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Can George Soros’ Methods Be Replicated?

I received this comment on one of my recent posts. The George Soros question got me thinking about how interesting the different philosophies are. Soros had an incredible career, but is it possible to replicate his general strategy?

Here is the basic comment from the reader:

Your posts have given me a great deal of information. 

What is your opinion on George Soros’ theory of reflexivity? I was reading Seth Klarman’s Margin of Safety, and it mentioned how in rare times price will actually affect value of the underlying company. This actually made me fearful since then value investing wouldn’t work. One of his examples was a company in financial distress. If (the market) thinks it’s worthless the company will go insolvent because no one wants to buy the stock they’re selling or no one wants to give a loan to the company.

Even if the company is valuable… if the market doesn’t recognize it, management may take the market’s perception to heart and do actions that will eventually bring the market’s perception to reality.

Soros interests me since sometimes price does affect value, and his theory of reflexivity sort of correlates with value investing.

What do you think?

I added some thoughts, but here is my basic response: 

Thanks for the nice words. I appreciate you reading…

Soros built an incredible record. I’ve read his book but find his methods too abstract for my liking. Soros is a philosopher. I get the impression from reading his work that he desires more than anything else to be the smartest man in the room. I’m not trying to disparage him, this is just my opinion I got from reading his writing. I do think he is an incredibly smart guy, and he probably has difficulty explaining his ideas to the everyday person, and that’s probably why his writing comes off like that to me. (read: I’m not smart enough to keep up with his ideas!)

Reflexivity Goes into the Too-Hard Pile

I personally prefer much simpler ideas. Reflexivity is a way to think about the world. It has some merit I think… but it’s very difficult to replicate a method like Soros’. It’s not impossible, but very difficult. It’s an art form.

Plain vanilla value investing has some art as well, but it’s less abstract. It’s far easier to figure out how much a stream of cash flow is worth, or better yet, figure out how much the assets are worth that the company currently has on its balance sheet than trying to figure out the opinions of value that the majority of market participants are going to place on a particular asset class or group of stocks.

Value investing is about figuring out what something is worth and paying a lot less. Soros’ method is more focused on figuring out what other people think, and then trying to predict how they will react.

Keynes Beauty Contest

Keynes talked about the market being a beauty contest where the winner was determined not on beauty alone, but by who the majority of voters thought was most beautiful (or even the next derivative after that!)…

“It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.” – John Maynard Keynes, General Theory of Employment Interest and Money, 1936

This might be true in the short term, but in the long term, the market is not a “voting machine, it’s a weighing machine”. (Graham is easier for me to grasp than Keynes and Soros.)

With No Leverage, the Market’s Opinion Matters Not

Your comments about companies caring about the way people think about them has merit when it comes to leveraged institutions such as financials or other companies with lots of balance sheet risk. These companies could go bankrupt if there was a colossal run on the system (like 2008 or worse), but these events are rare and the way to defend against them is to avoid taking on leverage risk. Companies without debt (or low amounts of debt) don’t have to worry about how the market thinks about them.

So I respect Soros’ results, certainly they are tough to beat… but even tougher to replicate. Buying cheap stocks in the tradition of Schloss or Graham is much easier for an investor like me to replicate. I have the discipline and the emotional mindset to do so, and it doesn’t take a genius to do it.

I usually ask myself these questions when considering a new idea:

  1. Do I understand how the business makes money?
  2. Is it cheap?
  3. What are the insiders doing? Any catalysts?
  4. What are the risks?
  5. What’s the upside?

I try to find easy to understand situations where I can buy assets or earnings cheap. Doing that over and over again over time tends to work very well.

Thanks again for your thoughts. Always fun to consider different ideas. Thanks for reading…

11 thoughts on “Can George Soros’ Methods Be Replicated?

  1. There is an interesting thread on forex factory about George Soros entitled:
    ”How George soros made his billions”

    The general consensus is that George Soros theory of reflexivity isn’t really a usable or function theory at all. It seems that no one can follow it, and his son even went as far as saying that it is a load of rubbish.

    The guys over there believe that Soros made his fortune by great at risk management, and knowing when he wrong… there are a few select quotes to back that up.

  2. John, thanks for your post.

    Soros’s theory still has merit. Feedback loops make sense, events influence mind and vice versa. I looked in to that thread and it made me think that Soros probably has his theory deeply imprinted in his brain. The guy has been striving to be a philosopher for decades so surely that had an impact on him.

    I recently read F Wall Street by Joe completely. Made me want to stick with the value investing strategy since it’s so simple. Although I wonder how to act differently then others..

    Soros primarily uses psychology to invest, (ex: studying other people’s behavior)

    On an unrelated note: What do you think of investing in cheap community bank stocks?

    1. Thanks for reading… I like community banks as a business. They are commodities for the most part, but some are nice little businesses with good managers. They of course have to be analyzed, but some are interesting. I have a list of a bunch of them that I put together with prices that I would consider them at. I own a couple of them now, and am in the process of building a basket of them. I put them in the quantitatively cheap asset category.

  3. hi,excellent article! what i think about this topic is that everyone has their own investing habit which fits them. many people have their own ideas of what is value investing. many fund managers think it is buying great business at reasonable price. but i think it is not enough for passive investors like me. buying depressed stocks which can come back is ture value investing for me.

  4. Having read Alchemy of Finance, the book in which Soros espoused his “Theory of ReflexitibtyMy impression from my first read of Soros’s Alchemy of Finance was that he used his Theory of Reflexivity has a framework to generate Market Themes/Hypothesis – the way a given market’s price would evolve over a period or due to some ongoing/forthcoming event which (could) impacts its price. He then went ahead to test this Hypothesis by taking a position. The key here is that he views his reasons for trading as “hypothesis” not “fact” as someone trading/investing based on some dogma of market behaviour such has value investing or rational expectations would, so he’ll readily change his mind should his hypothesis fail – cut his position and sometimes even take up the opposite side i.e. go from Long to Short. In the Real Time experiment that he uses to test the Theory in the book, he made more money discarding his original hypothesis than following it.
    So to a certain extent it’s not an investment decision making tool the way value investing is. Its more a way of looking at how things – including markets, work without assuming that’s the way it is going to work. The mere process of looking at how things work is empowering enough to give you necessary information to make calls. Should the thing not work out as you called it, you could potentially gain an understanding as to what was missing in your hypothesis, incorporate this and generate another hypothesis and test it.
    To replicate this approach is about adopting this mind set. While this comes through in the book itself, also reading up on Karl Popper – whose ideas influenced Soros Theory and Philosophy, will allow you better understand the process Soros says he uses.

  5. My opinion is that some people like Jim Cramer’s hedge fund (+24% annualized), or Steve Cohen can use all sorts of dangerous investment practices and still beat the market, just because they are super obsessed with the market, it’s their money on the line, they are taking on various risks in excess of the market, and there is a survivorship bias (all the Jim Cramer’s who went bankrupt aren’t publicized). I also place George Soros in that basket.

    For Soros in particular I’d also argue that the only technical analysis method that is believed to work in academic finance — momentum — may have played a large role. Generally academic finance has shown that technical analysis doesn’t work, except momentum. As a review, momentum tends to persist at the 1 year mark, and reverse at the 2 to 5 year mark. When Soros discussed his trading it seemed that a lot of the plays were based on momentum and leverage. I could see that in ordinary portfolios momentum adds a small edge, but when you have Soros who’s super obsessed with trends, and not afraid to use tons of leverage, then sure it could add up to very substantial returns over his career (but with also higher bankruptcy risk).

    I believe value investors can much more safely incorporate momentum by position sizing, which can add a slight edge: (1) Scale in or out of positions more slowly when “fighting” price momentum; or (2) Scale in or out of positions more slowly if fighting momentum trends in the financials of operating company.

    It’s a bit odd to combine the “madness of crowds” momentum measure with Ben Graham’s insight of the value investor being contrary to the short term voting machine of the market. However, I think it’s actually reasonable if we reflect that some of the best value investing performance has been delivered by small funds which did time or event arbitrage around the mistakes of larger market players. If we believe that these large players are emotional and cannot put on their positions instantaneously, then money will slosh in and out of stocks according to some trends. While the value investor at heart must be against emotional trends, he/she can scale in or out cautiously in recognition that these trends tend to persist in the short term.

    1. It’s an interesting take… I’ve read the research on momentum and according to the tests, it does appear to work. In my opinion, those types of strategies are very difficult to implement and are more speculative. It’s true, there are outstanding speculators, and Soros and Jim Rogers were two examples of great speculators. But I think it’s a completely different skill set and it involves more analysis of “the other market participants”. You’re participating in Keynes beauty contest, which is a much more difficult game in my opinion than simply picking cheap stocks… but some have done well with the beauty contest.

      1. Yes, I also find those strategies way too hard to understand. With value investing you can get positive expected value bets, which depend on an operating company, and rely on empirical facts and statistics. The only question is whether one can get enough of a positive expected value to justify one’s time cost / client fees in doing so. If not, do value indexing, or Magic Formula, or something similar, very simple.

        With short term speculation, I suppose one could get positive expected values if one can make valid assumptions about the emotional state of many other market participants, or the quant approach of trying to model all those emotions with intricate formulas. But these could hardly be said to be an inherently stable or robust source of positive expected values. One reason is that a slight positive expected value of some short term emotional trend could be fighting a long term negative expected value due to being “on the wrong side of value.” For example, momentum may add a little value, but since it only adds a little value, it’s not like it’s safe to construct bets that are “with momentum and against value” (that didn’t work out so well in the Dot com bubble).

        It is therefore something of a mystery to me why so many would seek out “being gamblers” (situations which in general have negative expected value) rather than “being the casino” (positive expected value). I was discussing this with an owner of a financial company and his sales manager at a party recently that my wife went to. The owner said rather bluntly, “There are two types of people in the world, those who F and those who get F’ed. Make sure you know which side you are on. And always take the money.”

        The sales manager had a more nuanced view that people are motivated by sex, status, and comparisons to their neighbors, so people are very emotionally driven social creatures. Thus people don’t look at it in terms of “here’s a negative expected value bet.” They say, “well my neighbor already took that bet in a rising real estate market, and it paid off, and they now have two houses!” Or, “I could put in only $20 and potentially make enough to buy a nice car, $20 is psychologically almost no loss, but the nice car would be great to have.”

        This speculative behavior is something of a mystery to me but I like to try and understand it so I can have a better chance of identifying (and therefore profiting) off of pockets of it. I sometimes briefly feel these speculative emotions register in my mind but then I just start mentally calculating probabilities, rates, expected values, etc because those seem far more reliable to me than some “emotional whim”.

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