John Maynard Keynes became the acting Chairman of National Mutual Life Assurance Society in 1921 until his resignation in 1938. Each year, an annual meeting was held in London, where Keynes spoke at length about National Mutual, among other topics.
The time period makes it unique. Britain was recovering from World War I. Markets in Britain and the U.S. were changing. Then the ’29 Crash and Great Depression hit. Of course, we all know how that turned out.
But Keynes didn’t. His speeches offer not only his annual assessment of the events but his thoughts on National Mutual’s investment policy in the midst of it all.
Luckily, The Times of London printed his speeches in full after each annual meeting.
In the very first speech, Keynes lays out the difficulties of investing in an environment with a growing list of new investment “opportunities” and the importance of having an investment policy.
The test of success in an active investment policy is to be found in an ability to avoid losses when security values are falling, whilst, nevertheless, obtaining profits when they are rising. Anyone can make profits on gilt-edged investments when gilt-edged investments are all going up…
But investment, on the other hand, provides both more pitfalls and also more opportunities than formerly. The wide fluctuations even in securities fo the highest class, which have occurred in recent years, are likely to continue in the near future; while the range and choice of investments now available afford opportunities for an active policy which did not exist previously.
The requirements of Government and municipal finance have now led to the creation of stocks of the greatest possible variety and of all maturities, from perpetual stocks to short-dated bonds. The new problems of investment thus presented are, in the opinion of your board, the most difficult and the most important with which the insurance world is now faced. They believe that the gradual building up of a sound investment policy is the most vital part of their duties.
Under Keynes, National Mutual held a much larger portion (roughly 5x larger) of its funds in stocks than the average life assurance company. That resulted in a nice return — “more than 7 percent, free of income-tax, on the average of the last seven years.”
In his 1928 speech, he lays out the investment policy – built on capital preservation — and makes the argument for holding a large portion of stocks.
An investment policy which has shown these profits can fairly claim to have passed the test of results.
On several previous occasions I have had something to say about the principles underlying this policy. Speaking very broadly, it has consisted in constant care and activity — a line of action which was the object of much more criticism when we began than it is now. We have acted in agreement with the following quotation from the annual report of the Carnegie Corporation:
“The funds of a great endowment can be kept only by a systematic revision month by month of all the securities of the endowment and by a continuous process of sale and exchange as circumstances may affect the financial soundness of this of that security.”
In particular, we have been pioneers amongst the life offices in the practice of employing a substantial part of our funds in the purchase of Ordinary shares.
The arguments in favour of holding a certain proportion of Ordinary shares are, from the point of view of the individual office, broadly two — one of them of a permanent character, the other possibly temporary. The permanent reason is to be found in the advantage of spreading the fund between assets such as bonds, expressed in terms of money value, and assets representing real values. Formerly, this result could be secured by means of investment in real estate; and until recently, it was not practicable to invest in real values on a large scale in any other way. To-day, however, the position is quite different. On the one hand, real estate as an investment is subject to serious drawbacks, and few insurance offices would wish to invest heavily at the present time either in agriculture land or in urban house property. On the other hand, the public joint stock company has taken a tremendous leap forward and now offers a field for the investment of funds which simply did not exist even 20 years ago.
Now, when we speak of the new policy of investing a certain proportion of an insurance fund in Ordinary shares, we have primarily in view — without any intention of excluding investments in railways and public utilities — these (in round figures) 250 companies with a total Ordinary share market capitalization of about £1,500,000,000. These represent the live large-scale business and investment world of to-day, and any investment institution which ignores or is not equipped for handling their shares is living in a backwater.
In addition to the above, there are about 70 railway and other public utility companies — many of them with a much longer investment history behind them — which have on the same tests a market capitalization of about £392,000,000, or an average of more than £5,000,000. Finally, there are the Ordinary shares of companies overseas, particularly in the United States.
In short, the centre of gravity of business, and therefore of investment, is not where it was. A “conservative” investment policy is apt to mean in practice backing the enterprises which were in the the van 30 years ago, instead of backing the new ones which are the characteristic achievement of the best business brains of to-day.
The second reason for investing in Ordinary shares is the fact that they are undoubtedly under-valued relatively to bonds after making all due allowances for risk and other relevant considerations. The fact that most well-managed and progressive concerns divide substantially less than they make introduces a cumulative, compound interest element which is often overlooked. Calculations made by Mr. E. L. Smith in America and Mr. Raynes here, confirmed by common experience, fully bear this out. For example, the results published during 1926 of 1,572 companies and analyzed in the Economist show that in the aggregate the allocations to reserves equalled 2.02 per cent of the Ordinary share market capitalization. Whether this under-valuation will still remain by the time that all our friends and colleagues in the insurance business have followed our example (i.e. have invested some 20 per cent of their total funds in this way), I am more doubtful.
Not to keep it onesided, Keynes lays out the argument against too.
What are the arguments on the other side? For there are undoubtedly important objections. To judge from our own experience, they are mainly two. In the first place, the knowledge required and the care and attention which must be given are much greater, with the result that the burden of work and responsibility which is thrown on the board and on the executive is increased. It means that the directors have serious duties to perform, and in cases where the directors have not performed serious duties for many years, and perhaps between 70 and 90 years of age, there must always be a doubt whether it is wise to put new duties on them. Moreover, however much care and attention is given, it is extraordinarily difficult to acquire enough information to justify a substantial investment. The next great step forward in the evolution of joint stock enterprise of widely diffused ownership will follow, I think, from a revised company law which will insist on much greater publicity of accounts and will strengthen the hands of the auditors.
The second objection is to be found in the relative narrowness of the market — in spite of the fairly large total capitalization — except in a few cases. Out of some 250 commercial, industrial, and produce companies, you will have your work cut out to discover 50 which are prima facie attractive and about which you can acquire adequate information. The National Mutual, although our total fund now exceeds £5,000,000, is one of the smaller units amongst insurance offices. With a larger fund the dilemma would soon be reached between having to invest an amount in given companies which is rather too large for the market and having to go outside the range of the detailed information at the disposal of the office. We have sometimes tried to overcome this difficulty by deciding to back an industry rather than a particular business, dividing our investment between all the leading firms in the business, even though we might not know much about them individually. We have had considerable success along these lines. But the difficulty still remains.
1922 and 1928 National Mutual Life Assurance Society Meeting Speech – The Times
John Maynard Keynes on Human Nature and Markets
E. L. Smith: Birth of Stocks for the Long Run