The latest academic research into the performance of John Maynard Keynes as an investor adds some important detail to a story that has long fascinated – and inspired – stock market historians and professionals. It is well known that the most famous economist of his day made a fortune for King’s College, Cambridge, where he was the Bursar for more than 20 years, by buying and selling stocks for the college’s endowment and speculating happily in stocks and commodities on his own account.
For most of the interwar period, in addition to his many public and professional commitments as an economist, he was also an active participant in the investment decisions of two insurance companies, as chairman and investment director respectively. Given the extraordinary influence that Keynes’ writings on economics and the stock market have had on subsequent generations of professional investors, it is something of a surprise therefore to find that there is still a gap in the literature, in the shape of a detailed professional analysis of the performance of the King’s College endowment during the period when he was solely responsible for the management of the college’s finances.
There has been one quantitative study of Keynes’ performance, based on the King’s College archives, but this was limited in scope and ironically somewhat overstated his achievements, Professors David Chambers and Elroy Dimson find in their new research paper. The annualised alpha achieved by the King’s College endowments, on their calculations, was not 14%, as previously estimated, but a mere 8% – still a remarkable achievement in a 22 year period (1924-1946) that was amongst the most turbulent of the twentieth century. It was only at the end of the 1920s, in the height of the stock market boom, that the funds seriously lagged the UK market in relative performance.
Keynes himself lost a lot of money in the 1929 crash, which he failed to anticipate, and this experience was a big factor in his decision early in the 1930s to switch his investment approach from one that was what we would now call a topdown macro strategy to one based instead on a concentrated portfolio of individual stocks, which he traded relatively infrequently. Even the most brilliant economist of his day, a former Treasury official with exemplary contacts in the City and Whitehall, found he was unable to make money consistently by trying to call the turns in the credit cycle.
The most important decision that Keynes made as the manager of the King’s endowment, we can see now, was to move the unrestricted part of the college funds heavily into equities, at a time when most institutional investors were still either unwilling or actively prevented from moving away from fixed interest securities. The equity weightings in the funds he controlled averaged over 70%, whereas most insurance companies in the 1930s had barely 10% and the two largest colleges in Cambridge did not change their statutes to allow any equity investments at all until after the Second World War.
Chambers and Dimson add some important detail to the stockpicking strategy that Keynes pursued. Their analysis shows that he was a fully paid up member of what we might now call the unconstrained alpha fund school. The tracking error of the King’s unrestricted funds was 12.6%, a substantial amount of active risk. Except during the Second World War, the majority of his holdings were drawn from outside the largest 100 stocks of the day.
Around 80% of his holdings were drawn from just two of the ten sectors of the market, mining and industrials. (In two of the years sampled in the study, like some of the smartest unconstrained professionals today, he held absolutely nothing in bank shares). In the 1920s and towards the end of the period, he held a lot of stocks with above-average dividend yields, but in the 1930s, he dramatically increased his holdings of lower-yielding mining and recovery stocks. At one point more than half his portfolio produced no dividend at all.
In a well-known letter to the chairman of one of his insurance companies in 1934, Keynes wrote: “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”. This, in essence, is the philosophy that Warren Buffett and a number of other admired value investors have subsequently adopted with great success. Keynes, it is worth noting, arrived at this conclusion, a couple of years before the first edition of Graham and Dodd. Consistent with this philosophy, turnover in the King’s funds remained relatively low and the concentration of holdings relatively high, though it declined in the 1940s.
Chambers and Dimson run some other statistical tests of the King’s College funds, in an attempt to establish whether Keynes displayed some common behavioural faults as an investor. Their conclusion is that he was over-confident about his abilities in the 1920s and at times a poor trader. He became a better investor with age and experience, which is hardly a surprise. Perhaps their most important finding is one that I have found comes through every analysis of successful investors’ behaviour that I have seen, namely that investors only flourish best when operating in an institutional environment that actively allows them to use their individual skills to best advantage. That however requires a measure of trust in the personal integrity of the individual concerned that is not easily found or given.
The Chambers and Dimson paper is available from www.ssrn.com
Jonathan Davis 