Quotes from Soros on Soros

I am reading the book Soros on Soros (Wiley, New York 1995). As you can already guess from the title, it is about George Soros talking about himself, his history, his investment philosophy, etc. I think it's a great book, everyone interested in speculating and finance should read it.

Here are some brilliant quotes I discovered as I read it.

p.6 -

In the last twenty years, there has been a lot of progress made in measuring risk for investment portolios. Why don't you employ these scientifice quantiative methods?

Because we don't believe in them. They're generally constructed on the assumption of efficient market theory. That theory is in conflict with my theory of imperfect understanding and reflexivity. I think that those methods work 99 percent of the time, but they break down 1 percent of the time. I am more concerned with that 1 percent. I see a certain systematic risk that cannot be encapsulated in those assumptions that generally assume a continuous market. I am particularly interested in discontinuities and I find that those measurements are of little use to me.

p.10 -

How would you describe your particular style of investing?

My peculiarity is that I don't have a particular style of investing or, more exactly, I try to change my style to fit the conditions. If you look at the history of the Fund, it has changed its character many times. For the first ten years, it used practically no macro instruments. Afterwards, macro investing became the dominant theme. But more recently, we started investing in industrial assests. I would put it this way: I do not play according to a given set of rules; I look for changes in the rules of the game.

p.10-12 -

Ordinarily, people think of money managers as having a combination of imagination and analytical ability. If you broke down all the skills into just those two categories, which one would be your particular strength - imagaination or analytical ability?

I think my analytical abilities are rather deficient, but I do have a very strong critical faculty. I am not a professional security analyst. I would rather call myself an insecurity analyst.

That's a provocative statement. What do you mean by that?

I recognize that I may be wrong. This makes me insecure. My sense of insecurity keeps me alert, always ready to correct my errors. I do this on two levels. On the abstract level, I have turned the belief in my own fallibility into the cornerstone of an elaborate philosophy. On a personal level, I am a very critical person who looks for defects in myself as well as in others. But, being so critical, I am also quite forgiving. I couldn't recognize my mistakes if I couldn't forgive myself. To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes.

You have said about yourself that you recognize your mistakes more quickly than others. That sounds like a necessary trait in investing. What do you look for to see if you are wrong?

As I told you before, I work with investment hypotheses. I watch whether the actual course of events corresponds to my expectations. If not, I realize that I am on the wrong track.

But sometimes things get off the track for a short time and then get back on the track. How do you know which is the case? That's what takes talent.

When there is a discrepency between my expectations and the actual course of events, it doesn't mean that I dump the stock. I reexamine the thesis and try to establish what has gone wrong. I may adjust my thesis or I may find that there is some extraneous influence that has come into the picture. I may end up actually adding to my position rather than dumping it. But I certainly don't stay still and I don't ignore the discrepancy. I start a critical examination. And generally, I'm quite leery of changing my thesis to suit the changed circumstances, although I don't rule it out completely.

p.16-17 -

Okay, critical thinking is one important factor. What other things do you consider important?

The amazing thing about investing is that there are so many different ways of doing something. We can be decribed as momentum investors, but there are value investors who do extremely well. Value investors don't do so well in our shop, because they don't have anybody to talk to. I had a very interesting experience with P. C. Chatterjee, one of my investment advisors. His concept was to look at technology companies as asset-rich companies, where the customer was treated as an asset. If a company had a strong customer base, it could be worth a lot even though it had a lousy management and a lack of products. And he felt that with a little push, these values could be unlocked. It proved to be a valid concept. For instance, he bought a big position in Paradyne. I went to see the company with him and, when I learned about all the problems they had, I came out quite despondent, wondering why the hell we owned the stock, and how we were going to get out. Yet, within a few weeks, AT&T bought the company for double the price we paid. He was right about the value of a strong customer base, but his way of looking at companies didn't fit in with mine.

Let me give you another example: there are periods of choppy markets when my style of investing is worse than useless. I insist on formulating a thesis before I take a position. But it takes time to discover a rationale for a perceived trand in the market; and sometimes the market will reverse the trend just when I manage to formulate a theory justifying it. If it happens repeatedly, it can be devastating. I am good at riding the tide, but not the ripples of a swimming pool. There was a period, in the early 1980s, when there seemed to be no tide, only ripples. I found a commodity fund manager, Victor Niederhoffer, who had a system for riding the ripples. He was well grounded in random walk theory. He looked at markets as a casino where people act as gamblers and where their behavior can be understood by studying gamblers. For instance, gamblers behave differently on Mondays than on Fridays, differently in the morning than in the afternoon, and so on. He regularly made small amounts of money trading on that theory. I gave him money to manage, and he made a good return on it. There was a flaw in his approach, however. It is valid only in a trendless market. If there is a historical trend, a tide, it can overwhelm these little waves that are caused by gambling behavior and he can be very seriously hurt because he doesn't have a proper fail-safe mechanism. I mention him because his approach is diametrically opposed to mine and there are times when his approach is appropriate. I have learned to be very boardminded as to the right approach. I am willing to use different people employing different approaches as long as I can rely on their integrity.

p.44-45 -

We'll get to that [discussion of your philosophy] later; for now, I'm curious about when and how you got back into the business world.

In 1966, since I didn't know much about American securities, I wanted to find a way to educate myself. I set up a model account with $100,000 of the firm's money, divided it into 16 parts, and invested one or two units into any stock that I considered to especially attractive. I worte a short memo explaining the reasons why I bought each issue, and I followed up with monthly reports reviewing the portfolio and discussing developments within the portfolio. I also provided a monthly performance record. I used this model account as sales tool to develop business with institutional investors. This was a very successful format, because it put me in contact with the investment community. During the years when I had been writing my philosophy, I had lived in a vacuum. Now, I was able to test my investment ideas on potential investors. If I got a good response, I realized that I was onto a good idea; if I got a negative response, I had to seriously question whether I was on the right track. I got some very valuable feedback.

That doesn't sound like you. You don't usually let other people tell you whether you've got a good idea or not.

Testing your views is essential in operating in the financial markets. Let me give you one example: there was a company called American Seal-Cap. When I visited management, they had a wonderful story to tell. I bought the story. One of my potential customers called me and said this was a great story, but there was a catch to it: management was notorious for lying and the story they told me was untrue. That was useful information. It shows how valuable it is to get this kind of feedback.

One of my first major efforts was in the trucking industry. I put 4 of the model's 16 units into trucking stocks. That worked out very well and it gave the model account a pretty good performance. Then, based on the model portfolio, we established a small investment fund called First Eagle Fund. In the following year, 1969, we established another small fund with a capital of $4 million called the Double Eagle Fund. This was a hedge fund: it was allowed to sell short as well as go long, and it was also allowed to use leverage. Then, as the two funds began to grow, a potential conflict of interest arose. We were recommending stocks to our clients tat we were also buying for our own account. Even though we were disclosing all our purchases, it became an impossible situation, especially when it came to selling. I gave up the model portfolio, left Arnhold & S. Bleichroeder, and set up my own hedge fund in 1973.

p.57 -

You had a fear of complacency.

That's right. But I think that I underwent a serious change in my personality during that period. There was a large element of guilt and shame in my emotional makeup, but I worked through it. I had some sessions with a psychoanalyst. It was rather superficial in the sense that I was never on a couch and it was only once or twice a week. nevertheless, it was a very important process. I revealed my biases, and by bringing them into the open, I recognized that they made no sense and therefore I could dismiss them.

Once I had a stone in the salivary gland in my mouth, which was extremely painful. The doctor took it out in an operation, which was also very painful. The stone was a round, hard ball. I wanted to preserve it because of all the pain that it had caused me. In a few days, I looked at it and it had turned into dust. it was pure calcium, which becomes powder when it dires. That is what happened to my hang-ups. Somehow, they dissolved when they were brought to light.

p.214-215 -

What's the difference [between natural science and reflexive events]?

Natural science deals with events that occur independently of what anybody thinks about them; therefore, it can treat events as a succession of facts. When events have thinking particupants, the chain of causation does not lead directly from one set of facts to the next; insofar as the participants' thinking plays a role, it leads from facts to perceptions, from perceptions to decisions and from decisions to the next set of facts. There is also the direct link between one set of facts and the next which is charateristic of all natural phenomena. But the more circuitous link cannot be left out of account without introducing a distortion. The distortion is negligible when people's thinking is close to reality; it becomes significant when perception and reality are far apart.

Why should they be far apart?

because the cognitive and participating functions can interfere with each other. When they do, they introduce an element of uncertainty both into the participants' thinking and the actual state of affairs. It is amazing how far they can be out of sync.

This to too abstract for me. Can you give an example?

Take a simple case: falling in love. The other person's feelings towards you are greatly influenced by your own feelings and actions, except in those rare cases, like Dante and Beatrice, where one person's feelings do not reach the other. Does she love me; does she not? There is an element of uncertainty here that would be absent if it were a question of knowledge. But this is a question of interactions and the interplay of emotions can produce a wide range of outcomes, some of which are sustainable, others not. When you fall in love, strange things happen. It would be quite inappropriate to treat love as a matter of fact, which is independent of the participants' beliefs.

More to come...