- Structural debt issues in China and European fragility will limit global growth.
- Soros is overweight gold and short the S&P 500.
- He trimmed his U.S. stock portfolio by 37%.
George Soros is an Hungarian-born, 85-years young hedge fund manager and philanthropist famous for his daring investment bets.
He is most famous for ‘breaking the Bank of England’ in 1992 by shorting the pound. Interest rates in the UK were much higher than in Germany and with the pound overvalued, Soros borrowed heavily to short the pound and forced the UK to exit the European exchange rate mechanism. The total estimated profit for Soros was one billion pounds.
There is a lot that can be learned from Soros, and there are $24.7 billion reasons (Bloomberg Billionaires) we should at least follow what the guy is doing. What is even more impressive than the Bank of England play is his average return per year by his Quantum Fund. While he was active at the helm of his fund, Soros managed to achieve returns of 26.3% over a 40-year period.
Figure 1: Soros vs Buffet. Source: Hedge Fund.
Net of fees, a mere $1,000 dollars invested in the Quantum Fund would return $11.3 million after 40 years, not bad. Soros retired from active management in 2011 but now he is back and this article is going to elaborate on what is he doing.
Current Macro View
In May, Soros disclosed a 19 million share stake in the world’s largest gold producer, Barrick Gold (NYSE: ABX). We almost don’t need to mention that ABX is up 168% year-to-date, which again shows that Soros still has it, even at 85. In the meantime, he also cut his U.S. stock holdings by 37% in the first quarter of 2016.
Soros is basing his bearish moves on various global uncertainties. He is worried that China will not be able to manage an economic slowdown and that its increased debt levels are just postponing the inevitable as lending is mostly used to cover for bad debt. He compares the Chinese economy to the U.S. 2007-2008 economy fueled by debt. Currently $2.4 trillion worth of loans are estimated as risky by Bloomberg, as borrowers’ interest payments are higher than their earnings. This represents 23% of Chinese 2015 GDP.
Soros is also bearish on Europe and as he said that “Europe is in mortal danger” due to its refugee crisis, potential Brexit and Greece. The migration crisis is not such a hot topic currently as things have settled, but the problem is not solved and the situation remains fragile with more than 2 million Syrian refugees in Turkey. On top of that, the Brexit vote shows how fragile Europe is and how any economic destabilization could soon reignite the Greek issue as the problems in Greece were never solved, just postponed by giving Greece more loans.
It is interesting how Soros focuses more on the macro trends like the long term debt trend in China, and refugee and Greek issue in Europe, and not so much on day-to-day news about monetary policies or market movements.
A bet that might scare a lot of people that have investments in mutual funds or ETFs is that besides the 37% decrease in his stocks exposure, Soros also bought 2.1 million put options on the SPDR S&P 500 ETF and further increased that bet by buying 1 million call options of the SPDR Gold Trust ETF. Buying put and call options means that Soros expects the markets to move relatively soon in his direction.
(A put option is a contract that gives the buyer the right to sell 100 shares of an underlying stock at a predetermined price for a preset time period, while a call option is a contract that gives the buyer the right to buy 100 shares of an underlying equity at a predetermined price—the strike price—for a preset period of time.)
The current cost of put options expiring in January 2018 is 10% of the SPDR S&P 500 ETF. The maximum Soros can lose is his total investment while if the S&P 500 declines more than 10%, he is in profit. A 20% decline would give him a 100% return, while a 30% decline would give him a 200% return. Similar risks and returns ratios are in place for his Gold ETF call options bet.
Soros has already made wonderful returns on his gold bets and probably some small negative returns on his S&P 500 shorts but that is the way he plays his game. By looking at long term macro structured trends like debt levels, bad debts, inflation or deflation, he manages to approximately time the markets, and by daring to put a large stake of his portfolio in it, he manages to get extraordinary returns (ABX is his largest current position).
Of course, Soros is not always right. In 2000 Soros constantly preached the inevitable burst of the tech bubble but was caught on the wrong side of that trade as he wanted to make money both in the creation of a bubble, and in its bust. In the first 4 months of 2000 his fund was down 22%. Monday’s stock price surge is working against Soros but this shows that in order to make extra returns, an investor has to be willing to also take extra risks and weather unfriendly market moves.
For those who want to know more about Soros and his investment style, a great start is his book Alchemy of Finance which gives great financial insight and an elaboration of the reflexivity theory, but is a difficult read.