Gearge Soros

Investing Structure

We position the fund to take advantage of larger trends – we call this marco-investing – and then, within those larger trends we also pick stocks and stock groups

Let’s say we use our money to buy stocks. We pay 50 percent in cash and we borrow the other 50%. Against bonds we borrow a lot more. For $1,000 we can buy at least $50,000 worth of long-term bonds. We may also sell stocks or bonds short in the hope of buying them back later cheaper. Or we take positions – long or short – in currencies or index futures. The various positions reinforce each other to create this three-dimensional structure of risks and profit opportunities. Usually two days – one up day, and one down day – are sufficient to tell us how the fund is positioned.

Buying Options

When you buy options, you’re paying the professionals a hefty premium for providing you with a leverage that we can create cheaper ourselves by borrowing against our securities.

Investment Theory

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% of the time, but they break down 1% of the time. I am more concerned with that 1%.

We are willing to invest our capital along three axes: we have stock exposure, we have interest-rate exposure and we have currency exposure.

Occasionally, there is a fourth axis because we do from time to time take positions in commodities.

Our understanding of the world in which we live is imperfect. The situations we need to understand in order to reach our decisions are usually affected by those decisions. There is an innate divergence between the expectations of the people taking part in the events and the actual outcome of the events. Sometimes the divergence is so small that it can be disregarded, but at other times it is so large that it becomes an important factor in determining the course of events. This is not an easy idea to communicate.

“Imperfect understanding”

Classic economic theory assumes that market participants act on the basis of perfect knowledge. That assumption is false. The participants perceptions influence the market in which they participate, but the market action also influences the participant’s perceptions.

Using Leverage

Managers of bond funds, if they have a positive view on interest rates, can lengthen the maturity of their portfolio to at most, 15 years. When they have a negative view, they can keep the average maturity short. We have a much greater freedom to manoeuvre. When we are bearish, we sell short; when we are bullish, we don’t have to buy long maturities; we can buy short maturities and use a lot of leverage.

Introduction

Thinking is part of the reality that people have to think about.

The belief that financial markets tend towards equilibrium and it is only government interference that prevents them from assuring a best allocation of resources……is both false and misleading.

The Concept of Reflexivity

The concept of reflexivity is very simple. In situations that have thinking participants, there is a two-way interaction between the participant’s thinking and the situation in which they participate.

Reflexivity renders participants understanding imperfect and ensures their actions will have unintended consequences.

Reflexivity and Economic Theory

The efficient market hypothesis claims that market prices fully reflect all the extant information. The closely related rational expectations theory holds that, in the absence of exogenous shocks, financial markets tend towards an equilibrium that accurately reflects the participants’ expectations. Together, these theories support the belief that financial markets, left to their own devices, assure the optimal allocation of resources.

The Human Uncertainty Principle

If perfect understanding were possible, there would be no room for human creativity.

Market Forces

I look for conditions of disequilibrium.

To others, being wrong is a source of shame; to me, recognising my mistakes is a source of pride. Once we realise that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes.

It hurts me to lose money and it gives me pleasure to win.

Trend is your friend most of the way; tend followers only get hurt at inflection points, where the trend changes. Most of the time I am a trend follower, but all of the time I am aware that I am a member of a herd and I am on the look out for inflection points.

There is nothing more self-destructive than denying your feelings. Once you are aware of your feelings you may not feel the need to show them. But sometimes, especially when you are under great strain, the need to hide it may make the strain intolerable. I remember an occasion, early in my career when I was practically wiped out in my personal account, yet I had to carry on in my job as if there was nothing wrong. The strain was unbearable. I could hardly bring myself to go back to the office after lunch. That is why I encourage my associates to share their problems.

Risk Taking

Risk taking is painful. Either you are willing to bear the pain yourself or you try to pass it on to others. Anyone who is in a risk taking business but cannot face the consequences is no good.

Going to the brink is something else – it serves a purpose. There is nothing like danger to focus the mind, and I do need the excitement connected with taking risks in order to think clearly. It is an essential part of my thinking ability. Risk taking is, to me, an essential ingredient in thinking clearly.

When you are a serious risk taker, you need to be disciplined. The discipline that I used was a profound sense of insecurity, which helped to alert me to problems before they got out of hand.

Success

Once you take your success for granted, you let down your guard.

I refuse to remain the slave of my business.