Monday, April 2, 2012

John Maynard Keynes, The Investor

An excerpt from chapter 12 of The General Theory of Employment, Interest, and Money by John Maynard Keynes:

The chapter is one of three that Warren Buffett has said investors should read.

"Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of "liquid" securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is "to beat the gun", as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.

This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves."

Later in the chapter Keynes equates this to games like Musical Chairs among others:

"These games can be played with zest and enjoyment, though...when the music stops some of the players will find themselves unseated."

In this Wall Street Journal article, Jason Zweig points out that Keynes was quite an investor. Well, at least he was once a change in investing styles occurred mid-career:
So an eight percent annual outperformance from 1924 to 1946.

Impressive, but clearly most of these exceptional results came after Keynes switched from the "macro" or "top-down" style to fundamental stock-picking.

In his earlier years, Keynes relied heavily upon monetary/economic signals to switch in and out of assets.

Using this earlier approach, Keynes went into the fall of 1929 with way too much stock exposure (83%) and paid for it.

Less than a few years after that experience, he switched from this "top down" approach to pure stock-picking focusing instead on the "bottom up" analysis of fundamentals.

Keynes also was known to concentrate his holdings (top five positions sometimes made up as much as 50% of the portfolio) and held shares for often more than five years.

Sound familiar? In Chapter 12 of The General Theory, Keynes said that the "spectacle of modern investment markets has sometimes moved me towards the conclusion" that they be set up in a way that will "force the investor to direct his mind to the long-term prospects and to those only."

Yet, Keynes also understood how difficult it was to get most market participants to act in this way.

The reason? There's a fundamental dilemma that impedes this from happening. More from Chapter 12:

"...the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is "liquid" (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk."

Finding the right balance is a problem persists to this day. I think it's safe to say we've gone too far in the direction of liquidity by a long shot but the same forces seem at work.

You don't have to agree with some of the economic theories of Keynes (on things like the need, at times, for government intervention in the economy) to learn from him when it comes to investing.

Adam

Keynes: One Mean Money Manager - Jason Zweig, Wall Street Journal
The General Theory of Employment, Interest, and Money - John Maynard Keynes

HT: Gaurang Sathaye
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