Even the famed economist and investor John Maynard Keynes struggled to beat the market, a new study has revealed – a reminder we mere mortals probably shouldn’t try.
Professor Robert Durand, an economist at Curtin University, said the study’s findings were proof that even “one of the greatest economists of our time” wasn’t much better than random chance at picking stocks.
“When you read the paper, it turns out that Keynes only beat the market in half the years he invested. So if you were the trustees of that fund, when would you invest in Keynes? It’s the toss of a coin.”
Keynes (pronounced ‘Canes’) looms large in economic history. As a British Treasury official, he predicted that imposing vindictive reparations on Germany after World War I would have disastrous consequences.
As a pre-World War II economist, he challenged neoclassical economics by arguing that government intervention was needed to moderate downturns – which shaped modern fiscal and monetary policy.
And after the Allied victory, he was instrumental in creating the post-war global economy, including the World Bank, the International Monetary Fund, and the Bretton-Woods system of fixed currency exchange rates.
In between all of this, he served as bursar of King’s College at Cambridge, where he was responsible for investing the equivalent of millions of dollars.
Two academics at Cambridge recently trawled through the meticulous records left behind by Keynes, and published their findings in the Business History Review journal.
One of their conclusions was that Keynes acted counter-intuitively after the market crash of 1929. When investors were fleeing the US stock market, he jumped in, snatching up undervalued companies – mainly investment trusts, public utilities and industrials.
“In the 1930s, Keynes had become the ‘long-term investor’ carefully sifting through the fundamentals and attempting to withstand the irrational behaviour of the herd,” the authors wrote.
This was used by the Wall Street Journal as proof of Keynes’ investing wisdom. And indeed, the tactic reaped him strong returns. Between 1930 and 1945, his average return on these US stocks was 13.6 per cent – above the average US stock market return of 8.4 per cent.
This is perhaps a powerful reminder that when it comes to the stock market, it pays to not trust your instincts.
Economics tells us we are susceptible to following the herd (jumping out or piling in when everyone else is), pay too much attention to short-term fluctuations, and are too loss averse, which clouds our judgement.
Keynes also invested for the long term. He did not buy and sell his US shares frequently. Recent economic theory tells us this is smart, as the attrition of fees from frequent trading erodes returns.
A finance professor at the University of Tasmania said Keynes’ strategy is a “great reminder” for Australians to take a long-term view of their investments, especially superannuation.
“It is a great problem that people start to worry about week-to-week fluctuations when they are not day traders,” Professor Mardi Dungey said.
“If you’re not a day trader, why are you worrying about that? You’ve got to set a long-term strategy.”
But according to the Cambridge study, Keynes’ US stocks outperformed the US stock market in only eight of the 16 years he ran the King’s College portfolio.
Curtin University’s Prof Durand said this was proof the average investor, with nowhere near the knowledge and experience of Keynes, should probably consider a passive investment strategy instead.
“You could invest in one of the greatest economists of our time, or toss a coin. You’d be as equally as well off as a passive strategy,” the professor said.
“It brings up the question of active versus passive investing and market timing and clearly if you’re using the coin toss criterion, Keynes ain’t doing a lot of good.”
Keynes was a value investor. He spent his time researching company fundamentals to find undervalued share prices. He even made several trips to the US to interview politicians, bankers and industry leaders to find out more about potential investments.
This is probably what most Australians picture when they think about the stock market. Unfortunately, it’s very hard to do.
New research tells us it’s much easier to simply ‘passively invest‘ in a well-diversified fund that matches the market. Prof Durand recommended this strategy.
“It turns out that finance theory tells us that passive investing is quite good for a number of reasons, and a lot of guys have won the Nobel prize for that.”