commissioner.org
| Source | Jayson Funke |
| Date | 12/08/26/18:11 |
| Keynes, the hedge fund pioneer
By Gavyn Davies www.ft.com 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 in”. 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 1946. 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 opposite. 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 dream. Gavyn Davies is co-founder of Fulcrum Asset Management and Prisma Capital Partner |
Copyright (c) 1998, Joongpil Cho