George Soros — Global Speculator from John Train’s The Money Masters
Also see Seth Klarman On The Essence of Speculation
George Soros probably has the top long-term record in percentage terms of any manager of a publicly held portfolio investment pool: about 34 percent per annum compounded for some nineteen years. Like Steinhardt [the hedge fund manager Michael Steinhardt], he makes heavy use of borrowed-money leverage; so his results are not comparable to those of a conventional fund manager. Ten thousand dollars invested in his fund when it began in 1969 was worth over $2.8 million in 1988. The Quantum Fund, his Curaçao-based vehicle, is now some $2 billion.
THE TRADER
Soros’s book The Alchemy of Finance (New York: Simon & Schuster, 1987) describes his transactions from August 18, 1985, to November 7, 1986.
As we will see as we go along, Soros likes exotic terms for things: He calls this trading period “The Real Time Experiment.” The diary covers one of Soros’s most successful periods, during which his fund’s net asset value per share doubled.
The trading diary starts in August 1985. It will be recalled that the Reagan election of 1984, followed by tax cuts and a defense buildup, had set off a boom in both the dollar and the stock market. Foreign investors
liked what they saw, an America resolved to stand firm against Soviet pres-sure, and an expanding economy that welcomed foreign participation.
The influx of foreign money during the early Reagan period lifted both the dollar and the capital markets, and helped fuel a round of economic expansion that attracted even more money, putting the dollar up further.
THE START
This, then, is the background when Soros’s trading diary opens on August 18, 1985. The fund is worth $647 million. Some readers will re-member that at this period investors were worried that a rise in the money supply meant a boom, with higher interest rates, and subsequent bust; the economy was feared to be in eventually for a “hard landing.” Cyclical stocks, beneficiaries of the boom, were strong, and stocks whose fortunes depended on low interest rates were weak.
In his diary Soros declares that he doubts this conventional wisdom in toto. He expects the dollar to weaken and interest rates to rise, pro-voking a recession. So instead of buying cyclical stocks that would bene-fit from a continued boom, he buys takeover candidates, together with shares of property-insurance companies, then enjoying one of their best years on record. As to currencies, Soros is playing the thesis of a weaker dollar by buying D-Marks and yen. In addition he thinks OPEC is break-ing up, and so goes short oil.
Three weeks later, on September 6, 1985, nothing has worked. The mark and yen have both declined, and since Soros had been long some $700 million in those two currencies, more than the value of the whole fund, he has lost money. By September 6 he has built up his D-Mark and yen positions to just under $800 million, almost $200 million more than the value of the fund.
BETTING ON THE YEN
Now comes the so-called Plaza meeting of a group of five finance min-isters with their central bankers, called on a Sunday by the U.S. Treasury. That night, Sunday in New York but already Monday morning in Hong Kong, Soros plunges in and buys yen heavily. The yen rises strongly, and Soros makes 10 percent on his yen position, which he has built up to $458 million.
In his September 28 entry Soros describes the Plaza accord coup as
“the killing of a lifetime . . . the profits of the last week more than made up for the accumulated losses on currency trading in the last four years . . .” Four years is a long time to be under water! This statement certainly illustrates the difficulties of currency trading.
By September 27 D-Marks have risen from 2.92 to the dollar to 2.68, or 9 percent, and the yen from 242 to 217, or 11.5 percent. The combi-nation of profits and increasing the bet have pushed the combined hold-ings in these two currencies from $791 million up to $1 billion by September 27, but because of adverse movements in the stock market and oils the whole fund has advanced only (if that’s the word) 7.6 percent a share. In other words, the 8–10 percent currency profit has been diluted by other holdings.
The stock market has declined, which Soros regards as reinforcing his bear position on the dollar: A poor stock market will discourage both con-sumer and business outlays. Also, a decline in the value of stocks reduces their value as collateral, a further depressant.
PYRAMIDING AGAINST THE DOLLAR
By the first week in November 1985, Soros has reached the peak of his speculation against the dollar: D-Mark and yen positions total $1.46 billion, almost double the value of the fund. This means increasing his commitment to a trend as the trend continues . . . also known as pyra-miding. Pyramiding is a good way to sustain serious damage in margin speculation, since when the trend reverses, even temporarily, you risk being caught overexposed.
“The reason I am nevertheless willing to increase my exposure is that I believe the scope for a reversal has diminished. One of the generaliza-tions I established about freely floating exchange rates is that short-term volatility is greatest at turning points and diminishes as a trend becomes es-tablished” — an important hint for the currency speculator.
Full chapter and more here John Train’s The Money Masters
