Saturday, December 11, 2010 24 comments

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:

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.

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24 Response to John Maynard Keynes - A great investor

hugh
December 12, 2010 at 7:49 AM

Sivaram, 

Thanks for the great article.  Thanks also for the link.  I did not know about that website. 

There is a volume of Keynes' Collected Writing that deals specifically with his investments.  The multi-volume Collected Writings is usually in libraries designated as reference books.  The Investment volume contains letters that he wrote to other investor friends along with summaries by the editor.  I think that toward the last 20 years of his investing, he would hold only 2-3 companies in which he felt he had a high certainty of knowledge of their future earnings results.  He  called them his "pets", and he would use margin. If I remember correctly, I think that this volume mentions specific companies that he owned.

There also is a 3 volume biography of Keynes by Skidelski, but the authour seems to go out of his way to talk about everything except Keynes' investing history.

Thanks again,

Hugh

hugh
December 12, 2010 at 7:49 AM

Sivaram, 

Thanks for the great article.  Thanks also for the link.  I did not know about that website. 

There is a volume of Keynes' Collected Writing that deals specifically with his investments.  The multi-volume Collected Writings is usually in libraries designated as reference books.  The Investment volume contains letters that he wrote to other investor friends along with summaries by the editor.  I think that toward the last 20 years of his investing, he would hold only 2-3 companies in which he felt he had a high certainty of knowledge of their future earnings results.  He  called them his "pets", and he would use margin. If I remember correctly, I think that this volume mentions specific companies that he owned.

There also is a 3 volume biography of Keynes by Skidelski, but the authour seems to go out of his way to talk about everything except Keynes' investing history.

Thanks again,

Hugh

Sivaram Velauthapillai
December 12, 2010 at 3:50 PM

Thanks for the info Hugh. I have enough books on my list to read so probably won't get to Keynes' stuff for a long time, if ever :-P


Hugh: "I think that toward the last 20 years of his investing, he would hold only 2-3 companies in which he felt he had a high certainty of knowledge of their future earnings results.  He  called them his "pets", and he would use margin. "

Do you know if that is for the Chest endowment fund or was that for his personal portfolio? If it was for the Chest portfolio he was running, the use of leverage means his returns weren't as great as they seem.

One of the reasons I consider Warren Buffett to be (possibly) the greatest investor of all time is because Buffett doesn't use leverage (except for the amount that comes from the insurance float). There are hedge fund guys who post numbers far better than Buffett but I consider them worse because a lot of it is due to leverage.

Anyway, thanks for bringing up the detail about Keynes' use of leverage.



Hugh: "There also is a 3 volume biography of Keynes by Skidelski, but the authour seems to go out of his way to talk about everything except Keynes' investing history.  "

Doesn't surprise me. John Keynes' main job wasn't investing so all his other work overshadows his investing.

Hugh
December 12, 2010 at 5:14 PM

I think that he was running the Chest Endowment Fund, his own money, investment partnerships with contingency fees that he had set up with his wealthy friends, and he was on the investment board of a big british insurance company.  I think that he was using margin for all but the insurance fund.  

  For the insurance committee, in his letters he was grumbling about how they would not listen to him for any of his recommendations mainly because his investments were often companies with problems.

I think that it mentioned that he owned a US auto company and maybe US Steel? in the 30's.  I can't remember because I read those books around eight years ago.  I rememeber being surprised that he was using leverage. 

The collected writings investment volume was around 150 pages and it contained Keynes letters to his investment friends and some of his letters as chairman of the insurance company.  They were a fun read. However, the editor seemed to not have a background in investing. I remember wishing that there was more. Also, overall the collection was vague.  It did not explain exactly what he held, or how much leverage he used.  It was more like a collections of letters that he had written to friends off the top of his head.  Overall, it did not give a full picture of what he was doing.

I recently read that a library in London that inherited his papers, has more unpublished letters on investing, but they have not released them yet.

The skidelski bio is over a 1000 pages and I found it to be very slow.  I think that Bill Miller recommended it for its explanation of Keynes' macroeconomic view.

I remember being frustrated with skidelsky because he wrote about keynes sex life, his childhood, his university life, his artist friends, his government service, his politics, and tons of macroeconomic stuff but literally nothing on his investing.  I think Skidelsky's background is economics.

Hugh

Hugh
December 12, 2010 at 5:15 PM

I think that he was running the Chest Endowment Fund, his own money, investment partnerships with contingency fees that he had set up with his wealthy friends, and he was on the investment board of a big british insurance company.  I think that he was using margin for all but the insurance fund.  

  For the insurance committee, in his letters he was grumbling about how they would not listen to him for any of his recommendations mainly because his investments were often companies with problems.

I think that it mentioned that he owned a US auto company and maybe US Steel? in the 30's.  I can't remember because I read those books around eight years ago.  I rememeber being surprised that he was using leverage. 

The collected writings investment volume was around 150 pages and it contained Keynes letters to his investment friends and some of his letters as chairman of the insurance company.  They were a fun read. However, the editor seemed to not have a background in investing. I remember wishing that there was more. Also, overall the collection was vague.  It did not explain exactly what he held, or how much leverage he used.  It was more like a collections of letters that he had written to friends off the top of his head.  Overall, it did not give a full picture of what he was doing.

I recently read that a library in London that inherited his papers, has more unpublished letters on investing, but they have not released them yet.

The skidelski bio is over a 1000 pages and I found it to be very slow.  I think that Bill Miller recommended it for its explanation of Keynes' macroeconomic view.

I remember being frustrated with skidelsky because he wrote about keynes sex life, his childhood, his university life, his artist friends, his government service, his politics, and tons of macroeconomic stuff but literally nothing on his investing.  I think Skidelsky's background is economics.

Hugh

Hugh
December 12, 2010 at 5:15 PM

I think that he was running the Chest Endowment Fund, his own money, investment partnerships with contingency fees that he had set up with his wealthy friends, and he was on the investment board of a big british insurance company.  I think that he was using margin for all but the insurance fund.  

  For the insurance committee, in his letters he was grumbling about how they would not listen to him for any of his recommendations mainly because his investments were often companies with problems.

I think that it mentioned that he owned a US auto company and maybe US Steel? in the 30's.  I can't remember because I read those books around eight years ago.  I rememeber being surprised that he was using leverage. 

The collected writings investment volume was around 150 pages and it contained Keynes letters to his investment friends and some of his letters as chairman of the insurance company.  They were a fun read. However, the editor seemed to not have a background in investing. I remember wishing that there was more. Also, overall the collection was vague.  It did not explain exactly what he held, or how much leverage he used.  It was more like a collections of letters that he had written to friends off the top of his head.  Overall, it did not give a full picture of what he was doing.

I recently read that a library in London that inherited his papers, has more unpublished letters on investing, but they have not released them yet.

The skidelski bio is over a 1000 pages and I found it to be very slow.  I think that Bill Miller recommended it for its explanation of Keynes' macroeconomic view.

I remember being frustrated with skidelsky because he wrote about keynes sex life, his childhood, his university life, his artist friends, his government service, his politics, and tons of macroeconomic stuff but literally nothing on his investing.  I think Skidelsky's background is economics.

Hugh

Sivaram Velauthapillai
December 12, 2010 at 7:26 PM

Thanks for the detailed info. If I ever get interested in Keynes, or need a diversion from my usual investment interests, I know where to turn. A lot of libraries, at least the rich ones in America and elsewhere, are digitizing their archives and putting them online. Perhaps the papers will be put online at some point.


Hugh: "I  remember being frustrated with skidelsky because he wrote about keynes sex life, his childhood, his university life, his artist friends, his government service, his politics, and tons of macroeconomic stuff but literally nothing on his investing.  I think Skidelsky's background is economics.  "


It could also be that the intent of the book is not on investment techniques or indeed anything to do with investing. The target audience may be the general public, which is not interested in details pertaining to investing.

Your criticism reminds me of what many amateur investors say of Alice Shroeder's massive Buffett biography, Snowball. I haven't read Snowball yet but those into investing were dissapointed that it didn't focus on Buffett's investing techniques. The book caught some by surprise, especially given that Shroeder was an analyst and the book apparently had little to do with stock analysis or business analysis of any sort. The reason clearly was that the book was intended at the general audience. (For what it's worth, it seems that Alice Shroeder may write a future book on Buffett's investment techniques but it remains to be seen.)

PlanMaestro
December 13, 2010 at 1:06 AM

I am currently reading Lords of Finance where Keynes is a minor character. It is fascinating to see how he went bust a couple of times side by side his expectations of the world and what did happen.

The first time went bust he expected a deterioration of European currencies, Germany in particular, because of war reparations and the strong US position after the war. He was caught in a zig-zag and was saved by his father. His thesis was right but did not protect himself. He then came back and made a bundle on it.

In 1929 BEFORE the crash he lost 75% of his wealth and had to close his margins accounts when he did not anticipate the FED tightening to bust the stock bubble. It crashed commodity prices in the process when Keynes was hopelessly long (Australia and Argentina were the first in recession). At least that saved 25% of his wealth into the crash.

Fascinating how one of the best macro prognosticators the world has seen, was not able to make money in a period where good macro prognostications were critical. I am only half into the book and he has been busted twice.

PlanMaestro
December 13, 2010 at 1:11 AM

If you are not interested in the Bloomsbury Group you can jump into the second tome that is the best.

PlanMaestro
December 13, 2010 at 1:13 AM

Good point.

PlanMaestro
December 13, 2010 at 1:18 AM

I can not find it in Amazon. Which volume is it?

Hugh
December 13, 2010 at 9:03 AM

I think that this might be the Collected Writing volume, but I am not sure.  I could not find a list of all the the volume titles anywhere on the internet. I remember that two different volumes in Collected Writings had "investments" in the title.

http://www.amazon.com/Collected-Writings-John-Maynard-Keynes/dp/0521230705

Also, I felt the same way about the Snowball.  I was hoping for a book more like Confidence Game.  However, I do understand that authors have different target audiences. :'(   

Hugh

PS:  Sorry about the multiple identical posts.  For some reason my browser keeps doing this here.

Hugh
December 13, 2010 at 9:03 AM

I think that this might be the Collected Writing volume, but I am not sure.  I could not find a list of all the the volume titles anywhere on the internet. I remember that two different volumes in Collected Writings had "investments" in the title.

http://www.amazon.com/Collected-Writings-John-Maynard-Keynes/dp/0521230705

Also, I felt the same way about the Snowball.  I was hoping for a book more like Confidence Game.  However, I do understand that authors have different target audiences. :'(   

Hugh

PS:  Sorry about the multiple identical posts.  For some reason my browser keeps doing this here.

Pat Shuff
December 13, 2010 at 4:02 PM

Years ago, when I was running my own brokerage firm, an opportunity was presented for me to hire a gentleman who possessed a PhD. Shortly after I retained his services, I excitedly told my mentor and best client of what I thought was a hiring coup for my company. His silence let me know he wasn't impressed.
About two weeks later, I received a plain manila envelope from him containing a photocopy of an essay entitled, "From the Garden." It was written in the 1930's about the great economist John Maynard Keynes. In London during this period, a group of very smart and well-connected financiers had convinced Keynes to manage a public fund that they would market. His stellar reputation and credentials would surely bring in many clients, and high fees would flow to these organizers and Keynes. It never occurred to them that Keynes couldn't manage money. During a short period of time, the value of the assets garnered by these individuals and entrusted to Keynes dwindled away. He was quietly removed from the management of the portfolio and returned to his previous role as an economist.

http://seekingalpha.com/article/12344-concerns-with-the-new-wisdom-tree-etfs

Sivaram Velauthapillai
December 13, 2010 at 6:03 PM

PlanMaestro: "Fascinating how one of the best macro prognosticators the world has seen, was not able to make money in a period where good macro prognostications were critical. I am only half into the book and he has been busted twice."


In my newbie opinion, macro investing is extremely difficult. After all, how many successful macro investors have you heard of? I can't think of too many other than Soros, Rogers, and a few others. Other than Soros, there may not be a bilionaire who made money through macro investing. I don't know for sure though.

Even if you get the trend right, the security you buy or sell may not behave as expected.

Sivaram Velauthapillai
December 13, 2010 at 6:04 PM

Don't worry about the duplicate posts :)  I try not to censor this site so I usually leave all the messages (although my automatic spam filter doesn't allow some to go through)...

Anonymous
December 14, 2010 at 7:16 AM

Siv:  First, this is a really interesting article.  Thank you.  I am not a fan of Keynes,though I had heard he was an able investor.  It is thus very interesting to see your analysis of his investment techniques.

Second, while Buffet is not using "leverage", his massive selling of naked index puts is exactly that:  leverage.  I remember reading an article which stated that the new regulations recently put forward by US Congress would hamper these kinds of investments, because Buffet would have to actually put cash on reserve to cover these puts.  Well, that would have made the position far less attractive because it would restrict the movement and investment of cash used to cover the puts.  I read one explanation of the investment wherein Buffet said that Berkshire Hathaway would be able to invest the premiums until the expiration of the contract--but the restrictions would require putting the premiums (and then some) in cash instruments.

Hugh
December 14, 2010 at 7:09 PM

Maybe Keynes did not use margin in the Chest fund account.  I am not sure.

Hugh

Hugh
December 14, 2010 at 7:10 PM

Maybe Keynes did not use margin in the Chest fund account.  I am not sure.

Hugh

Peter Dunn
December 14, 2010 at 7:16 PM

Hi Siv:  that was me who wrote the last comment.

Sivaram Velauthapillai
December 14, 2010 at 7:24 PM

Credit for the article goes to the site I linked. I did almost nothing in this post; the work was done by maynardkeynes.org. Good job by that site...


GUEST: "Second, while Buffet is not using "leverage", his massive selling of naked index puts is exactly that:  leverage."


The put options are a form of leverage but it is more similar to his insurance float than straight margin (or borrowings). Yes, it is a type of leverage but it is also something very different. After all, Buffett is making a directional bet by selling the put options. It is similar to how you receive insurance premiums ahead of time, well before the catastrophe potentially occurs. Your decision with the put (i.e. whether you are right or wrong) is more important than the fact you have leverage. No one enters into these transactions because they want leverage. In contrast, if you wanted leverage you would definitely go and borrow money.

Apart from insurance-type leverage, the only time I know of--I'm not an expert on Buffett though--that Buffett used leverage (apart from risk arbitrage) was when he issued bonds in the 70's.


In any case, Buffett's record, even without the insurance float is amazing. If you just look at his public share holdings (i.e. ignore the impact of float by not looking at Berkshire Hathaway book value growth), his record is amazing. There are many hedge funds who post similar numbers but they use leverage.

Anonymous
December 20, 2010 at 5:37 PM

First, thank you for the very interesting info on Keynes as an investor, and I agree that Buffett is a phenomenal investor without the insurance float.

Now my quibble: I think that you have to accept that Buffett uses leverage, you can't just waive it away because it's insurance float instead of something else. I think that Buffett's genius is to magnify his investing skill using other people's money - in particular, money that does not need to be repaid based on the value of the assets purchased. Insurance float is leverage, but it is vastly superior to margin debt because it doesn't need to be repaid at the exact moment that the assets purchased are cheap. That's the problem with margin debt - you have to repay it at the worst possible moment because your broker is always looking at the value of the collateral.

I would guess that Buffett doesn't have any problems with leverage, but he will ensure that he never gets a margin call.

-CR

aktiespartacus
December 23, 2010 at 4:42 PM

Great article and interesting to learn more about Keynes.

Sivaram Velauthapillai
December 23, 2010 at 6:20 PM

Thanks... Happy Holidays...

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