Warren Buffett or Benjamin Graham would be likely choices for greatest ever investor, but Julian Hofmann argues that this honour can only go to one man, and it’s neither of them.
“Some surprise has been expressed about the large fortune left by Lord Keynes. Yet Lord Keynes was one of the few economists with the practical ability to make money.” - Financial Times, 30 September 1946
John Maynard Keynes has a justifiably legendary reputation for dragging the world of economics into the 20th century, at a time when economic depression was leading to the rise of extremism and instability.
His General Theory of Employment, Interest and Money is still the foundation of modern macro-economic policy despite the rise of monetarism in the 1980s. However, what has been less well explored until recently, was Keynes’ extraordinary ability as a value investor.
The numbers speak for themselves. The surprise at Keynes' fortune on his death, as reported by the Financial Times, was understandable – the £400,000 cash he bequeathed, plus a fine art collection along with Sir Isaac Newton’s original papers, was estimated to be worth about £30 million at today’s prices. What makes this even more extraordinary is that this entire fortune was not inherited, or earned via a lifetime of high-paid work, but almost entirely the result of investing in the stock market during some of the worst bear markets ever recorded.
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Unlike Benjamin Graham, Keynes didn’t leave behind a single testament to his investment beliefs. His views on investing are copious but are spread across thousands of lectures, articles, speeches and correspondence in his role as fund manager for different institutions. It has taken academics quite some time to draw them all together into one coherent narrative. So, it is about time that ordinary investors learned the lessons of an investment master.
“The market can stay irrational for longer than you can stay solvent” - John Maynard Keynes
Keynes’ investing life began as an early form of momentum investor after setting up a syndicate in 1920 to play the currency markets. With many countries dropping the gold standard for the duration and aftermath of the First World War, currencies such as the French franc, Italian lira and the German Reichsmark became very volatile. By going long on the US dollar, Keynes was speculating on a long-term decline in European currencies, and, for a while, he made extraordinary profits: more than $110,000 in a few months, or £2.86 million at today’s prices.
Unfortunately, a short-term reversal wiped out the capital in less than a week. However, via a loan from the financier Sir Ernest Cassel, he weighed back in, made the back the losses and paid off his original investors in full by 1922.
While he had correctly called the trend that inflation would debase a currency such as the Reichsmark (partly because of the punitive Treaty of Versailles) investors’ irrational short-term optimism had wiped him out. This was an important lesson in the fundamentals of the market for Keynes: the market is fundamentally about radical uncertainty where prices can be influenced by either irrational exuberance or pessimism.
Keynes the commodities guru
As the 1920s wore on, Keynes jumped on to the commodities bandwagon, forecasting correctly as it turned out, that a war-ravaged Europe would require vast amounts of raw materials to rebuild. He thought that the commodities market would throw up regular price inefficiencies in the frequent mismatches between demand and supply. By using his government contacts to access price information, and reading almost everything available, Keynes thought he could profit. He went long on Indian jute, American cotton, lard, linseed oil, petroleum, rubber, anything that could be useful to reconstruction.
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Keynes’ profits on commodities trading*
Tin, 1921- 1930: £17,000 (2021: £850,000), this is an aggregate total.
Cotton, 1921 -1929: an average of between £4,970 and £6,500 (2021: £248,500 and £325,000) between 1921 and 1929.
Wheat: not clear from the records, although, apparently, he actually took delivery of wheat on one occasion to try and benefit from a higher spot market price.
*Source John F. Wasik, The Keynes Way to Wealth
Keynes as value investor
Keynes’ time as a commodities trader came to an abrupt end in 1928 as world prices started to fall – a rehearsal for the Wall Street crash in 1929 – and his positions started losing money. John Wasik makes clear that Keyne’s success in commodities is somewhat difficult to judge, although his biographer Robert Skidelsky reckons that Keynes was worth about $3.4 million at today’s prices in 1927. Keynes had expected a stock market crash, but did not foresee it coming in 1929, but his long positions in commodities meant that this insight was largely irrelevant and he lost 80% of his net worth in the crash.
“When the facts change, I change my mind…”
The loss of most of a second fortune led Keynes to almost sell his prize paintings (he couldn’t find a decent buyer), but the experience caused him to reassess his whole investment approach from the ground up. From trying to call the cycles and anticipate market movements, Keynes developed the strategy that we now recognise as value investing.
Keynes’ response to the Wall Street Crash was to reflect on what had gone wrong. He basically realised that the “animal spirits” in the market would always react in ways that meant trying to call the cycles or market movements was a recipe for failure over the long term. Although battered by the Great Crash, he held on to a number of influential money management positions, particularly as manager of the King's College Cambridge endowment fund, and this allowed him to change direction and test out a new investment approach. It is also helpful that Keynes would often mirror his investments on behalf of King's in his personal portfolio so we can get an accurate portrait of his personal investment taste.
Justyn Walsh in Investing with Keynes argues that this new approach to value investing can be summarised in six key rules which Keynes developed and followed throughout the 1930s.
Keynes’ six rules of investing
- Focus on estimated intrinsic value based on projected earnings.
- Allow a sufficiently large margin of safety between the quoted price of a share and its intrinsic value.
- Follow your own judgement and apply a contrarian strategy if appropriate.
- Follow a buy-and-hold strategy and ignore constant price quotation and transaction costs.
- Practice portfolio concentration by investing large chunks of capital in a small number of stocks.
- Find a balance between “equanimity and patience” and the ability to act decisively.
What is unusual about Keynes’ approach is that it acknowledges the existence of uncertainty, as well as accepting that forming a value judgement about investments is as much an art as a science; or, as Warren Buffett puts it: “A number that is impossible to pinpoint but essential to estimate.” He was also disarmingly candid about the fact that investing was, in many ways, simply about avoiding making stupid mistakes.
There can be no doubt that Keynes followed his own advice, as Walsh makes clear: after 1929 he outperformed the market on 21 out of the 30 available aggregate accounting years across both markets at a time when the S&P500 net return was zero and the London market barely doubled. The King's College fund appreciated from £30,000 in 1920 to around £380,000 at the time of Keynes’ death, solely from capital gains on the portfolio as dividends were spent on debt servicing or building works. At a 2018 price of £1=£63.81, Keynes’ stewardship raised King's’ endowment from £1.91 million to £24.2 million in just a decade.
Without a doubt, John Maynard Keynes was the greatest value investor ever.
Justyn Walsh, Investing with Keynes: How the World’s Greatest Economist Overturned Conventional Wisdom and Made a Fortune on the Stockmarket, Simon & Schuster.
John Wasik, The Keynes Way to Wealth: Timeless Investment Lessons from the Great Economist, McGraw-Hill.
Chambers, Dimson & Foo, Keynes the Stockmarket Investor: a Quantitative Analysis.
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