Key takeaways

● The Quantum Endowment Fund, established by George Soros, is one of the most renowned hedge funds globally.

● Soros once concluded that market prices would always be "wrong".

● He made enormous profits from his bets against the British pound, the Thai Bhat, and the Japanese yen.

George Soros is a legendary financier. He started with Quantum Endowment Fund (https://www.quantumamc.com/) with Jim Rogers, another well-known investor. The fund earned the reputation of "one of the most famous hedge funds in the world" by achieving a 35% annual return from 1969 to 1994. (In the book "Soros: The World's Most Influential Investor" by Robert Slater, the author mentioned from 1969-1994, the returns were 35% net of fees annually.)

Soros and his fund caused quite a stir in the financial world in the late 1990s by leading several major speculative attacks in different countries. His achievement manifested what "money never sleeps" actually means.

Strategies

George Soros's notions of how the market works, derived from years of hands-on experience, contradict the conventional school of thinking.

When most market analysts believed in the efficient market hypothesis, that is, investors behaved rationally by nature, and the market operated towards equilibrium, Soros held a different view. He argued that perfect knowledge and perfect competition were unattainable. It was imperfect understanding or bias that played a key role in shaping events, such as the cases of tulip mania or the South Sea bubble. Thus, the assumption that "financial markets were always right" was, to Soros's mind, apparently false. No wonder he once noted he was "fascinated by chaos. That's really how I make my money."

Case Studies

First, identify a growing bubble as the target.

Second, speculate on the forex market with hedges on the stock and futures market at the height of the bubble.

Third, take profits when the market goes against him.

Let's take a look at his three major currency attacks. (How Soros Broke the British Pound, Oct 16, 2018), (Here's how George Soros broke the Bank of Thailand, Sep 7, 2016), (Soros fund bets against the yen, makes $1 bln, Feb 14, 2013)

Broke the Bank of England

Soros earned an estimated $1 billion in a single day and himself the nickname "the man who broke the Bank of England" from his bet against the British pound. To understand how that happened, we'll need a bit of the context.

The British pound (GBP) joined the European Exchange Rate Mechanism (ERM) in 1990, where all currencies were pegged to the German Mark (DEM) in an attempt to make investments between Britain and Europe more stable and predictable. However, as the economic circumstances in Germany changed, the British government found itself struggling to combat a recession while keeping the exchange rate within the pre-determined range. Convinced that Britain had to let go of the ERM, leaving the pound to collapse, Soros amassed an enormous short position of $10 billion. On September 15, 1992, the pound began to plunge. Several hours later, the British government announced a 5% raise in the interest rate and started buying the pound using its foreign reserve. But the actions didn't work. After an emergency meeting, the country was forced to withdraw from the ERM. Soros and other speculators amassed handsome returns.

An Alleged Culprit of the Asian Financial Crisis

Soros was also blamed for causing the Asian Financial Crisis.

In the early 1990s, Southeast Asian countries were booming, especially Thailand, with average GDP growth of 9.1% during 1990-1995. To sustain the high-speed expansion, the Thai government liberalized its financial market further to fuel domestic lending. Soros sensed an opportunity. He believed the country's economy was overheating, and the baht, its currency, was overvalued. So he repeated his attack against the British pound: selling off the baht on the forex market. The Bank of Thailand reacted by purchasing the currency back with dollars, raising the interest rate, and restricting foreigners' access to the baht during the first few months. The counterattack worked. The speculators were fended off, but only for the time being.

Soros came back a month later with more ammunition. With other big traders, he attacked Thailand's stock, forex, futures, and derivatives markets. The Bank of Thailand was unable to cope this time. By October 24, 1997, the baht depreciated by 60% against the dollar. Soros made a reported $2 billion profit.

Bet Against the Japanese Yen

Japan slid deeper into recession in 2012 as the country was hit hard by the earthquake and tsunami of 2011. Yet the Japanese yen had remained strong since 2008, which Soros and many other hedge fund managers believed was overvalued.

At the end of 2012, Prime Minister Shinzo Abe released his economic stimulus strategy: substantially increasing the money supply and lowering the interest rate to even negative. Again, Soros found the weak spot. Similarly, he began shorting the yen using put options while longing for Japanese stocks with leverage. The yen weakened by approximately 17% during this period. This bet netted the financier an estimated $1 billion.

Not All Success Stories

In 1981, Soros was convinced that the US treasury yields were set to spike as the Fed tried to tame inflation. So, he went long on long-term bonds with huge leverage. However, the economy remained strong, and the interest rate continued to climb, driving up the cost of borrowing. Eventually, his fund lost hundreds of millions of dollars in total.

The great market crash in October 1987 also cost Soros dearly as he held long positions on American stocks. The net asset value of his Quantum Endowment fell by 26% and registered a $650 to 800 million loss.

His speculative attack on Hong Kong in 1998 ended up in failure, too. The Hong Kong SAR government defended its currency attacked by speculators with a close to HK$120 billion war chest, stabilizing both the forex and the stock markets. It was reported that Soros lost around $1 billion in this attack.

Soros Quotes

1. The worse a situation becomes, the less it takes to turn it around, the bigger the upside.

2. Stock market bubbles don't grow out of thin air. They have a solid basis in reality, but reality is distorted by a misconception.

3. The financial markets generally are unpredictable. So, one has to have different scenarios.

4. Markets are constantly in a state of uncertainty and flux, and money is made by discounting the obvious and betting on the unexpected.

5. A lot of the evil in the world is actually not intentional. A lot of people in the financial system did a lot of damage without intending to.

6. The reality is that financial markets are self-destabilizing; occasionally, they tend toward disequilibrium, not equilibrium.

7. I put forward a pretty general theory that financial markets are intrinsically unstable. That we really have a false picture when we think about markets tending towards equilibrium.

8. Market fundamentalists recognize that the role of the state in the economy is always disruptive, inefficient, and generally has negative connotations. This leads them to believe that the market mechanism can take care of all the problems.

9. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes.

10. I think there's a lot of merit in an international economy and global markets, but they're not sufficient because markets don't look after social needs.

All the above quotes come from the website: https://www.brainyquote.com/authors/george-soros-quotes

The Bottom Line

Into the 21st century, George Soros and his Quantum Endowment gradually stepped away from the spotlight, mainly doing less lucrative arbitrage of lower risks. But Soros and his investment philosophy have a lingering effect on the capital market. To some extent, he showed the world that speculation is not the equivalent of evil. Instead, "success is where opportunity and preparation meet."

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Any illustrations, scenarios, or specific securities referenced herein are strictly for illustrative purposes. Past investment performance does not guarantee future results. Investing involves risk and the potential to lose principal.

Short selling is the process of selling borrowed stock at the current price and then closing the trade by purchasing the stock at a future time. What this essentially means is that, if the price drops between the time you enter the trade and when you deliver the stock, you turn a profit minus any fees or expenses.

When short selling there is no limit on how high a stock price could rise so the potential loss is unlimited. Other risks include dividend risk and margin risk, this strategy is not appropriate for all investors.