Keynes, King’s and Endowment Asset Management


David Chambers


University of Cambridge – Judge Business School, Department of Finance & Accounting

 

Elroy Dimson


London Business School; University of Cambridge – Judge Business School

 

Justin Foo


University of Cambridge – Judge Business School

August 19, 2014
Abstract:

Founded in 1441, King’s College was one of Cambridge University’s wealthiest Colleges, endowed with a vast agricultural portfolio. John Maynard Keynes was appointed bursar just after WWI and initiated a major reallocation to equities, an innovation at least as radical as the late 20th century commitment to illiquid assets by Harvard and Yale. Keynes initially pursued a market-timing approach to investment with mixed success and failed to anticipate the 1929 market crash. Thereafter, his switch to a patient buy-and-hold strategy allowed him to maintain his commitment to equities in the subsequent market slump, reflecting the natural advantages that accrue to long horizon investors. Keynes’ innovations in endowment asset management, implemented over a dynamic period of capital market development and economic turbulence remain of great relevance to modern investors emerging from the Great Recession.

Introduction

John Maynard Keynes’ experiences managing his Cambridge College endowment illustrate several lessons still relevant to endowments and foundations today. Keynes himself, when looking back over his investment career in the late 1930s, spoke of the need to understand the illiquidity risk attaching to an alternative asset such as real estate and of the benefits to recognizing the extent of an organization’s investment skills and resources in tailoring investment policy.

Most pertinent to the subject of this volume, Keynes’ investment experiences during the Great Depression of the 1930s are relevant to modern-day investors during the Great Recession. He had to discover for himself the difficulty of making profits from market timing when the stock market crashed in 1929. Thereafter, hisself-proclaimed switch to a more careful buy-and-hold stock-picking approach in the early 1930s allowed him to maintain his commitment to equities when the market fell sharply once more in 1937-38. In so doing, he provides an excellent example of the natural advantages that accrue to such long-horizon investors as university endowments in being able to behave in a contrarian manner during economic and financial market downturns.

King’s, one of the thirty-one Cambridge Colleges, was founded in 1441 by King Henry VI and lavishly endowed with agricultural real estate which stretched the length and breadth of England. Famous Kingsmen other than John Maynard Keynes include Sir Francis Walsingham, secretary of state and organiser of Queen Elizabeth I’s spy service; Sir Robert Walpole, prime minister, Alan Turing, the father of modern computing; and the novelists E. M. Forster and Salman Rushdie.

For centuries, their agricultural estates formed the bulk of the endowment assets of the oldest Colleges and King’s was no exception. When Keynes became involved in the management of King’s endowment just after World War I, he immediately undertook a substantial reallocation of the portfolio away from real estate into the new asset class, equities. At the time, other institutional investors remained reluctant to follow suit and it was not until after Keynes’ death that they began to follow his example. Oxford and Cambridge (“Oxbridge”) Colleges have a natural concern for preserving their wealth for future generations (Tobin, 1974) and are the ultimate long-horizon investors. Keynes spotted an opportunity for such patient, long-term investors in making a substantial allocation to equities, an innovation at least as radical as the commitment to alternative assets in the late twentieth century by Yale and Harvard. He selected an asset mix for King’s consistent with the implications of standard models of consumption and portfolio choice that were to appear many decades later, as described, for example, by Campbell and Viceira

(2002). Keynes can justly be regarded as among the first institutional equity investors.

This paper describes why Keynes held strong views about equities and how he changed his investment approach to the benefit of lower transaction costs. We also highlight how King’s benefitted from earning an emerging risk premium on UK equities despite the economic turbulence of the 1930s as well as from additional risk premia obtained through tilting the portfolio toward both value and smaller- capitalization stocks.

His investment strategy benefitted the endowment considerably to the extent that upon his death King’s had at least drawn level with Trinity, the richest of the Cambridge Colleges. In the post-Keynes era, the endowment has had a more

chequered history, illustrating the challenges in trying to emulate Keynes’ unconventional investment approach.

The paper begins with a summary of Keynes’ various investing roles in Section 2. Section 3 describes our data, followed by a discussion of endowment asset management before Keynes in Section 4. We then review Keynes’ management of the endowment in Section 5 and how investment policy evolved after

Keynes in section 6. Finally, we discuss Keynes’ legacy in Section 7 and Section 8 concludes.

2.Keynes’ Investing Life

While still a Cambridge student, Keynes had written in 1905 to his friend,

Lytton Strachey, saying that:

I want to manage a railway or organise a Trust, or at least swindle the investing public; it is so easy and fascinating to master the principles of these things” (Moggridge, 1992: 95).

Here was a young man supremely confident in his abilities. It was therefore no surprise that he remained extremely active throughout his life investing in stocks,

bonds, currencies and commodities1. He was, in effect, similar to a modern global macro hedge fund manager.

Just after World War I, Keynes began trading currencies both for himself and on behalf of the Syndicate, an investment pool he formed with the City financier

Oswald Toynbee (O.T.) Falk, whom he had met at the British Treasury. Keynes was one of the first traders to exploit the development of the forward currency markets and pursued a fundamentals based trading strategy (Accominotti and Chambers,

2014).

Keynes also traded, largely on his own account, a wide variety of commodities – cotton (Cristiano and Naldi, 2012), tin (Cavalli and Cristiano, 2012) and wheat

(Fantacci, Marcuzzo, and Sanfilippo, 2010; Foresti and Sanfilippo, 2012). Overall, his record trading in commodities was rather mixed and marked by periods of large gains and losses.

In addition to his considerable personal investment activity, Keynes was involved with a number of investment institutions. He was appointed Director of the

National Mutual Life Insurance Company, one of the City’s oldest institutions, in

1919, becoming its Chairman in 1921. Following persistent disagreements over investment policy, he resigned in 1938. Keynes’ experience at a smaller family-runinsurer, the Provincial Insurance Company, was altogether more fruitful. As a

Director from 1923 until his death in 1946, Keynes successfully persuaded Francis Scott, the managing director, of the advantages of investing in equities and frequently recommended shares that were also held in his personal account (Moggridge, 1983, p.51).

Three other funds, the A.D. Investment Trust, the P.R. Finance Company and the Independent Investment Company, were co-founded with O.T. Falk in the early 1920s. The latter two had chequered

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