George Soros is one of the most successful hedge fund managers ever. While at the helm of the Quantum Fund (founded by Soros and Jim Rogers in the 70s), he generated an average annual return for investors of 30%.
Across this ten-part series, I’m taking a look at Soros’ life, trading career, and political involvements. In the first three parts of this series, which can be found at the links below, I covered the beginnings of Soros’ Quantum Fund, Soros’ trades against the Bank of Thailand and possibly Soros’ most famous trade against the British pound in 1992.
- George Soros Part One: Early Career
- George SorosPart Two: Breaking The Bank of Thailand
- George SorosPart Three: Breaking The Bank of England
- George SorosPart Four: The Yen And The Bear
- George Soros Part Five: Soros In Court
George Soros Part Six and Seven: Volatility and trading mentality
When reading about George Soros, it is very easy to conclude that he is either the undisputed champion of predicting the direction of financial markets or his significant influence in the world has been the driver of his returns over the years. There are many who believe Soros’ impressive trading performance over the years can be traced to the latter. But it is all too easy to make this assumption.
There are several periods in the Quantum Fund’s life where the trading decisions made by Soros and his team could have quite as easily bankrupted the fund and its investors as produced profits. Indeed, when Soros broke the Bank of England the Quantum Fund was risking more than $10 billion worth of losses if the trade didn’t play out as expected (although it should be said that Soros only decided to go all in when it looked as if the Bank of England would capitulate and the risk of losing was much reduced).
Unless you spend time digging through Soros literature to find information on the billionaire’s losing trades and near misses, it’s difficult to believe that Soros never actually made any mistakes in his career. But he did. In one week during 1987, the Quantum Fund lost a staggering $840 million, and it was Soros’ aggressive positioning and trading that exacerbated investor losses.
The George Soros roller coaster
The Quantum Fund’s troubles in 1987 are detailed in More Money Than God by Sebastian Mallaby. At the end of September 1997, a few weeks before the October crash — now known as Black Monday — the Quantum Fund was up by 60% year-to-date. Soros believed that the Japanese equity market was heading towards a cliff and at some point, during the next few months a stock market crisis would occur in Tokyo.
Soros positioned the Quantum Fund according to this view shorting Japanese equities, however, at the same time the fund was long the US market. The story goes that on October 14, the Financial Times published an article written by Soros which claimed that the crash would arrive in Tokyo, which set off a chain reaction.
In the days following the publication of the piece, US equities began to decline and finally on October 19 the market capitulated. The Dow Jones lost 22.6% of its value in one day. By being short Japan but long the US, Soros was hedged, so relative to the rest the market on Black Monday Soros did fairly well. In the days following troubles began to emerge for the Quantum Fund.
In the days after Black Monday, US equities rallied, and Soros’ strategy started to pay off but on Wednesday the Nikki followed suit jumping by as much as 9.3% in a single day, the index’s biggest one-day gain since 1949. In typical Soros style, the Quantum Fund had built a large oversized position against the Japanese market structured via futures in Hong Kong due to greater liquidity. Unfortunately, even though Soros had attempted to design his position in a way that would allow him to get in and out with as little friction as possible, the market’s 9.3% gain coupled with his intention to sell first Hong Kong’s regulators to halt futures trading. The Quantum Fund had been bitten by its own mistake.
To add insult to injury, after two days of gains on Thursday, October 22, US indexes declined and Soros tried to book gains. Once again the Quantum Fund’s mammoth futures position worked against it. Noting that there was a large seller in the market, traders across Wall Street intensified their selling of US futures. Once again the Quantum Fund was stuck. By the end of the week, the Quantum Fund was sitting on losses of 10%, not 10% on the week, 10% year-to-date. In five trading days, the fund had been gone from being up 60% on the year to being down by 10%, a loss of $840 million.
How did the world’s greatest hedge fund manager react to this loss? He kept trading. After unwinding the positions in US and Japanese equity futures, Soros concluded that the dollar was overvalued. In typical Soros style, the Quantum Fund placed a sizeable leveraged bet against the dollar only a few weeks after Black Monday. This time around the trade worked out and value of the dollar fell generating attractive but not overwhelming profits for the Quantum Fund and its investors. By the end of 1987 Soros had erased all of the Black Monday week losses and the fund was back in the black for the year. The Quantum Fund ended 1987 up 13%.
George Soros – Volatile trading
The events of 1987 are very revealing; not only do they show that Soros made costly mistakes, but they also show that George Soros is a very headstrong trader. 1987 could have been a disastrous year for the Quantum Fund, going from 60% up to 10% down in a single week is nothing short of gambling and would have prompted investors to seriously question Soros’ ability to look after their cash and achieve steady long-term returns without being wiped out overnight.
The Quantum fund’s volatile returns during 1987 were just a side-effect of the aggressive trading strategy Soros employed. I have covered briefly the trading strategy Soros used during his career already earlier in the series, but it’s hard to truly appreciate the strategy without understanding some key trading examples. The trades against the Bank of England, Bank of Thailand, Bank of Japan and the events of 1987, showcase Soros’ trading style from several different angles, but they all showcase the same trading mentality.
The main takeaway from all of these cases is that Soros cared more about the risk-reward profile than anything else. Stanley Druckenmiller, one of the Quantum Fund’s most celebrated money managers, has stated the most important thing he learnt from Soros over the years is, “it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong… It takes courage to be a pig. It takes courage to ride a profit with huge leverage. As far as George Soros is concerned, when you’re right on something, you can’t own enough.”
Maximising profits and minimising losses was just one element of the strategy. While managing the Quantum Fund, Soros was chiefly a trend follower. Even though the billionaire has expressed a liking to go against the herd, in the book Soros on Soros he writes that the trend is your friend most of the time, and “trend followers only get hurt at inflection points, where the trend changes.” Indeed, Soros has been known to buy into bubbles (he described gold as the “ultimate asset bubble” in early 2010 while buying the commodity and profiting as the price bubbled up to $1900) and against both of the Bank of England and Bank of Thailand Soros was following wider market sentiment, although he was more aggressive than most of his hedge fund peers chasing the same trade.
Writing for the Irish Times in 2014 Proinsias O’Mahony summed up the trend-following and emotion driven trading approach used by Soros perfectly:
“Soros does not believe in the idea of efficient markets driven by rational investors, instead arguing for the “twin pillars of fallibility and reflexivity”.
Markets can influence the events they anticipate, he says. One cannot truly separate market sentiment and economic fundamentals, as the former can actually shape and change the latter. Bullish sentiment may cause prices to rise, and rising prices in turn create a wealth effect, affecting consumer spending.
In a negative environment, the reverse applies. Investors’ views influence events, and events influence investors’ views.
There is, he says, a “two-way reflexive connection between perception and reality which can give rise to initially self-reinforcing but eventually self-defeating boom-bust processes, or bubbles”.”
But for all the praise there has been of Soros and his trading over the years, O’Mahony’s Times article gives another perspective on the billionaire’s trading, this time from his son, Robert:
“My father will sit down and give you theories to explain why he does this or that”, he once said, “but I remember seeing it as a kid and thinking, ‘Jesus Christ, at least half of this is bullshit’.
“I mean, you know [that] the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm and it’s this early warning sign.”
So, you can argue that Soros’ decisions are based on sound logic and skill but his trading is also influenced by instinct, something that in today’s world of high-frequency trading, quant funds and Ivy League analysts without any hands-on business experience is almost impossible to find.
This article was originally published in ValueWalk.
Photo: Wiki
