Did you know that a $1,000 investment with George Soros in 1969, would have
been worth about $4 million by the year 2000? For more than three decades, this
maverick hedge fund manager generated 30.5% average annual returns, after
management fees. His flagship Quantum Fund is revered by investors. Despite the
animosity generated by his trading tactics and the controversy surrounding his
investment philosophy, George Soros spent decades at the head of the class
among the world's elite investors. In 1981, Institutional Investor
magazine named him "the world's greatest money manager."
Soros' Philosophy
George Soros is a short-term
speculator. He makes massive, highly-leveraged bets on the direction of the
financial markets. His famous hedge fund is known for its global macro strategy,
a philosophy centered around making massive, one-way bets on the movements of
currency rates, commodity prices, stocks, bonds, derivatives and other assets
based on macroeconomic analysis.
Simply put, Soros bets that the value of these investments will either rise or
fall. This is "seat of the pants" trading, based on research and
executed on instinct. Soros studies his targets, letting the movements of the
various financial markets and their participants dictate his trades. He refers
to the philosophy behind his trading strategy as reflexivity. The theory eschews traditional ideas of
an equilibrium-based market environment where all information is known to all
market participants and thereby factored into prices. Instead, Soros
believes that market participants themselves directly influence market
fundamentals, and that their irrational behavior leads to booms and busts that
present investment opportunities.
Housing prices provide an interesting example of his theory in action. When
lenders make it easy to get loans,
more people borrow money. With money in hand, these people buy homes, which
results in a rise in demand for homes. Rising demand results in rising prices.
Higher prices encourage lenders to lend more money. More money in the hands of
borrowers results in rising demand for homes, and an upward spiraling cycle
that results in housing prices that have been bid up way past where economic
fundamentals would suggest is reasonable. The actions of the lenders and
buyers have had a direct influence on the price of the commodity.
An investment based on the idea that the housing market will crash would
reflect a classic Soros bet. Short-selling
the shares of luxury home builders or shorting the shares of major
housing lenders would be two potential investments seeking to profit when the
housing boom goes bust.
Major Trades
George Soros will always be
remembered as "the man who broke the Bank of England." A well-known
currency speculator, Soros does not limit his efforts to a particular
geographic area, instead considering the entire world when seeking opportunities.
In September of 1992, he borrowed billions of dollars worth of British pounds
and converted them to German marks.
When the pound crashed, Soros repaid
his lenders based on the new, lower value of the pound, pocketing in excess of
$1 billion in the difference between the value of the pound and the value of
the mark during a single day's trading. He made nearly $2 billion in total
after unwinding his position.
He made a similar move with Asian currencies during the 1997 Asian Financial Crisis, participating in
a speculative frenzy that resulted in the collapse of the baht (Thailand's
currency). These trades were so effective because the national currencies the
speculators bet against were pegged to other currencies, meaning that
agreements were in place to "prop up" the currencies in order to make
sure that they traded in a specific ratio against the currency to which they
were pegged.
When the speculators placed their bets, the currency issuers were forced to
attempt to maintain the ratios by buying their currencies on the open market.
When the governments ran out of money and were forced to abandon that effort,
the currency values plummeted.
Governments lived in fear that Soros would take an interest in their
currencies. When he did, other speculators joined the fray in what's been
described as a pack of wolves descending on a herd of elk. The massive amounts
of money the speculators could borrow and leverage made it impossible for the
governments to withstand the assault.
Despite his masterful successes, not every bet George Soros made worked in his
favor. In 1987, he predicted that the U.S. markets would continue to rise. His
fund lost $300 million during the crash, although it still delivered low
double-digit returns for the year.
He also took a $2 billion hit during the Russian debt crisis in 1998 and lost
$700 million in 1999 during the tech bubble when he bet on a decline. Stung by
the loss, he bought big in anticipation of a rise. He lost nearly $3 billion
when the market finally crashed.
Conclusion
Trading like George Soros is not for the faint of heart or the light of
wallet. The downside of betting big and winning big is betting big and losing
big. If you can't afford to take the loss, you can't afford to bet like Soros.
While most global macro hedge fund traders are relatively quiet types, avoiding
the spotlight while they earn their fortunes, Soros has taken very public
stances on a host of economic and political issues.
His public stance and spectacular success put Soros largely in a class by
himself. Over the course of more than three decades, he made the right moves
nearly every time, generating legions of fans among traders and investors, and
legions of detractors among those on the losing end of his speculative activities.
