John Maynard Keynes - A great investor

John Maynard Keynes

Many readers have likely heard of John Maynard Keynes, arguably the most influential economist of the 20th century. Keynes is most famous for debunking the old theories of classical economics and developing a systematic way of analyzing macroeconomics with consideration of politics and philosophy. Yet, I'll bet that only a few readers would know that he was also one of the top investors of all time. Investing wasn't Keynes' main job and he wasn't exactly a money manager so his investing activities aren't widely known.

Investing Style of Keynes

John Keynes' investing style appears to be a cross between contrarian investing and value investing, involving concentrated bets. As Warren Buffett quoted in his 1991 shareholder letter, Keynes is to have said:

As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence...

He was clearly a fan of concentrated investing, which is also the style favoured by me.

Quoting the excellent maynardkeynes.org, Keynes apparently said:

It is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find any one agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is the right moment for selling it.

An interesting way to think about contrarian investing. The fact that only a few succeed in investing means that it pays to be contrarian. However, you don't want to be contrarian for the sake of contrarianism.

Initial Attempt = Failure

Yes, things didn't start off well for Keynes. His initial foray, at the age of 36, was a failure. As maynardkeynes.org recounts,

Keynes traded on high leverage - his broker granted him a margin account to trade positions of £40,000 with just £4,000 equity.

He traded currencies including the U.S. dollar, the French franc, the Italian lira, the Indian rupee, the German mark and the Dutch florin.

His work as an economist led him to be bullish on the U.S. dollar and bearish on European currencies and he traded accordingly, usually going long on the dollar and short selling European currencies.

Easter 1920 found Keynes vacationing in Rome. He learned that his open currency trades had made him a profit of £22,000 on francs and a loss of £8,000 on U.S. dollars. A jubilant Keynes wrote to his mother from Italy on April 16 to say that he was, “indulging in an orgy of shopping. . . I think we have bought about a ton so far. . .”

Keynes soon learned that short-term currency trading on high margin, using only his long-term economic predictions as a guide, was foolhardy. By late May, despite his belief that the U.S. dollar should rise, it didn’t. And the Deutschmark, which Keynes had bet against, refused to fall. To Keynes’s dismay, the Deutschmark began a three-month rally.

Keynes was wiped out. Whereas in April he had been sitting on net profits of £14,000, by the end of May these had reversed into losses of £13,125.

John Maynard Keynes started off as a currency trader, moving to commodities a bit later on. He attempted to invest based on macroeconomic predictions—keep in mind that he was an economist—and it didn't exactly work out in the short run. I didn't quote the rest of the article but Keynes appears to have broke even later on but this was definitely a painful start.

This is a good example of why most economists aren't good investors (although for different reasons, a similar thought applies to why accountants aren't necessarily the best investors or why executives aren't the best investors). Trying to map economic events into asset price movements is extremely difficult, and impossible in some cases. There are many (pure) macro investors who try to do this but I suspect most fail.

Using margin (borrowing) to leverage yourself also opens up the possibility of catastrophic losses. The method I follow is that of Warren Buffett: one shouldn't use margin except for risk arbitrage*. Keynes was more of a risk-taker and appears to have used it quite heavily in his early days.

Keynes did continue with his macro-oriented investing but he gradually started to pursue a different investment method.

Fork in the Road Leads to Fundamental Analysis

John Keynes started managing an endowment fund and this is where his superb track record lies. As maynardkeynes.org says,

His investing philosophy changed over time - Keynes began to doubt his initial belief that he could profit from his broad understanding of economic cycles. He grew to favour making large investments in individual businesses. Keynes was a logical man and individual businesses had balance sheets he could study and they sold products or services whose value he believed he could assess objectively.


Keynes spent half an hour each day on stock market research - in the morning, still in bed - studying company reports, reading the financial sections of the newspapers and speaking to his various brokers by telephone.

Whether he realized it or not, Keynes eventually became a fundamental analyst. His short-term macro-oriented trading in currencies and commodities morphed into long-term stock holdings based on fundamental analysis. Part of this shift may have been due to the fact he was managing an endowment—can't lose money!—rather than his own money. But a lot of it is likely stems from experience.

Performance Record

Keynes appears to have posted around 12% annual return over a 20 year period. This would put him in the campe of a superinvestor like Martin Whitman, who has historically posted a similar record. I would personally consider Keynes' record far superior to Martin Whitman or anyone that posted around 15% in the 80's and 90's. Quoting maynardkeynes.org, the reasons we should consider Keynes to have a superior record are:

•This performance was achieved during a period that encompassed both the crash of 1929 and the build up to World War Two, both of which proved disastrous for British stocks.

•In the same period of time, the British stock market fell 15 per cent.

•The growth in the value of the Chest Fund was entirely due to capital appreciation. There was no dividend reinvestment because Keynes spent all of the dividends on the college. He believed the fund was there to provide money for the college and was scornful of the way other Cambridge colleges managed their finances, referring to them as “savings banks”.

The chart below shows how difficult the British market was at that time:

(source: maynardkeynes.org)

The British market posted an annual return of a little less than -1% during the 18-year period while Keynes posted around 12% per year. Very impressive.

Keynes also appears to have not reinvested dividends so his returns are truly spectacular—recall that dividends were a huge chunk of the return in that era.

Although difficult to say from this chart—logarithmic chart is ideal when measuring performance—it does seem that Keynes' portfolio is very volatile. I have no idea what he was investing in but they fluctuated quite a bit. His portfolio seems to have fallen around 50% from 1930 to 1932, whereas the British index fell a bit less; and his portfolio fell by roughly 1/3rd from 1937 to 1939. On the positive side, the portfolio skyrocketed in several periods. Overall, it was a volatile portfolio.

The volatility leads me to believe that Keynes' holdings were very contrarian and speculative, or he held small-caps and mid-caps. Without reading further on this matter I can't say what was driving the portfolio.

Summary

To sum up, John Maynard Keynes was not just a great economist but also one of the top investors. Since he never worked on Wall Street or managed portfolios professionally (apart from the endowment fund), he isn't widely recognized. I don't know much about the shares he invested in but I do share his contrarian thinking and his preference for concentrated investments.



Footnote:
* I have mentioned this occasionally in the past but to reiterate... do keep in mind that, just because you aren't using debt to boost returns doesn't mean that your company isn't. Financial leverage can come from you, the investor, or from the company you invested in. You can keep your debt as low as you can but if your company doesn't then it sort of defeats the purpose. Furthermore, there is another type of leverage inherent in companies and it's called operating leverage. This refers to how sensitive revenue changes are on income. Again, you may run a "safe" portfolio with no borrowings but if the company you own has high operating leverage, your investments are riskier than it seems.