George Soros: Master Money Man

Soros was born in Hungary in 1930 and immigrated to England with his family in 1944 to escape the Nazis. After graduating from the London School of Economics and briefly working for a British investment bank, he immigrated to the United States and began his career as a money manager.

MONEY MANAGEMENT

Soros' eponymous company runs a hedge fund that some market participants believe is the world's largest, runs several more conservative funds, and invests in stocks, bonds, currencies, and real estate. Soros himself is most famous for his highly leveraged speculations in the foreign exchange markets. Most notably, he made more than $1 billion in a single day in 1992 by selling short the British pound on the eve of a devaluation of the currency. Soros correctly predicted that the British government would not take the actions needed to maintain exchange rates. He was confident that the politicians lacked the ability to pay the huge political costs that would result. On September 17, 1992, a day that became known as "Black Wednesday" and made Soros famous, the authorities devalued the currency because the only alternative was to dramatically raise interest rates and cut back on government spending. After the fact, his bold move was dubbed "the one-way bet" by the British and US media because in retrospect it seemed obvious that Soros was correct, but at the time few had the insight or courage to bet against the British pound.

CURRENCIES

Soros is most famous as a currency trader but has also been active as a stock market investor, typically allocating about 60% of his investment company's funds to equities. His record in the 1970s and into the 1990s was so impressive, with an average annual return of 31% for his flagship Quantum Fund, that the news that he had purchased a stock would cause its price to skyrocket, much as news of an investment by Warren Buffett does today.

Because many institutional investors watched for his actions to mimic them, Soros has always been secretive about his trades, but the broad themes that underlie his investment approach can be determined from his numerous public statements. Like so many other great investors, from Bernard Baruch to Peter Lynch, Soros repeatedly stated that financial markets are frequently irrational; stock prices are unstable and most often do not reflect fundamental values. Therefore, to profit, he purportedly reasoned, investors must buck the conventional wisdom.

CYCLES

Soros has referred to a "reality gap." He noted that stocks go through boom-and-bust cycles that are caused by the perceptions of investors. At the beginning of a favorable trend, investors' perceptions and reality are close, but as the trend becomes more obvious, optimism causes a gap to develop between reality and perceptions. This gap will cause the stock to become significantly overvalued. But then there will be a "moment of truth" when investors recognize the gap. The stock price will thereafter move downward until the cycle begins again.

The idea of a "reality gap" cycle is an old one; it was embraced by Charles Dow a hundred years ago and remains as a cornerstone of Dow theory. Similar ideas have been voiced by Warren Buffett as well as others.

Soros focuses on the big picture rather than on the details of a particular company. He is alert for broad social, economic, and political trends. Perhaps because of his personal experiences of European political instability in the 1930s and 1940s, he has always searched for societal factors or trends that could move the markets dramatically in the near future.

He stated that when you have identified a sector that will benefit from a trend, invest in only two companies: the best performer and the worst. Soros asserted that "the worst quite clearly offers the biggest possible turnaround. A change in industry fortunes will have the biggest impact there because the worst-off is likely to be most leveraged. At the other end, the best will obviously benefit because it is a market leader."

Investing in a company that can be said to be "the worst" seems counterintuitive, and is contrary to the approaches of Benjamin Graham and Warren Buffett, among others, who believe in investing only in the best companies. But like Graham and Buffett, Soros said that he would only invest in companies with management that is responsive to the interests of shareholders. The company management should believe its prime purpose is to enhance the value of shareholders' investments.

SOROS TODAY

Over the last few years, the returns of Soros' investment vehicles have been lackluster. Some market observers attribute this to greater efficiency in the currency markets, which they argue have negated some of Soros' favorite currency-trading strategies. Others point out that since the late 1990s, Soros has left stockpicking to less nimble lieutenants, including his son Robert.

Today, Soros devotes most of his time to various philanthropies. He has created organizations intended to encourage democracy in eastern Europe, and he is an active backer of programs questioning the virtues of globalization and fighting for the legalization of drugs. Soros' success was in many ways unexpected, as are his views against globalization and for drug legalization. But his financial triumphs fit a pattern followed by many, if not all, great investors. He diligently studied the financial markets, developed clear ideas to guide him, and had the courage and independence to stick to them even when he was bucking widely held dogmas.

James Maccaro is an attorney and freelance writer. He has written articles for Newsday, Ideas on Liberty, The Massachusetts Law Review, and other periodicals.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.