No one is a Keynesian now—at least not among money managers.
And that is a shame.
A new analysis of the investment performance of John Maynard Keynes proves that the famous economist also was one of the greatest investors of the past century. By understanding what made Keynes such a star, investors can get a firmer grasp on why so many of today's money managers seem so dim.
Regardless of how you feel about his theories on the need for governmental intervention in the economy, Keynes (1883–1946) long has had a reputation as an outstanding investor. Until now, however, no one had ever gone to the trouble of reconstructing his investment track record.
David Chambers and Elroy Dimson, finance scholars at the University of Cambridge and the London Business School, respectively, have spent much of the past few years picking apart Keynes's portfolios.
They have found out that Keynes's returns were extraordinary. How he achieved them was even more remarkable. (To read the research paper, click here.)
From 1924 through 1946, while writing numerous books and overhauling the global monetary system, Keynes also found time to run the endowment fund of King's College at Cambridge.
Over that period, according to Messrs. Chambers and Dimson, Keynes outperformed the U.K. stock market by an average of eight percentage points annually, adjusted for risk.
Such great investors as Benjamin Graham, Peter Lynch, John Templeton and Warren Buffett beat the market by an annual average of three to 13 percentage points over their careers. Most of them, however, didn't have to cope with the Great Depression or World War II.
How did Keynes do it?
Flexibility, resilience and independence.
Keynes began as what we would today call a "macro" manager, relying on monetary and economic signals to rotate in and out of stocks, bonds and cash. He traded foreign currencies and commodities. As a director of the Bank of England, Keynes was privy to inside information about interest-rate changes, although there isn't evidence that he traded on it.
But Keynes wasn't a very good macro manager. He lagged behind the British stock market miserably until 1928, and he had 83% of his primary portfolio in stocks going into the fall of 1929.
"It's hard to time the markets," Mr. Chambers says. "Keynes struggled with it, and then he missed the 1929 crash—even with an unrivaled network of information sources."
So Keynes made a series of radical changes: He switched from being a "top down" asset allocator to a "bottom up" stock picker. He tilted sharply toward undervalued small and midsize companies.
Keynes also made titanic bets on industries he thought were cheap; by 1936, he had 66% of his portfolio in mining stocks and not a farthing in bank or energy shares. South African gold companies, he correctly foresaw, would benefit from falling currency values.
Keynes wasn't only a pioneer in owning stocks when most big investors favored bonds. He also relished risk, concentrating as much as half of his assets on his favorite five holdings or, as he called them, his "pets." Keynes clung to his typical stock for more than five years at a time. Only partly in jest, he had proposed making "the purchase of an investment permanent and indissoluble, like marriage." (Today, the average U.S. stock fund has only 19% in its five biggest positions and hangs on to its typical stock for just 15 months.)
The "tracking error" of Keynes's portfolio—the extent to which it behaved differently from the market as a whole—ran nearly four times higher than is typical at institutional funds today, report Messrs. Chambers and Dimson.
Keynes was no mere contrarian. He was the epitome of his own definition of a long-term investor: "eccentric, unconventional and rash in the eyes of average opinion." To emulate Keynes, "you have to be idiosyncratic," Mr. Chambers says. "That's easy to say but much harder to execute."
One of Keynes's biggest advantages, say Messrs. Chambers and Dimson, was that the board of King's College gave him uncontested authority to invest as he wished.
Today, such latitude can be found only in smaller investment boutiques—Fairholme, FPA, Longleaf and Yacktman, to give a few examples—that operate independently and don't kowtow to their clients. That latitude, of course, comes at the risk of horrific returns in the short run and the chance that the best talent might bolt.
At most larger investment firms, meanwhile, portfolio managers must invest in narrow "style boxes" and sheepishly shadow the performance of their peers. The prime directive at today's weak-kneed asset-management companies is to ensure that their portfolios never deviate much from average results. That discourages clients from fleeing and enables firms to keep earning fat fees—maximizing their own returns while minimizing those of the clients.
Even more than in Keynes's day, it is worth hiring an active money manager only if you have the confidence that he or she is a free spirit who will have a completely free hand.
Otherwise, with Keynes no longer available, you might as well buy an index fund.— firstname.lastname@example.org; twitter.com/jasonzweigwsj