Keynes’ words of wisdom remain relevant for 2017
What would John Maynard Keynes do if he was investing in 2017?
The British economist, who revolutionised his field last century and had an enormous influence on the way governments manage their economies, was also a pioneer of money management who laid the groundwork for successors like -Benjamin Graham, the “father of value investing”, and Graham’s most famous pupil, Warren Buffett.
At this time of year, while the air is thick with advice for would-be investors, it is useful to reflect, especially as the world economy faces such uncertainty.
What might Donald Trump’s election mean for US healthcare stocks, for example? Will the British pound sink further or rebound strongly as Brexit talks proceed? Will Opec hold the line on its production-cutting deal? Can the new Italian government last a year?
In any case, how do such questions factor into something like JP Morgan’s year-end roll call, which has Unilever, Anglo American and BP on its list of stocks most likely to outperform this year, while InterContinental Hotels, Marks & Spencer and BHP Billiton are expected to be laggards?
Keynes’ investment career from the early 1920s until his death in 1946 covered a period of even greater turmoil.
Still, the compound annual growth he achieved for the Kings College, Cambridge, endowment fund was more than 12 per cent over 20 years, compared to a loss of 15 per cent for UK equities as a whole. And he did that without reinvesting dividends, which were used to fund the college’s expenses. One investment principle Keynes learnt – through success as well as hard-won lessons – was to avoid following the herd.
“When you find anyone agreeing with you, change your mind,” he wrote in 1937. “When I can persuade the board of my insurance company to buy a share, that, I am learning from experience, is the right moment for selling it.”
Contrarianism is a hallmark of value investing and it is a drumbeat that Graham and Mr Buffett also have marched to.
“Most people get interested in stocks when everyone else is,” says Mr Buffett.
“The time to get interested is when no one else is. You can’t buy what is popular and do well.”
But that doesn’t mean simply buying when everyone else is selling.
Would you have invested in Venezuela’s stock market last year? The country is a well-known economic basket case whose inflation rate has risen from 75 per cent to 180 per cent in the past two years and whose currency, the bolívar, is officially at 10 to the US$ but costs at least 1,000 to the US$ on the black market.
If one had invested $1,000 in the Caracas stock exchange index at the start of 2015, that would be worth on the face of it around $4,000 now.
Yet, even a cursory scratch below the surface shows that, a) most of the money propelling Caracas shares is local, where people with means see stocks as a safer bet than banks or even sovereign debt and, b) any foreign investor would find it near impossible to pull money out because of foreign exchange controls.
Which leads to another of the Keynes/Graham/Buffett principles of value investing: buy into companies (or securities, more broadly) that you feel you understand well.
How well do you know New Zealand’s whole milk powder futures market? It also had a spectacular year, gaining close to 50 per cent in US dollar terms. Will rosy economic forecasts for New Zealand move it on again this year, or are milk exports to Asia the key?
Another of the principles is to avoid trying to time markets.
“Keynes came to appreciate the futility of market timing when he failed to profit from such tactics during the stock market crash of 1929,” David Chambers and Elroy Dimson wrote in the Financial Analysts Journal last year, when they closely examined how he managed the Kings College fund.
Keynes developed “a more careful buy-and-hold stock-picking approach in the early 1930s [that] allowed him – in contrast to the period immediately following 1929 – to maintain his commitment to equities when the market fell sharply once more in 1937-1938”, they write.
Another key plank of value investment is a subtle one: a balanced but concentrated portfolio. In other words, a small number of holdings that balance risk.
For Kings College, Keynes’ first move was to recognise that its almost exclusive investment in property (since it was first endowed in the 15th century) was an unrecognised risk as it couldn’t be sold quickly if needed and market prices were hard to track. Property can be an emotional investment, especially for individuals who have managed to get on the property ladder in the UK, where house prices in the past three decades have risen four-fold – or a healthy 5.7 per cent annually.
However, investment in a broad portfolio of UK equities with reinvested dividends rose by 1,433 per cent over the same period. Though the stock market has had a bumpy ride in recent years, it gained more than 14 per cent last year to close at an all-time high above 7,100.
The biggest gainers last year were BP and Royal Dutch Shell, both up more than 40 per cent on the year as oil prices recovered from their slump, with North Sea Brent crude futures up more than 50 per cent on the year.
Are commodities stocks a good buy? Well, JP Morgan thinks Anglo American, a big miner, should be a winner this year even though it was already up by 287 per cent last year, but not BHP Billiton, which was up by 71 per cent.
Keynes and his acolytes have often been quoted saying there is no substitute for deep research and picking investments you believe in long term. “Diversification is a protection against ignorance,” Mr Buffett has said.
But Mr Chambers and Mr Dimson also note that Keynes had a different view when it came to investors who lacked the know-how or resources.
“This is perhaps the most relevant piece of advice that Keynes had for those [investors] with limited time and resources,” they write.
“The alternative to an active investment approach is to focus on minimising management costs and to move toward a passive approach.”
Boring as it may seem, your property, low-cost share index tracker funds and some money market or bond exposure may be what Keyenes would put you in for 2017.
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Updated: December 31, 2016 04:00 AM