|Keynes, the hedge fund pioneer
By Gavyn Davies
THE MACROECONOMICS of John Maynard Keynes continue to dominate the
global economic policy debate to this very day. But many have
forgotten that the great intellectual was also one of the most active
investors of his era.
He made and lost several fortunes, for himself, his friends, his
college (King’s, Cambridge) and for City institutions which he chaired
or founded. In some respects, he was an early hedge fund investor,
first in macro in the 1920s, and then in equities in the 1930s. He
ended as one of the most successful investors of the first half of the
last century, but along the way he learnt many lessons which resonate
to this day.
His investment activities really started in the early 1920s, when he
became convinced that the currencies of the economies devastated by
the first world war (Germany, France and Italy) would soon collapse as
inflation took hold. These positions soon made money, and an
overconfident Keynes proclaimed that with “a little extra knowledge
and experience of a special kind”, the money “simply comes rolling
Not quite. In May 1920, the markets became temporarily optimistic
about developments in Germany, and over-leveraged positions in the
market were rapidly reversed. Keynes and his syndicate were
effectively wiped out, though he managed to survive by borrowing more
money from his father, and by 1922 he had repaid syndicate members and
had amassed a personal fortune of £21,000.
His macroeconomic reasoning had proven sound, as usual. Nevertheless,
he had learnt a key lesson: that the market can stay “wrong” for
longer than most investors can stay liquid.
Keynes was not deterred. By the late 1920s, he believed that the
Federal Reserve would be able to maintain economic growth at a high
level, because inflation was under control. He was therefore exposed
both to equities, and especially to commodities in 1928-29, when the
Fed unexpectedly tightened interest rate policy and the global cartel
in rubber collapsed.
Again, he sustained large losses as the Great Depression started. A
double lesson here: don’t fight the Fed, and never, ever misread the
Fed (which, of course, is much easier said than done).
D.E. Moggridge, in his outstanding 1992 biography, says that “Keynes
was extremely stubborn during short-term market fluctuations”.
Over-confidence, mixed with stubbornness, is a very bad combination
for a macro investor, and his record in the 1920s was not impressive.
Keynes, however, learnt humility from his experiences in the markets,
as all great investors do. In the mid 1930s, he was convinced that
President Franklin D. Roosevelt would succeed in stimulating the US
economy, and he again used margin to leverage his personal portfolio.
He had a volatile ride, but this time he was right, and he made the
bulk of his personal fortune, which exceeded £400,000 when he died in
Furthermore, Keynes had adopted a new approach to investing in
individual equities. As early as 1924, he had realised that the risk
premium on equities should provide a long-term excess return on
equities relative to bonds, when the conventional wisdom was the
After that, his strategic allocation to equities was groundbreaking. A
big lesson here: selecting the right asset class is always the most
critical foundation for long-term success.
But in the 1930s, his stock selections for his King’s College
portfolios were also highly successful. A fascinating recent paper by
academics David Chambers and Elroy Dimson examines his record, using
data from the King’s College archives. Keynes’ method was to make
concentrated investments in a relatively small number of stocks, on
the principle, adopted by Warren Buffett, that “it is a mistake to
think that one spreads one’s risk by spreading too much between
enterprises about which one knows little”.
He also identified other risk premiums which have since proven
durable, by investing mainly in small- or mid-cap stocks,
high-dividend payers, and other “value” stocks. He became a contrarian
investor, mainly buying stocks which had recently underperformed the
general market. He used leverage, but by now applied concerted
discipline to contain his risks. Many of these techniques are used by
the most successful equity long/short funds today.
According to Chambers and Dimson, in the 22 years he managed the
King’s portfolios, Keynes’ long-term Sharpe ratio, a measure of
risk-adjusted performance, was a very respectable 0.69, compared with
0.45 on a balanced portfolio at the time. Aiming for anything higher
than that, as some hedge fund managers do, is to chase the impossible
Gavyn Davies is co-founder of Fulcrum Asset Management and Prisma