Monday, December 2, 2013

Wasik, Keynes’s Way to Wealth

John Maynard Keynes was not only a renowned economist, he was an investor. He managed his own money as well as that of King’s College, his friends and family, and insurance companies. As John C. Bogle writes in his introduction to the book, “His spectacular success showed not only his passion for making money, but his growing aversion to losing it. As someone who had gained two fortunes through his trading prowess and lost them through his hubris, Keynes is a stellar example of how an investor can learn, fall on his face more than once, and still come out ahead.” (p. xxxiv)

John S. Wasik explores this investing journey in Keynes’s Way to Wealth: Timeless Investment Lessons from the Great Economist (McGraw-Hill, 2014). Let me start with the rewards of the journey: what Keynes did with his wealth. He bought art as well as rare books and manuscripts. The Keynes collection of rare books, bequeathed to King’s College in 1946, is, according to the college’s web site, “especially strong in editions of Hume, Newton and Locke, and in sixteenth and seventeenth century literature. About 1300 books in this collection have been catalogued on the online catalogue. … Keynes’s collection of manuscripts by Newton, Bentham, John Stuart Mill, etc., is housed in the Modern Archive Centre.” A man after my own heart, but with a bigger budget.

Keynes was a speculator. According to his own definition, “The essential characteristic of speculation … is superior knowledge. We do not mean by this the investment’s actual future yield … we mean the expected probability of the yield. The probability depends upon the degree of knowledge in a sense, therefore it’s subjective. If we regard speculation as a reasoned effort to gauge the future from present known data, it may be said to form the reins of all intelligent investing.” (p. 8)

In 1920 he set up an investing syndicate to trade currencies, both long and short. Initially, he was successful, but then in the space of four weeks the syndicate’s entire capital was wiped out. With the help of a “birthday present” from his father and a loan from a financier Keynes got back in the game and by the end of 1922 was able to repay all of his investors and then some. At that point he decided to add even more volatile commodities to his trading portfolio. “When it came to commodities, Keynes was an absolute data wonk. His documenting of commodity price supplies and fluctuations fills nearly 400 pages of Volume 12 of his collected writings.” (p. 26)

His commodities trading seemed to go well for some time, but then came the stock market crash of 1929 and the attendant collapse in demand for commodities. He lost some 80 percent of his net worth.

“Although Keynes was well known for his arrogance and his air of intellectual superiority, the humbling experience of having nearly lost two fortunes changed his thinking on the best way to invest. The macro view of trying to guess where the economy was moving, and to link currency and commodity trades to those hunches, had failed in a big way. His new focus on confidence, sentiment, and psychology made all of his extensive research into prices, supply/demand ratios, and monetary movement seem irrelevant.” (pp. 48-49)

Keynes became a bottom-up investor, holding concentrated positions in companies that he was familiar with and in whose management he “thoroughly believe[d].” (p. 116) He used leverage; from 1929 to 1945 it “amplified his winnings” (and of course his losses as well), “multiplying his net wealth by a factor of 52.” (p. 118)

As for asset allocation, he was a tactical investor. As he wrote in 1938, “the whole art is to vary the emphasis and the center of gravity of one’s portfolio according to circumstances.” (p. 115) But for the most part he now focused on the long-term profitability of companies. His investment philosophy rested on three principles: (1) “a careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time; (2) a steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until they have fulfilled their promise or it is evident that they were purchased on a mistake; (3) a balanced investment position, i.e., a variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g., a holding of gold shares amongst other equities, since they are likely to move in the opposite directions when there are general fluctuations).” (pp. 111-12)

His principles have certainly had lasting power; they underlie some of the most successful investment portfolios today.

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