John Maynard Keynes–The Original Warren Buffett

In the current era of aggressive fiscal stimulus and loose monetary policy following the financial crisis, John Maynard Keynes is often invoked as a forefather of much of the economic thinking adopted by the Federal Reserve in its policy response.

While Keynes’s intellectual legacy is assured in the field of macroeconomics, another aspect of his mastery of financial markets is that Keynes was also a highly successful investor in his day.

In “John Maynard Keynes, the Investment Innovator,” by David Chambers and Elroy Dimson, the authors examine Keynes’s investing track record over a 25 year period, from 1921 through 1946, as he managed the endowment of King’s College at Cambridge University. Keynes handily outperformed his benchmark, the British common stock index, by approximately 8% per year over this period.  That’s a lot of alpha, and stacks up pretty favorably against even today’s gold standard investor, Warren Buffett. Buffet achieved outperformance of approximately 10% versus his S&P 500 benchmark from 1965 through 2012 (http://www.berkshirehathaway.com/2012ar/2012ar.pdf). Clearly, given his phenomenal track record, Keynes was doing something right.

So how did Keynes do it? Did he get stock tips from King George V? Was he short the buggy whip manufacturers? Perhaps he bought railway stocks trading at 52-week lows?

No. Keynes achieved his investment success in much same way as did a contemporary of his from across the Atlantic, Ben Graham. Like Ben Graham, Keynes was a value investor, who purchased stocks trading at a discount to their intrinsic value. In particular, Keynes favored smaller companies, as well as those with a high dividend yield. These strategies, which today we might refer to as involving the small-cap effect and the value effect, anticipated the approach favored by generations of successful value investors. The below figure shows the investment performance of the King’s College discretionary portfolio, managed by Keynes from 1922-1946.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Keynes lagged the market in only 6 of the 25 years he managed this portfolio. 4 of these years occurred in the 20s, when he pursued a top-down, market timing approach, which he subsequently discarded for a bottoms up approach that performed much better. Overall, we think these results were, as Ben Graham himself might have put it, “quite satisfactory.”

Ultimately, it would appear Keynes was not a strict adherent to the efficient market hypothesis, which argues markets are always correctly priced.
As Keynes put it:

“[Markets] are governed by doubt rather than conviction, by fear more than forecast, by memories of last time and not by foreknowledge of next time. The level of stock prices does not mean that investors know, it means they do not know. Faced with the perplexities and uncertainties of the modern world, market values will fluctuate more widely than will seem reasonable in the light of after-events.”

Keynes was a man ahead of his time, not only terms of his economic insights, but also with respect to his approach to investing. We wonder how he would fare today, in markets dominated by giant “too big to fail” banks, and buffeted by default concerns. Given his intuitive grasp of human nature and his strong value investing instincts, he would have probably fared pretty well.

One thing is certain: If Keynes were alive today we would do our best to make him a quant!