Friday, November 13, 2015

John Maynard Keynes' change in investment philosophy

Via Chris Mayer in his book, 100 Baggers:
Keynes’s investment performance improved markedly after adopting these ideas. Whereas in the 1920s he generally trailed the market, he was a great performer after the crash. Walsh dates Keynes’s adoption of what we might think of as a Warren Buffett sort of approach as beginning in 1931. From that time to 1945, the Chest Fund rose tenfold in value in 15 years, versus no return for the overall market. That is a truly awesome performance in an awfully tough environment. 
A more recent paper is “Keynes the Stock Market Investor,” by David Chambers and Elroy Dimson. They add more interesting details about how his investing style changed. As Chambers and Dimson note, “As a young man, Keynes was supremely self-assured about his capabilities, and he traded most actively to the detriment of performance in the first period of his stewardship of the College endowment up to the early 1930s.”  
In the early 1930s, he changed his approach. With the exception of 1938, he would never trail the market again. This change showed up in a number of ways. First, he traded less frequently. He became more patient and more focused on the long-term. 
Here is his portfolio turnover by decade: 
1921–1929:  55%
1930–1939:  30%
1940–1946:  14% 
Turnover was just one aspect of Keynes’s change. Another was how he reacted during market declines. From 1929 to 1930, Keynes sold one-fifth of his holdings and switched to bonds. But when the market fell in the 1937–1938, he added to his positions. He stayed 90 percent invested throughout. 
This is a remarkable change. It again reflects less concern about short-term stock prices. He was clearly more focused on the value of what he owned, as his letters show. The authors of the paper note of Keynes’s change, “Essentially, he switched from a macro market-timing approach to bottom-up stock-picking.” 
In a memorandum in May of 1938, Keynes offered the best summing up of his own philosophy: 
1. careful selection of a few investments (or a few types of investment) based on their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments; 
2. a steadfast holding of these investments in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it has become evident that their purchase was a mistake; and 
3. a balanced investment position, that is, a portfolio exposed to a variety of risks in spite of individual holdings being large, and if possible, opposed risks. 
Here is one last bit of advice from the same memo: 
In the main, therefore, slumps are experiences to be lived through and survived with as much equanimity and patience as possible. Advantage can be taken of them more because individual securities fall out of their reasonable parity with other securities on such occasions, than by attempts at wholesale shifts into and out of equities as a whole. One must not allow one’s attitude to securities which have a daily market quotation to be disturbed by this fact.