Monday, July 9, 2012

Keynes the Investor (Part I)

Writing in Saturday's Financial Times, columnist John Authers cited a study by David Chambers and Elroy Dimson on the investment prowess of John Maynard Keynes.

Keynes, of course, is mostly known today for the branch of economics that bears his name:  Keynesian economics.

The debate about whether policies using fiscal stimulus (a distinctly Keynesian idea) or monetary tools (think Milton Friedman) to spur economic growth has raged in government and academic circles since the late 1970's, so I will not comment on it here.

However, what is less known about Keynes is that he was a terrific investor as well.

Keynes was supposed to have spent just 30 minutes a day thinking about investing. Typically he would study the morning papers while lying in bed, call his broker if necessary, then spend the rest of the day on his true passion of economics.

Initially Keynes approached investing with the same arrogance he did academic matters.  Not surprisingly, this lead to near-disaster.

Keynes nearly went bankrupt in the late 1920's when his leveraged plays on commodities went badly, and it was only through some clever financial maneuvers (and some stopgap financing from a wealth patron) that he was able to stay afloat.

But this near-death experience taught Keynes some valuable lessons.  For starters, he learned something that should be ingrained in all investors' collective minds:

"Markets can stay irrational longer than you can remain solvent."

But there was more, as the paper published by Chambers and Dimson write.

Keynes took on the management of the investment portfolio of King's College in Cambridge, England.  Here's what Chambers and Dimson conclude about the impact that Keynes made (I have added the emphasis):

The most overlooked of Keynes’s many accomplishments is that he was
among the first institutional managers to allocate the majority of his portfolio to the new alternative asset class of equities. 

At the end of the 20th century both British and US long-term institutional investors had the majority of their assets invested in equities, public and private. In contrast, their ancestors one hundred years earlier regarded common stocks (ordinary shares) as extremely risky and shunned this asset class in favour of fixed income and property.

At the end of the 1930s British life insurance companies still had only a 10% allocation to ordinary shares. Keynes, on the other hand revolutionised the way his own Cambridge college endowment was managed from the early 1920s until his death in 1946. In committing his portfolios to equities where he was free so to do, he exploited the risk premium available to long-term investors over conventional fixed income assets which was subsequently to emerge over the course of the last century (Jorion and Goetzmann, 1999).

For the last 22 years of Keynes's life, from 1924 to 1946, the endowment of Kings College return 15.2% per annum.  By comparison, an index of UK stocks grew at less than half of this rate - +8.1%.

My next post will discuss some of ways that Keynes was able to achieve such spectacular results, and how they might be applicable today.