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John Maynard Keynes is widely regarded as a great economist. It is less known that he was also a very successful investor, pioneering techniques and establishing principles that have now become investment lore, said Elroy Dimson, co-director for the Centre for Endowment Asset Management at Cambridge Judge Business School, at the 2014 European Investment Conference. Dimson explained that access to the archives covering Keynes’s management of the endowment portfolio at King’s College, Cambridge, allows an objective review of his investment philosophy and performance.
When Keynes assumed authority over the endowment fund at King’s College in 1921, the fund was severely constrained by the Trustee Act, so he persuaded the College Fellows to separate a part of it into a discretionary portfolio over which he had complete control. Dimson argues that over the period 1922–1946, the annual performance of this portfolio averaged a return of 16%, compared with 10.4% for a market index calculated by Dimson and co-authors. Such outperformance did not come without commensurate risk: The tracking error was 13.9%, reflecting high levels of concentration. The resulting Sharpe ratio (reward to risk) of 0.73 seems like a good outcome for an active investor.
How did Keynes generate such good performance? Dimson said the archives of transactions, valuations, investment reports, and related correspondence have allowed researchers to piece together Keynes’s evolving style, including his failures and the lessons he learned from them. Dimson contends these are as follows:
- Active Management: Keynes did not believe that markets were efficient. Instead, he claimed that they are “governed by doubt rather than conviction, by fear more than forecast, by memories of last time and not by foreknowledge of next time.” In Chapter 12 of The General Theory of Employment, Interest and Money, which Warren Buffett suggests as required reading, Keynes writes that “It might be supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual. . . . It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise.”
- Long Termism: Keynes believed in holding investments for the long term. Portfolio turnover averaged 56% during approximately the first half of the period of his management, falling to only 14% in the second (and more successful) half. He observed that “[Professional investors] are largely concerned, not with making superior long-term forecasts . . . but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it ‘for keeps’, but with what the market will value it at, under the influence of mass psychology. . . .”
- Stocks over Bonds: In a radical departure from the conventional wisdom of those times, Keynes favored equities over fixed income for investors with very long-term horizons, such as endowments. On average, he allocated the majority of investments in the discretionary portfolio to UK stocks. This move was far ahead of other university endowments in the United Kingdom or the United States and certainly ahead of other institutional investors. During the period of his management, the equity risk premium leapt up to 4.9%, well above the 0.3% for the two prior decades, resulting in a real return of 8.3% per annum.
- International Investing: Keynes invested in securities with broad international exposure. For example, in the late 1930s, the economic exposure to the United Kingdom in the portfolio fell below that to the United States and even that to Africa. Such bold diversification prefigured many modern institutional investors and diverged from the typical “home bias” of those times.
- Bottom-Up Stock Selection: Keynes started with a top-down approach, hoping to profit from macro calls based on business cycles and market timing. However, the results were disappointing: “Credit cycling . . . needs phenomenal skill to make much out of it. . . . We have not proved able to take much advantage of a general systematic movement out of and into ordinary shares as a whole at different phases of the trade cycle.” From the early 1930s, Keynes switched to a bottom-up, stock-picking style, focusing on a few stocks: “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 about and in the management of which one thoroughly believes.” Warren Buffett must have learned much from these words.
- Concentrated Portfolios: While Keynes liked international diversification, he selected stocks from a narrow range of industries. For example, he hardly ever invested in bank stocks despite the significant weight of the sector in the market. And even though the number of portfolio holdings rose from around 20 to more than 60 within two decades, the weights in his favorite stocks continued to increase as he added to existing positions. At times, more than half the portfolio was invested in only five stocks. In 1936, 66% of the portfolio was exposed to only mining stocks.
- Value Orientation: Keynes often attributed his success to his “careful selection of a few investments” based on their “intrinsic value.” For example, he greatly favored investing in a South African mining company, Union Corporation, because its share price was at a 30% discount to its estimated breakup value. The counterpart of the value tilt was a preference for high-dividend yields. Keynes’s value-oriented approach echoes that of Benjamin Graham, though there is no record that the two ever met or communicated.
- Contrarianism: Keynes was anything but conventional — in any domain of his life! He bought stocks when everyone else stuck to bonds. He diversified across borders when others did so across sectors. He took the long view when others were more myopic. And he opportunistically bought art — Matisse, Seurat, and Picasso, among many others — partly for economic gain when it was largely seen as an aesthetic indulgence. He understood the risks of groupthink, where “it is better for reputation to fail conventionally than to succeed unconventionally.” Contrarian investing, he said, was “the one sphere of life and activity where victory, security and success are always to the minority, and never to the majority. When you find anyone agreeing with you, change your mind.”
Dimson stated that the impressive results that Keynes generated for the endowment fund at King’s College, Cambridge, stemmed from these early insights and beliefs, many of them foundation stones in the evolution of the investment profession. Yet, he concluded, Keynes devoted relatively little time to the activity — usually no more than half an hour every morning before he got out of bed!
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