Changing His Mind
David Chambers and Elroy Dimson have published a wonderful paper on Keynes the Stock Market Investor, which analyses John Maynard Keynes’ remarkable investment record as the effective Chief Investment Officer of Kings College Cambridge over a period of a quarter of a century. It’s a fascinating insight into the evolution of one individual from underperforming, overconfident, macro-based and behaviorally biased to an outperforming, realistic, stockpicking rationalist.
That this journey happens to have been made by one the last century’s most famous economists, and that it flies in the face of much of his own macroeconomic theory merely adds piquancy. The lessons, though, are applicable for any investor, whether genius or not.
Equities, Sir?
Perhaps the key point about Keynes’ investing style was his selection of equities as his preferred asset class: a very unusual decision for the time when most institutions were focussed on bonds. His particular insight was that equities offered a way of riding industrial growth, that they offered both return and income premiums over bonds and that the equity risk premium of shares over bonds would ensure a profitable, if volatile ride. This was by no means a no-brainer; as the paper points out, between 1900 and 1920, before Keynes moved into equities, the equity risk premium was 0.3%, but rose to 4.9% over the next twenty five, covering the remainder of his life.
Yet, despite his correct analysis of the landscape of asset classes Keynes failed to make significant returns over is first decade as an investment manager, as he persisted with an investment approach based on top-down analysis using something called the ‘credit cycle theory of investment’: utilizing monetary and economic indicators to determine when and whether to move between the different major asset classes of cash, bonds and equities. The results of this approach was poor, as Keynes himself admitted:
“Credit cycling means in practice selling market leaders on a falling market and buying them on a rising one and, allowing for expenses and loss of interest, it needs phenomenal skill to make much out of it”
Traders beware.
Patience is a Virtue
In fact over that first decade or so Keynes managed to underperform the market by an average of 5.3% a year. Any normal institution would have fired any normal investment manager but Keynes was no ordinary man and Oxbridge colleges are no ordinary…
