chunk of
the return was due to foreign currency appreciation as the
index returned +7.1% measured in local currencies. The
dollar fell to its lowest level on a trade-weighted basis in
September on the back of Federal Reserve Bank
comments about battling deflationary pressures. The
euro was one of the strongest currencies, but the yen
reached its highest level against the dollar since 1995,
prompting the Japanese government to intervene in
September.
The MSCI Europe index returned +19.4% for the
quarter, while MSCI Japan was up a more muted 5.8%.
All EAFE markets appreciated with the exception of
Ireland, which was hurt by credit rating downgrades.
Japan and Switzerland were the only two markets to post
gains of under 15% in dollar terms, while the best
performers – Norway, Spain, and Austria – approached
30% gains.
Sector performance was similarly broad based.
Energy, Materials, and Telecommunications posted the
highest performance. Technology was the only sector to
post merely single-digit returns within EAFE markets,
while Health Care, Utilities, and Consumer Staples
lagged, reflecting a preference for cyclicals over
defensives in general. Financials were nestled sedately in
the middle of the pack for this quarter after several years
of being an extreme performer on one side or the other.
Japanese and German financials underperformed, but
elsewhere in Europe the sector held up well.
The quarter was not clearly a period of risky assets
outperforming, however. The EAFE Small Cap index
returned +17.5% to just barely edge out its large cap
cousin, and the Emerging Market index didn’t pull too far
away, registering an 18.0% gain. The EAFE Value and
Growth indices provided nearly identical returns of
+16.4% and +16.6%, respectively. On GMO’s quality
measure (blending high profitability, stable profitability,
GMO Quarterly Update
and low leverage), the highest quartile and lowest quartile
returned +15.6% and +15.0%, respectively, while the
middle 50% outperformed.
The largest positive individual impact for the quarter
came from BP, as news flow was reasonably positive and
investors’ attention proved fairly short. Mining
companies like Rio Tinto and Xstrata were also
contributors, and Europe banks like Lloyds, BNP
Paribas, and Société Générale appeared high on the list.
Outlook
A big story of the last few years has been high
correlations as stocks move together, up or down,
depending on investor sentiment to take on risk. This
should provide stock picking opportunities as
fundamentals are less correlated than market movement.
Measured in conventional ways, however, value spreads
are fairly tight, and the overall valuation of markets is not
especially enticing. At this point, the best opportunities
are likely found by picking out the good that has been
punished with the bad over the last few years, identifying
stocks and countries where true value exists, and where
the quality of the business is strong enough to not force
one to make a call on the macro economy for an
investment to turn out to be prudent.
Emerging Market Equities
Market Review
The third quarter began and ended on an upbeat note,
August being the sole bearish month. Investors have
gained greater confidence in the prospects of a global
economic recovery. In particular, they have been
attracted by the prospects of high growth in emerging
markets, which is a marked contrast to the outlook for
developed markets. The asset class jumped to its highest
level since the credit crisis, supported by a surge of
inflows.
Chile’s economy grew 6.5% in the second quarter
from a year ago, the biggest rise in five years. National
economic output is approaching levels before the
February earthquake, which caused an estimated $30
GMO Quarterly Update
billion in damage. Consumption has jumped following
the quake, with retail sales growing strongly. Chile’s
central bank has raised rates by 2 percentage points in
four months. The rate increase, along with the strength
of the domestic economy and continuing robust prices
for copper, the country’s main export, has sent the
Chilean peso on a bull run.
Manufacturing accelerated in China for a second
straight month in September, adding to signs that the
fastest-growing major global economy is stabilizing.
China’s growth has helped pull in imports from around
the world, assisting in the global recovery. In the face of
rising pressure from property value appreciation in China,
the central bank has avoided raising interest rates and
instead has attempted to micromanage the real estate
issues. It has asked banks to dampen credit growth,
raised their reserve ratios, and issued a series of guidelines
that tighten requirements on mortgages, especially for
multiple home purchases. Economic growth fell to
10.3% last quarter from an annual pace of 11.9% in the
prior three months.
The Indian stock market was hit by fears of tightening
monetary policy. The central bank raised a benchmark
rate and pledged to review borrowing costs at meetings
every six weeks, rather than once a quarter. Accelerating
growth is running against capacities in power, roads, and
ports. Foreign funds desirous of participating in the
strong pace of economic growth have pumped in a
cumulative 891.2 billion rupees ($19.8 billion) in 2010.
India’s gross domestic product expanded 8.8% last
quarter from a year earlier, the highest among major
economies in Asia after China. Investors have bid up
valuations on expectations that the growth will continue
and on optimism that its domestic demand is relatively
insulated from the issues impacting global economic
growth.
Thailand’s stock market has been one of the best
performers this quarter despite a political stand-off. The
two sides disagree on how much authority appointed
soldiers, judges, and royal advisers should wield over
elected politicians. Ignoring politics, investors chose to
13
focus on the brightening economic picture. Gross
domestic product rose 9.1% in the second quarter after
having jumped 12% in the three months to March, the
best two quarters of growth since 1995. The central bank
raised its benchmark interest rate and signaled further
increases as the economy continues to grow faster than
expected. The central bank expects the economy to
expand as much as 7.5% this year, a pace that would be
the highest in several years.
Turkey’s ruling party won a referendum, widely
viewed as an indicator of the general elections next year,
by a larger than expected margin. Investors cheered the
increased odds of a continuation of Prime Minister
Erdogan’s policies, which have helped deliver
record economic growth. The referendum included
amendments that bring Turkey’s military further under
civilian control. It will also restructure the judiciary,
giving the government more control over appointments
to various courts. The vote has been welcomed by both
the country’s leading business group and the European
Union. Turkey’s economy grew at an annual rate of
more than 10% in the first two quarters.
Outlook
In this outlook we cover some notable country
developments that we feel could be key drivers in the
coming months.
Philippines President Benigno Aquino plans to boost
the country’s credit rating and lure foreign investors by
shrinking its record budget deficit. The government,
which has pledged to avoid raising taxes, is instead
considering changes in cigarette and alcohol levies and
stepping up prosecution of tax evaders. Markets have
been receptive to Aquino’s proposals to cut the deficit
and boost the economy, including a plan to offer
investors $16.7 billion of infrastructure projects. In
addition, the economy is currently benefiting from some
tailwinds. Boosted by exports and remittances, it grew
7.9% last quarter, the fastest pace in three years. The
central bank has also kept rates at a record low of 4% as
inflation continues to be mild. After several years of
14
lagging other emerging Asia markets, the Philippines
could enjoy a growth spurt if the reform plans actually
get implemented.
Mexico sold $1 billion of 100-year bonds, the longest-
maturity debt issued by a Latin American country. The
International Monetary Fund forecasts Mexico’s
economy will expand 4.5% this year. Contrary to the
barrage of headlines on drug-related gang violence, the
economy is doing well. The government has taken
significant steps to introduce more competition in key
sectors of the economy. The 16-year-old North
American Free Trade Agreement continues to be a key
driver. Gross domestic product expanded 7.6% in the
second quarter, boosted by U.S. demand for everything
from refrigerators to cars. Mexico’s exports to the U.S.
have gained market share from China as companies took
advantage of the lower shipping costs from a border
country. It is too soon to make firm pronouncements,
but it would be interesting if the haze of drug violence is
masking a genuine transformation in Mexico.
When Lula da Silva, the current Brazilian president,
was campaigning in 2002, markets were hypersensitive to
candidate pronouncements and Lula’s eventual victory
depressed values significantly. After nearly eight years in
office, Lula has record popularity ratings. The economy
clocked a rate of more than 8.8% in the first half of the
year, and unemployment fell to 6.7% in August. GDP per
capita has jumped to $8,217 in 2009 from $2,870 in 2002.
Dilma Rousseff, Lula’s designated successor, finished
first in the initial round of elections and will face her
main rival, Jose Serra, in a run-off later in October. In
these elections, the bulls have barely broken their stride
to examine the differences between Rousseff and Serra.
Rousseff has pledged continuity with her mentor’s
policies that, in addition to generating a strong pace of
economic growth, have also caused the federal
government’s spending to rise as a percent of the
economy, resulting in a deficit of 3.4%. Serra, on the
other hand, has been more critical of government
spending growing faster than the pace of economic
growth. Time will tell whether the markets have
sharpened their foresight in the eight years since 2002.
GMO Quarterly Update
Prime Minister Viktor Orban’s party swept the local
elections held in early October in Hungary. The party
already enjoyed a clear majority in parliament and now
does not have to face an election until 2014. Orban came
to power earlier this year after promising to end the
ongoing austerity programs and spur economic growth.
Hungary was one of the hardest-hit emerging markets
during the crisis because of its foreign currency debt.
About 80% of Hungarian mortgage loans are
denominated in Swiss francs as households thought it
was an easy way to circumvent the high interest rates in
their own currency. Orban has announced significant
taxes on banks and cutbacks in public services. But, the
party has also made news for battling the central bank
and for pushing back against the IMF on budget-deficit
targets. Rating agencies have not taken this well – S&P
lowered the outlook on Hungary’s BBB- rating to
negative in July. However, in September the Cabinet did
commit to a deficit of no more than 3% of gross
domestic product in 2011. And the market, which has
generally been punishing Hungary during each bout of
risk aversion, has chosen to view the latest election
outcomes optimistically. They are betting that the
government will have the flexibility to make hard
decisions on the next budget, due by the end of October.
Given the uncertainty in the market, clarity can certainly
help prices. However, the events of the last few months
suggest a non-trivial possibility that investors might not
like the details that will emerge in the next few weeks.
Fixed Income
Review
Global government bond markets were strong and
the dollar weak in the third quarter. Bond yields began
their decline amidst the August equity market wobble,
and then accelerated lower in anticipation of “QE2” by
the U.S. Federal Reserve. The global hunt for yield
ensured that bond yields from emerging countries
followed suit, and the gap between the two narrowed
during the quarter.
GMO Quarterly Update 15

J.P. Morgan Global The euro witnessed a fairly substantial reversal of

Government Bond Index Yield
4.5%
Em erging
(Right Hand Scale)
4.0%
3.5%
3.0%
2.5% Developed
(Lef t Hand Scale)
2.0%
1/05 1/06 1/07 1/08
The prospect of “Quantitative Easing 2” or, more
appropriately, “Quantitative Credit Easing 2” also took
its toll on the U.S. dollar, which declined rather uniformly
during the quarter. In aggressively pursuing the portfolio
balance channel transmission mechanism, the Federal
Reserve hopes to buy up safe assets that investors are
apparently hoarding, forcing them to buy risky assets.
Foreign currency assets apparently fit the bill. Among
developed market currencies, Swedish krona and
Australian dollar were the two biggest gainers, rising by
15.6% and 14.6% against the greenback, respectively.
Sweden was one of only three developed countries to
raise policy interest rates, increasing them by 50 basis
points to 0.75%. In Australia, surging commodity prices
added to the Australian dollar’s allure, where the 4.5%
policy rate offers a welcomed carry relative to
commodities themselves.
fortunes, rising by 11.5%. In the prior quarter, the euro
9.0% declined by 9.5% amidst worries over the health of
8.5% weaker euro members. During the third quarter, the
8.0% much anticipated release of the bank stress tests served to
7.5% calm market fears, even as many market participants
Q3 7.0% flagged the flawed design of the tests themselves. In
what must be good news for the Swiss National Bank,
6.5%
which had earlier accumulated substantial euro holdings
6.0%
in trying to drive the Swiss franc weaker, the euro rose by
5.5%
1% relative to the Swiss franc.
5.0%
1/09 1/10
In September, the Bank of Japan surprised the market
when it engaged in its first yen-weakening, unilateral
intervention since 2004. Although this limited
September’s rise to only 0.5%, the yen was still up 5.9%
for the quarter.
Emerging currencies particularly benefited from the
U.S. dollar’s demise; in spot terms, all but one of the
emerging currencies rose during the quarter, with the
only laggard the Argentine peso (-0.8%). Including carry,
however, even the peso gained (+1.4% total return).
Renewed confidence in the euro led to even larger gains
among the periphery. Czech crown rose by 16.5%,
Polish zloty by 16%, Hungarian forint by 14.9%, and
Romanian leu by 14.0%. Such gains easily erased the
prior quarter’s losses.
In Asia, the Chinese renminbi rose by 1.3%, its first
notable quarterly rise in two years. This led to strength

Third Quarter 2010 Currency Spot Returns

15.6 16.0 16.5
14.6 14.9
14.0
12.8
11.5
10.4 11.0
9.5 9.9
8.3 8.0
7.0 7.2
6.1 6.2 6.2 6.8
5.3 5.9 4.9 5.4 5.%
3.6 3.4
2.5 2.9
1.3 1.4 1.6 2.2
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16
across the region, with 2%+ gains in Korea, Thailand,
Singapore, Philippines, Malaysia, India, and Taiwan. In
Latin America, the big winner was Chilean peso, +12.8%,
which followed the upward trajectory of copper prices.
Government bond markets rallied in the third quarter,
particularly when most world equity markets declined
sharply mid-quarter. In local currency bond index terms,
gains were the highest in the U.K., +3.7%, and the lowest
in Switzerland, +0.9%. The +1.9% index total return for
the euro area masked a wide range of outcomes among
euro currency participants, only the largest of which
(Germany, Italy, France, Spain, Netherlands, and
Belgium) pertain. Core euro zone debt markets,
including France and Germany, rose during the quarter,
by 2% to 3%. Meanwhile, Spanish bonds rose by 4.3%,
and Greek bonds rose by 4.0%, outperforming core euro
zone debt markets. Irish bonds, however, provided the
euro zone’s worst returns, falling by 4.3% during the
quarter. Ireland’s debt crisis is the latest to rattle Europe,
with officials attempting to stave off an emergency
bailout by promising to pump billions into its banks that
were hardest-hit. Outside of the euro zone, U.S.
(+2.8%), Canadian (+2.7%), Swedish (+1.3%), Japanese
(+1.1%), and Australian (+1.1%) bond markets reported
gains during the month.
GMO Quarterly Update
In local emerging currency bond markets, higher-
yielding Brazil, Colombia, and South Africa led the
markets, with returns of 10.1%, 8.6%, and 7.9%,
respectively. The index’s newest entrant, Chile, was the
only market to see a decline, falling 1%.
EMBIG’s sovereign spread tightened by 54 basis
points to 305 basis points during the period, and the bid-
offer spread on the index tightened as well. Among the
biggest index gainers for the quarter were Argentina,
Belize, and the Philippines. Argentina reaped the
benefits of its successful exchange of defaulted bonds,
the boom in soybeans, and global risk appetite. Tiny
Belize’s $550 million of restructured bonds have also
gained from the strong market tone, returning +65% in
the first nine months of the year. In the Philippines, the
new Aquino administration was able to convince the
market that it would use its political capital to implement
serious fiscal reform.
Among the lowest performers of the quarter were
Ecuador, Pakistan, and Tunisia. The lone Ecuadorean
2015 bond dropped 11% on the last day of the quarter
when disgruntled police officers took the president
hostage in a dispute over pay and benefits. Pakistan was
devastated by flooding that covered almost 20% of the
country’s territory, and the government’s weak response
disappointed foreigners and locals alike. Tunisian bonds
have a short duration and did not benefit as much from
falling rates as others.

Third Quarter 2010 Change in Interest Rates (10Y DM, 5Y EM)

0.2
0.0

0.0
-0.1 -0.1
-0.2 -0.1 -0.1 -0.1 -0.2 -0.1 -0.1
-0.2 -0.2 -0.2
-0.4
-0.3 -0.3 -0.3
-0.4 -0.4 -0.4 -0.4
-0.6 -0.5
-0.6
-0.7 -0.7 -0.%
-0.8
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GMO Quarterly Update 17

Third Quarter 2010 J.P. Morgan EMBIG Returns by Country

22.1
17.9

11.9
10.3 10.7 10.9 10.9 11.1 11.1 11.3
8.7 8.8 9.1 9.5 9.6 9.8
6.3 6.4 6.7 6.9 7.0 7.0 7.2 7.3 7.3 7.3 8.2 8.3 8.3
5.8 5.8 5.9
3.5 3.6 3.8 4.5
2.0 2.6
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Strategies
Currency positioning was a stand-out contributor
across fixed income strategies, both in developed and
especially emerging markets. In the latter, overweight
positions across Central Eastern Europe, the Middle
East, and Africa (CEEMEA) and much of Asia were
particularly helpful. In developed, overweights in the
Australian dollar, yen, Norwegian krone, and New
Zealand dollar were all positive contributors.
In emerging debt, external debt strategies had a
fantastic quarter thanks to asset class tightening as well as
positive contributions from both country selection and
security selection, the latter of which continued to be
aided by the former collateral pool performances. In
emerging local debt, security selection drove strategy
gains, followed by contributions from the former
collateral pool. The local strategy’s zero weight in
Thailand, whose bonds and currencies jumped despite
lingering political issues, weighed heavily on
performance. Although other non-Japan Asia currency
positions offset the loss due to the Thai baht
underweight, other country positions failed to offset the
loss on the bond side.
Though they continue to post welcomed gains, pools
once used for cash collateral were not the main
contributors for the quarter.
Outlook
With so many policy uncertainties lurking, it’s hard to
give a clear outlook these days. Perhaps the clearest, if
perhaps not the most original, observation is summed up
in the chart below: emerging debt yields far exceed the
paltry returns to deposits, and look increasingly tempting
relative to the ever-declining yields on developed
markets’ government bonds. Hence, the “wall of
money” that fund-tracking firms report in detailing
record inflows into emerging debt. Further evidence was
provided by the near record turnout for the emerging
market investor program at this year’s IMF/World Bank
meetings.
Global Bond Yields
14%
12%
EMBIG (External Debt)
10%
GBI-EMD (Local Debt)
8%

Developed-markets bond positioning was also 6%

positive, particularly the net long duration position tilted 4%

toward U.S., Canadian, and euro zone bond markets.
2% GBI Global (Developed Markets)
USD 3-Month LIBOR
0%
1/04 1/05 1/06 1/07 1/08 1/09 1/10
18
On our valuation metrics, external debt spreads on
average (represented by the EMBIG index) still offer
value relative to fundamentals, although some countries
are already more than fully valued. Among emerging
currencies, only a couple are overvalued. On average
(represented by the GBI-EMD) they are right in the
middle of our valuation framework: not expensive, but
not cheap, either. Local debt markets still offer value
relative to their G3 alternatives, but in some cases offer
pretty poor real yields when compared with domestic
inflation.
From there, the picture is murkier, and traditional
valuation tools are less useful. QE2 itself adds
tremendous uncertainty, as it telegraphs the worries of
U.S. policymakers about the current environment. The
post-Lehman spirit of coordination among global
policymakers seems to be fraying at the edges, a theme
GMO Quarterly Update
emphasized repeatedly during the IMF meetings.
Investors remain unsure whether this coordination
breakdown is good (e.g., some countries can check
themselves out of the ER and possibly be an engine for
growth), or bad (large, interconnected, cross-border
financial institutions not to mention global trade have
been relying on, and may still require, such coordination).
The so-called “currency wars” are one manifestation of
the coordination breakdown.
Then there are the uncertainties related to other
“unorthodox” policy measures. One wonders if France
will attempt to introduce some global approach to fx
policy when it takes over the G-20 on November 15.
With the IMF floating research trial balloons on the
topics of capital controls and 4%+ inflation targets, it’s
possible we could see “experimental” policies like the
rather unorthodox quantitative easing policies go global.

Disclaimer: The views expressed herein are through the period ending September 30, 2010, and are subject to change at any time based on market and
other conditions. This is not an offer or solicitation for the purchase or sale of any security, is not intended to be investment advice and should not
be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be
interpreted as, recommendations to purchase or sell such securities.
GMO Quarterly Update 19

GMO U.S. Core Strategy As of September 30, 2010

Inception: 9/30/85; Benchmark: S&P 500 Index
Performance1 Top Ten Holdings2,5
Total Return Net of Fees (%) Average Annual Total Return (%) Pfizer Inc. 4.8%
3Q YTD One Five Ten Since Microsoft Corp. 4.5%
2010 2010 Year Year Year Inception Google Inc. (Cl A) 4.0%
Strategy 11.96 0.99 9.74 -0.62 -0.28 10.62 Wal-Mart Stores Inc. 3.8%
3
Benchmark 11.29 3.89 10.16 0.64 -0.43 10.19 Merck & Co Inc 3.3%
Oracle Corp. 3.2%
Annual Total Return Net of Fees (%)
Procter & Gamble Co. 2.8%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Apple Inc. 2.6%
Strategy 0.19 -7.87 -19.73 26.64 9.85 3.66 9.75 1.65 -30.17 21.41 Johnson & Johnson 2.3%
Benchmark -9.11 -11.88 -22.10 28.69 10.88 4.91 15.80 5.49 -37.00 26.46 Coca-Cola Co. 2.1%
Total 33.4%

Risk Profile Since 9/30/854 Sector Weights5

Strategy Benchmark Underweight/Overweight
Alpha 1.36 0.00 Sector Against Benchmark Strategy Benchmark
Beta 0.93 1.00 Consumer Discretionary 0.0 10.4 % 10.4 %
2 Consumer Staples 6.6 17.9 11.3
R 0.96 1.00
Sharpe Ratio 0.45 0.37 Energy -6.3 4.6 10.9
Financials -10.4 5.2 15.6
Health Care 14.8 26.4 11.6
Characteristics5
Industrials -3.3 7.5 10.8
Strategy Benchmark
Information Technology 6.2 25.0 18.8
Price/Earnings - Hist 1 Yr Wtd Med 15.8 x 16.0 x Materials -2.3 1.3 3.6
Price/Book - Hist 1 Yr Wtd Avg 2.5 x 2.1 x Telecom. Services -1.7 1.5 3.2
Dividend Yield - Hist 1 Yr Wtd Avg 2.1 % 2.0 % Utilities -3.3 0.3 3.6
Return on Equity - Hist 1 Yr Med 19.2 % 15.3 %
-20 -10 0 10 20
Market Cap - Weighted Median $Bil $61.8 $42.1 GICS Sectors

Quarterly Strategy Attribution

!"
The U.S. Core Strategy returned +12.0% for the third quarter of 2010, topping the +11.3% return of the S&P 500 index.

!"
Sector selection detracted from relative returns for the quarter. The strategy saw positive returns relative to the benchmark attributable
to underweight position in Financials. Underweight positions in Materials and Telecommunication Services and an overweight in
Health Care were among the detractors.

!"
Stock selection added to relative returns. Selections in Information Technology, Health Care, and Financials added to returns versus
the benchmark while picks in Consumer Staples and Industrials detracted. Individual stocks adding to relative returns in the third
quarter included overweight positions in Pfizer, Oracle, and QUALCOMM. Stock selections detracting from returns versus the
benchmark included overweight positions in Procter & Gamble, Medtronic, and Microsoft.

1 Performance data quoted represents past performance and is not predictive of future performance. Returns are shown after the deduction of management fees,
transaction costs and other expenses, but before custody charges, withholding taxes, and other indirect expenses. The returns assume the reinvestment of dividends and
other income.
2 Portfolio holdings are percent of equity. They are subject to change and should not be considered a recommendation to buy individual securities.
3 The S&P 500 Index is a well-known, independently maintained and published U.S. large capitalization stock index.
4 Alpha is a measure of risk-adjusted return; Beta is a measure of a portfolio’s sensitivity to the market; R2 is a measure of how well a portfolio tracks the market;
Sharpe Ratio is the return over the risk free rate per unit of risk. Risk profile data is gross.
5 The above information is based on a representative account selected because it has the least number of restrictions and best represents the implementation of the strategy.
The performance information above is supplemental to the GIPS® compliant presentation that was made available on GMO’s website in April of 2010.
GIPS ® compliant presentation is available at www.gmo.com.
GMO © 2010