Keynes Was a True Investing Pioneer
12/05/2013 12:00 pm EST
John Maynard Keynes was at the forefront of the investing world, writes MoneyShow's Howard R. Gold, and his influential theories are often taken for granted today.
Before there was Benjamin Graham and Warren Buffett, before there was George Soros or David Swensen, there was John Maynard Keynes.
Keynes, whose economic theories have been hugely influential (though they remain controversial), pioneered many of the investing concepts we now take for granted.
He speculated in currencies and commodities decades before Soros and Jim Rogers; weighed stocks' intrinsic value in anticipation of Graham and Buffett; grasped the critical importance of diversification long before Harry Markowitz, and revolutionized institutional investing more profoundly than Swensen did at Yale and Jack Meyer did at Harvard.
He also posted astonishing returns, easily beating the stock indexes, albeit with considerable volatility. But that came only after he made and lost two fortunes in the Roaring Twenties. Those traumatic losses made him turn from speculation to investing.
A new book, “Keynes's Way to Wealth,” by veteran financial journalist John F. Wasik, tells the story. Unearthing a trove of new material from the library of King's College at the University of Cambridge in England, Wasik has made a persuasive case for Keynes as one of the investing giants of the past century and tells what investors can learn from him.
- Read Howard's take on the shortcomings of Keynesian economics on MoneyShow.com.
Astonishingly, “not one of [the major Keynes biographies] gets into investing,” Wasik told me.
Maybe because the rest of Keynes's life was so fascinating. A protean intellect who attended Eton and Cambridge on scholarship, he was profoundly influenced by economist Alfred Marshall, philosopher G.E. Moore, and mathematician Bertrand Russell, all of whom populated the Cambridge of that time.
Keynes became part of the Bloomsbury group, the famous social circle that included the great novelist Virginia Woolf. Bloomsbury's ethos was radical and Utopian. “All Victorian notions of behavior, worldview, and culture were being thrown out the window,” wrote Wasik.
Keynes's unconventional thinking pervaded his 1919 book, “The Economic Consequences of the Peace.” A devastating critique of the Versailles Treaty, it warned the victorious Allies that they were squeezing Germany too hard and that the latter would face “the menace of inflationism.” Unfortunately, Keynes turned out to be prescient, as the treaty, and the Weimar hyperinflation, paved the way for the Third Reich.
The book, which became an international bestseller, also gave Keynes ideas on how to make money. “Believing that postwar inflation would hurt the values of the French franc,…the German reichsmark and the Italian lira…, Keynes shorted these currencies,” wrote Wasik. But his profits vaporized when the market rallied in a temporary burst of optimism.
He responded by plunging into commodities. Poring through thousands of pages of dusty documents at the Cambridge library, Wasik was astonished by how active Keynes was. “There were thousands of commodities trades,” he told me.
But things all came crashing down in 1929.
“He was on the wrong side of most of his trades when demand collapsed,” the book said. “The macro view of trying to guess where the economy was moving, and to link currency and commodity trades to those hunches, had failed in a big way.”
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Losing 80% of his net worth was a wake-up call. “He learned that this stuff he called 'animal spirits' you couldn't predict,” said Wasik.
So, he radically changed his investing style, focusing on equities. “In the face of the worst sell-off in history, Keynes, in effect, became a contrarian,” the book said. He emphasized large dividend-paying companies with solid franchises, such as utilities and miners. He also bought small- and mid-cap stocks.
He aimed to buy low and hold indefinitely. In 1938, he stressed the “careful selection of a few investments…having regard to their cheapness and potential intrinsic value over a period of years ahead.”
Across the Atlantic, Benjamin Graham was developing a similar approach, which he and David Dodd expounded in their 1934 classic, “Security Analysis.”
Keynes also was a revolutionary in institutional investing. Before Keynes, institutional investing meant “you bought and held bonds,” Wasik wrote. UK institutions had only 3% of their assets in stocks in 1920, and only 10% by 1937. Managing discretionary portfolios for King's College and two British insurers, Keynes “broke the mold…by investing the majority of his portfolios in stocks.”
But he also believed in the concept of “opposed risks”—holding offsetting asset classes like bonds, real estate, and gold. That anticipated the emphasis on diversification we find in modern portfolio theory.
- Read why Howard says diversification isn't working these days on MoneyShow.com.
Keynes, however, was a stock picker at heart . The portfolio he managed for King's College outshone the market throughout the 1930s, except for the crash of 1938, when he lost two-thirds of his fortune. But by the time he died in 1946, his estate was worth $36 million in 2013 dollars, Wasik wrote.
Two academic studies found that Keynes was an outstanding money manager. One King's College portfolio yielded annual returns of 16% from 1922 to 1946, trouncing the benchmark index, according to David Chambers and Justin Foo of Cambridge, and Elroy Dimson of the London Business School.
Still, “a high level of portfolio risk” accompanied Keynes's outsized returns—a standard deviation of 29%, a 1983 study found, more than double that of the market.
“He levered up like crazy,” Wasik explained. “He got loans to buy shares.”
That's obviously one thing investors shouldn't imitate. But buying low, focusing on intrinsic value, diversifying, and investing in dividend-paying stocks are all sound lessons we can learn.
And there's one more…
“The main takeaway is he had a plan,” Wasik told me. “If you have a plan, stick to it; ignore the market noise. Most people can't do it.”
But Keynes could and did, which is why in investing, if not in economics, we are all Keynesians now.
Howard R. Gold is editor at large for MoneyShow.com and a columnist for MarketWatch. Follow him on Twitter @howardrgold. The World MoneyShow Orlando is just 55 days away, for more information and to register for FREE click here...