What Can We Learn From Keynes the Investor?
Keynes’s legacy extends beyond theory to the world of action, speculation, and ambition
It is a strange thing to hear economists talk of ‘animal spirits’ who themselves appear to be animated by little more than elaborate, closed-off theories. There are more than enough economists who claim some insight into how economies operate without ever gaining first-hand experience of the market. Exposure to the markets is essential if we want a deeper understanding of the interplay between finance and economics. The two are intertwined, and one cannot be fully understood without the other.
When we invest our money and expose ourselves to the vicissitudes of the market, we are left with psychic imprints that stay with us through the rest of our investing lives. When markets tumble, we feel the sting through the loss of our own capital, and we are impelled to discover more of the mechanisms by which the market was driven down. Similarly, when markets are rising and all appears calm, we wish to learn what conditions bring about such fortuitous gains. Investing is learning, and you cannot learn how markets work without being an investor.
John Maynard Keynes is one of the most prescient economists of all time because he was also an investor. Not content merely to theorize, he actively sought out risks and the thrill of investing in all sorts of markets, from stocks and bonds to commodities and currencies. He was cleaned out on numerous occasions, yet rarely lost his head and certainly never blamed his losses on the deficiencies of the system. While not without his own moral criticisms of capitalism, which he developed throughout his life and career, he never succumbed to bitterness but kept up his passion for investing and trying to crack the code of the markets.
Keynes the philosopher
Keynes was the most brilliant non-economist to ever apply himself to the field of economics. His economic philosophy reflected his personal experience as a speculator and investor. Much like George Soros or Warren Buffett of today, Keynes strove for a deep and philosophical understanding of how markets operate. His practical insights into human psychology, coupled with his professional experience as a director of the Bank of England and an investor and trustee for numerous funds, produced some of the most important treatises on economics that remain the foundation of the field today.
The key to Keynes’s success was his curiosity and philosophical mindset, which loosed him from the rigid mores of classical economics. He was less interested in the beauty of his models or the ideal forms of economic organization envisioned by modern economists like Alfred Marshall. His theories were made to fit the exigencies of the economic data and the observable reality in which he found himself. His was a kind of economic realism that sought to address the world as it was, not as it was theoretically devised.
Keynes was not dogmatic, but he was mercurial, often changing his mind as every good investor does. To him, statistical methods in the hands of the philosophically untrained was a catastrophe waiting to happen. Keynes’s unbridled creativity combined with a practical nature stood in stark contrast to the rigid thinking of the so-called Austrian economists. The Austrians, of which Friedrich Hayek is the most well-known, took the traditional view of money and interest, and saw markets as mostly efficient.
Keynes, despite some moral misgivings about the capitalist system, sought to save capitalism from itself by pointing out some obvious contradictions in the traditional view. These observations centered on the role of human psychology and institutions on market outcomes. Economic participants are calculating, but they are also governed by emotions, of which fear and greed are the most powerful. There are also frictions created by government regulations and trade unions that cause wages and prices to be ‘sticky’.
The role of expectations is key in Keynes’s economics, but this insight may have been developed while contemplating the financial markets. In 1910 Keynes wrote:
The investor will be affected, as is obvious, not by the net income which he will actually receive from his investment in the long run, but by his expectations. These will often depend on fashion, upon advertisement, or upon purely irrational waves of optimism or pessimism. Similarly by risk we mean, not the real risk as measured by the actual average of the class of investment over the period of years to which the expectation refers, but the risk as it estimated, wisely of foolishly, by the investor.
Keynes the investor
Curiously, while Keynes was known for his macroeconomic thinking, his macro-based investment strategies did not perform particularly well. Keynes’s early forays into investing, as a trustee for his university’s endowment and as the manager of a small private fund, his top-down approach disappointed throughout the 1920s, and there is no evidence that Keynes had any market timing ability at all. With funds raised mostly from his associates in the Bloomsbury group of intellectuals, Keynes experimented with his own probabilistic models, investing like a hedge fund before the term was even used.
When the system of fixed exchange broke down after World War I, Keynes and his investment partner Oswald ‘Foxy’ Falk began speculating on the newly-floating currencies. Starting operations in 1920, Keynes went long the US dollar while shorting the German mark, French franc, and Italian lira. Early success was unwound when he bet against the British pound, which rose on the back of the Bank of England’s decision to raise interest rates. Then the European currencies rose against the dollar in a short and sharp rally that lasted long enough to wipe out Keynes’s highly leveraged positions.
Thankfully, his Bloomsbury investors chose not to redeem, enabling Keynes to take out a loan to pay off what he owed to Falk (around £5,000). By the end of 1922 he had repaid his debts and even made a modest but tidy profit.
This lack of success as a macro investor solidified Keynes’s view that beating the market was no mean feat. While markets were not always efficient in the classical sense, understanding when assets were fairly-valued and when animal spirits had taken over required a sophisticated framework for analyzing markets.
Keynes was also deep in commodities and achieved a modicum of success through the 1920s. But in 1928 he was long rubber, wheat, cotton, and tin when these commodities began to fall, forcing him to sell his U.S. shares to cover his losses. The stock market collapse that ushered in the Great Depression left Keynes with a portfolio dominated by 10,000 shares in the Austin Motor Company, whose value fell from £1.10 per share in January 1928 to £0.25 by the end of 1929.
Keynes was not done whetting his speculative instinct, but his experience of the Great Depression led him to refine his approach. Following the 1929 stock market crash, Keynes transformed into a value investor and bottom-up stock picker. His new strategy involved buying stocks and holding them for the long term. Rather than succumb to the grab for liquidity, investors should take advantage of the market’s panic psychology to find bargains.
It was one thing to develop a value system of investing but quite another to live it out in the markets. Keynes was mostly true to his beliefs, despite the odd test of nerves. No one can say he did not have skin in the game. In 1936 he was even forced to take physical delivery of a month’s supply of wheat from Argentina, which he planned to store in the crypt of Kings College Chapel, although alternative arrangements were found.
By 1936, Keynes’s personal wealth totaled £500,000. There were more ups and downs to come, including the stock market crash of 1937, which saw Keynes’s portfolio take another massive hit, but he held on, staying true to his buy and hold strategy. It paid off. By the time of his death, Keynes had a £400,000 portfolio along with an art and book collection worth £80,000.
True knowledge comes through action
Not only did Keynes leave us with a towering economic legacy, he also gave us the foundations of a methodical, value-based investment strategy with a proven track record of success. No doubt Keynes’s attempt to develop a synthesized economic theory helped him to better understand markets, but equally his firsthand experience as a money manager and speculator surely led to some critical economic insight.
The lesson of Keynes’s life is that the best theories are borne of action. Today, investing has a kind of stigma attached to it, as if the scientific and serious-minded among us should not be wasting our mental energies on a base and unscientific pursuit. Nothing could be further from the truth. To gain an appreciation of the theory, we need to get down into the emotional and psychological weeds of the markets.
We need to take an active role ourselves — to experience the ups and downs — to test our knowledge and understanding. Theory is all well and good, but if we do not dedicate ourselves to the application of theories, adjusting them as we take in new information, and even overturning them when necessary, then we are not fully engaged in the pursuit of knowledge.